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What Shape Will the Recession Take?

By: Steve Johnson

6/11/2008 - 178 Comments

There are three shapes that the recession could take V, U or L depending on how the economy recovers.

Right now every economist seems to have a different opinion. Some say we will have a short recession like the last one after 9/11, while some say it could take several years and some say the recession will last for decades.

To help separate these three types of recessions, I thought I would use letters to give them a visual representation.

The V-Shaped Recession

The V-shape recession is a recession that goes down sharply and then right back up just as sharply.  An example would be the 2001 recession which lasted only 8 months.

This recession was primarily brought about by the 9/11 terroristic attacks on New York that created a wave a fear to sweep the nation, leading to a large sell off of the stock market.  Businesses than began pulling back, reducing supplies and hiring because they feared the economy was slowing down very quickly.

But, after a few months when everyone began to realize that the underlining fundamentals of the economy were still strong. The dollar was strong, interest rates were low, inflation was low and the global economy was still growing.  The stock market shot back up and businesses quickly begin hiring to increase production once again.  The Federal Reverse lowered the interest rates to flood the market with money and the nation went to war to seek and destroy the enemy that attacked us.  Fear was subdued, as hope took its place.

As an investor, all you needed to do was wait for the storms to pass and the value of your investments returned to pre-recession values.

The current economic downturn that started in August 2007 is getting close to the one year market as we approach August 2008.  It is becoming apparent that the current downturn (although not officially labeled a recession) is going to last longer than a V-shaped recession, which many economist including Allan Greenspan had initially suggested.

The U-Shaped Recession

The U-shape recession is a recession that goes down slowly and then stays there for a period of time (maybe a few years) before slowly recovering. A U-shaped recession could last anywhere from 2-10 years.  An example would be the 70’s recession which lasted about 8 years.

The 70’s recession was plagued with high inflation, unemployment and high interest rates.  From 71 to about 78, President Nixon and the Federal Reserve tried a lot of different tricks, including wage freezes, price controls and gas rationing in an attempt to control inflation and help the people that were suffering from it.  It wasn’t until Paul Volcker began increasing interest rates in 79 under President Carter, that inflation flattened out and then started to decline.  Inflation peaked at 13.5% in 1981 and was successfully lowered to 3.2% by 1983. This recession is best known for its ‘stagflation’, which is an economy with low growth and high inflation.

The economic numbers of the last few weeks are pointing to higher inflation and higher unemployment, which points to a U-shaped recession that could last for several years.  Last week the unemployment rate shot up to 5.5%, with a 5-month decline that has taken some 324,000 jobs out of the market.  Inflation is also on the rise, reaching 4.1% last month, which is 2.1% higher than the federal interest rate at 2%.  Inflation is beginning to affect everyone as oil and food prices are spiking to new highs.  The low interest rate also continues to weaken the dollar, which is encouraging money to flow out of the country and into foreign markets with better returns. 

As an investor, you can no longer just wait for the market to return, because many sectors of the economy may never recover at all.  The financial services, residential construction, retail and auto industries are in a tailspin. The current economic downturn that started in August 2007 with little sign of the bottom is starting to look like a U-shape recession.

The politicians cannot really do anything to stop the decline, although they will try as Nixon did in the 70’s.  They will talk and talk about their new ideas and stimulus packages until they are blue in the face, offering many people hope.  Yet oil prices are likely to stay elevated and the dollar is likely to continue to weaken, while inflation continues to climb.  The best thing the Federal Reserve could do to fight inflation would be to move the interest rates to 8% - to match the realistic inflation, but I highly doubt this is going to happen.

The L-Shaped Recession

The L-shape recession is a recession that goes down and then stays there for a long period of time without a recovery. An L-shaped recession could last 20 years.  An example would be the recession suffered by Japan in the 90’s, which they are still recovering from 25 years later.

This is the nightmare that nobody even wants to talk about. The Japan recession started when their economy was flying high and looked to be the next economic superpower.  And it all started with a housing market meltdown which a few years later resulted in a stock market meltdown.  The combination brought their economy to its knees.

The parallels of the housing market crash and the teetering stock market are staggering - especially if you add the other fundamental weaknesses plaguing our economy.  The current economy downturn doesn’t have a shinny spot anywhere.  America just maybe headed for an L-shaped recession, which will drastically reduce the average standard of living.  Last week the nation’s net worth declined for a second straight month, declining by $1.7 trillion dollars.

As an investor, you have to get out of the country and out of dollars.  If the government is going to let inflation destroy the value of the dollar, then you have to get your money out of dollars.  This is very hard to accept as an America who believes in America and its ability to rebuild and adjust to any difficulty.  The only way around this is to only invest in America companies that produce products for the rest of the world, because companies that produce products for America consumers are headed for bankruptcy.

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