What Can History Teach Us About Recessions?
- Is the U.S. on the verge of a recession? Economist David Rosenberg, who has 40 years of experience in the field, says yes.
- Our post-pandemic milieu and the war in Ukraine make comparisons to the Roaring Twenties (the 1920s, that is). Ongoing inflation suggests our era might look like the 1970s.
- David says neither of these comparisons are apt and that 2023 is much more like the late 1980s/early 1990s recession.
It's time to grab your fiscal umbrellas because the rain clouds of recession are gathering overhead.
That’s the forecast from David Rosenberg, founder and president of Rosenberg Research, an economic and financial market consulting firm he established in 2020 after years serving as chief economist for both Gluskin, Sheff and Associates and Merrill Lynch.
“The future is going to be one of fiscal restraint,” says David. “I think it will be global and it will be a necessity. Because coming out of this interest rate shock, you’re seeing debt service costs rise. That extra blade that cuts into program spending [is] going to have brutal implications for fiscal finances in the future.”
He calls Rosenberg Research a “top-down macro shop” that’s “very model-driven.” It’s focused on the causes and effects of finance, like the influences on interest rates, valuations and the overall (current) business cycle. Thousands of retail and institutional clients in dozens of countries depend on Rosenberg Research analysis for market insights.
But because David has 40 years of experience, “there’s a lot of intuition,” he says. “At my heart, I have a strong knowledge of economic and financial history. [It’s like] the old Mark Twain refrain about patterns — they might not repeat, but they certainly rhyme.”
Anyone without a strong sense of history has little chance of working at Rosenberg Research, he adds. “I want quant, but I want [people with] knowledge of history. … So it’s always important to know, from [a historical] perspective, what’s similar and what’s different.”
The bottom line? “I put a historical perspective on our quantitative analysis,” says David. “And quite more often than not, if you get the call right on inflation and you get the call right on interest rates, you get the call right on growth.”
David joined my colleague Alan Dunne on a Global Macro edition of Top Traders Unplugged to discuss the global macro outlook, including the parallels between the current economic cycle and past cycles, as well as the key differences that differentiate our current times from the 1920s, ’70s and ’80s.
Will the early- to mid-2020s ‘end in tears’?
After the pandemic, we heard media pundits speculate that we were about to enter a new “Roaring ’20s.” And it’s impossible to ignore the parallels between now and the 1970s, as well as parallels between Jay Powell and Paul Volcker. We might even draw parallels between now and the dot-com implosion of 2000. Are we at the end of a tech boom now and should we anticipate a possible bust?
Alan asks David to weigh in on which historical analogs are relevant (and useful) for us in 2023.
David says our current environment is “eerily similar to the late 1980s” because of the leveraged boom in commercial real estate that infected the savings and loan industry, which went through several years of rapid consolidation. The result: a credit crunch and a “three-quarter recession,” he explains. “The Fed took the funds rate from 9.78% down to 3%. Even after the recession, we had two to three years of very subdued disinflationary recovery on our hands.”
Subprime residential mortgages catalyzed the last (’08-’09) recession, but today, commercial real estate is once again the “problem child,” like it was in the late ’80s.
“We are seeing problems where most commercial real estate is situated on the regional banks, and we’re finding out the small banks aren’t so small anymore. It had that sort of flavor. Because the one thing you always know is — whether we have a recession or not — Fed tightening cycles always end in tears.”
Whether we have a recession or not, an economic downturn “usually pops whatever bubble, or whatever excesses there were, from the previous period of excessive accommodation. So [today’s climate] bears a lot of resemblance to the late 1980s in that regard.”
Rock and rolling recessions
The Roaring 1920s were such a culturally rich time — it can be tempting to make parallels with the 2020s. But David dismisses that “out of hand.”
He points out that Ed Yardeni, who spoke at John Mauldin’s annual conference, “has moved from the Roaring ’20s to ‘rolling recessions’” when characterizing our own era — to which David says, “I like Rolling Rock because at least you can drink that.”
The most apt comparisons between the 1920s and today are geopolitical and cultural: the war shock after World War I and the health shock after the Spanish flu. Now, we’re dealing with the fallout from the war in Ukraine and the post-COVID hangover.
“But the 1920s was a radically different time period, with a much younger and much more vibrant population than we have today,” David notes. “When you look at the median age of the population and the dependency ratio, it’s vastly different. We came into the 1920s with very low levels of public and private debt, believe it or not, even after fighting the [first world] war.”
However, our balance sheets are “strained” right now, “especially in the public sector, but also in other parts of the private economy,” he adds. “So we have a different quality of the balance sheet and we have different demographics.”
David says that because of better fiscal positions during the 1920s, tax rates declined throughout the decade.
“Does anybody believe that tax rates are going to be coming down [now]?” he asks.
“The one thing we know is that the levels of debt are unsustainable. And fiscal restraint is going to be the order of the day going forward. That wasn’t the case [in the 1920s] because the government balance sheet was in much better shape. There are just too many differences to draw a comparison.”
Technology now and then: ‘AI vs. transistor radio’
A lot of people talk about how our current milieu is similar to that of the 1970s — “and of course, that's been reinforced by the fact that Jay Powell, at every opportunity, has compared himself to Paul Volcker,” says David. “But Volcker inherited a 12-year institutionalized inflationary situation.”
Back then, the economy was “much more sclerotic and much more regulated,” he explains. “Technology back then was not AI. It was a transistor radio. I mean, Microsoft didn't go public until 1986.”
How does that compare to today? Well, we know where this inflation came from, David points out.
“It came from the policy response to the pandemic. I guess I would be willing, as an economic historian, to say that [our recent] inflation was transitory. It lasted 18 months. I don’t think anybody predicted, including me, that it was going to go to 9% last June, but we’ve almost cut that in half [by] right now, and we’re making progress.”
For an economist, inflation is like a “race between watching paint dry and grass grow,” he says. “It’s a process.”
Demand dynamics and supply shocks
While everybody says inflation isn’t falling fast enough, it has been falling just as fast in the past nine months as it did in the comparable period of the early 1980s under Paul Volcker.
“The makeup of the economy … comes down to what’s the same and what’s different,” David says. “The 1970s, again, had a much different demographic backdrop. [At the beginning of the decade, most] … of the Boomers were in their 20s. [Now], they’re heading into [or already are in] their 70s.”
Fifty years ago, we had a “different savings and spending dynamic with [increasing] household formation, which was going nuts in the 1970s,” he adds. “That was demand inflation.”
Compounding matters, OPEC raised world oil prices for seven years out of the decade. The oil price increased tenfold, from $3.50 at the time of the embargo in ’73 to $39 in 1979. That would trigger “massive inflation bolts, no matter what,” David notes.
Now, some experts predict that oil prices could rise to $800 a barrel, which is an inflation shock all its own. Our recent shock factors (the COVID-19 pandemic and the Russia-Ukraine war) led to supply constraints from multiple directions.
Is there a wolf at the door?
“It’s a natural inclination to view fiscal policy in the future as being one of restraint, not stimulus,” says David. “Unfortunately … Trump unnecessarily provided a trillion-dollar tax cut in 2018 at a time of full employment. How crazy is that? And then we had stimulus checks for all when we already had opened the economy. But I think that era of fiscal recklessness is over and we’re going to go through a prolonged period of … fiscal austerity.”
David knows that one of the risks to making predictions about an impending fiscal crisis is that if he’s wrong this time, people might see him as “the boy who cried wolf.”
“But just remember this,” he warns. “In that story, the wolf shows up.”
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.
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