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Understanding the red flags of recession

From the inversion of the yield curve, losses in the stock market, a trade war with China, Brexit to a looming recession, the past few news cycles have been inundated by constant talk of economic red flags that might have even made it to your Twitter feed. But what do these actually mean, and will they affect you?

Recession has been a hot talking point in American and global economics recently. But economics jargon is a huge barrier to entry, not to mention the fact that predicting, or even just understanding, what happens and why is exceedingly difficult — sometimes even for economists.

So, what is going on and why should you be interested?

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Red Flags at Home

Since the Great Recession in 2008, the U.S. economy has seen an unparalleled period of growth. It’s been growing for a full decade — the longest continuous period of economic growth in American history. But, recently, there have been a few red flags that things may be slowing down.

The most troubling sign of recession is the inversion of the bond yield curve. And before the yield curve can be explained, you have to understand how bonds work — boring, but necessary.

“Treasury bonds are ways for the Treasury of the United States to borrow money when spending is greater than tax revenues,” Bruce Seaman, professor of economics at Georgia State, said. “[Bonds] are very safe investments, and they are an important tool of the Federal Reserve Bank to influence the economy through monetary policy.”

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Basically, anyone from the average citizen to the filthy rich can loan money to the U.S. government when it is running on a deficit. Because the bonds are backed by the full faith and credit of the government, they are usually low risk and low reward.

When the Fed buys bonds, interest rates go down, the price of the bonds goes up and so does the amount of money in circulation; the opposite applies when bonds are sold. Bonds can vary in amount, how much money you loan the government, and in time to mature, when the government has to return your money plus interest.

The Fed sells and buys bonds to influence the economy directly through monetary policy or manipulating the money supply in the country. 

So here’s the problem: The yield curve on government bonds just inverted. This means that an investor’s return on a shorter-term bond, like a two-year bond, is now greater than the return on a long-term bond, a bond that takes a decade or more to mature.

This may seem like nothing, but keep in mind that traditionally, the inversion of the yield curve is strongly correlated with a coming recession. An inverse in the curve has preceded the last seven recessions — usually around 15 months in advance, according to Seaman.

However, Seaman notes that “an inverted yield curve is more of a red flag than an inevitable sign of future recession.” In order to understand the true probability of a coming recession, you have to understand what the Fed is doing to correct the yield curve and all other factors impacting the national and global economy at that time, which is tough to predict accurately.

Currently, the Fed is taking the necessary steps on their end to correct the yield curve, by reducing interest rates on short-term bonds so that they are less profitable than long-term bonds — righting the yield curve.

 

Complications Abroad: The Trade War

As if this hasn’t been complicated enough already, it gets worse with the global economy.

The American economy is interdependent with the rest of the world’s economy, which means that interactions abroad can impact us just as much as conditions at home.

Seaman gave a brief list of the factors currently impacting the global state of the economy, including the U.K.’s departure from the European Union, commonly known as Brexit, weakness in the German economy and another debt and currency crisis in Argentina.

Also, the U.S. and China have gone through a few rounds of increasing tariffs with one another. Just over a week ago, President Trump increased tariffs on $112 billon of Chinese imports.

“[There are] enormous uncertainties of the ‘trade war’ between the U.S. and China — economists do not share any optimistic views about trade wars being easy to win,” he said.

A tariff is a tax on imported or exported goods. Using them is a way for states to regulate the price and amount of goods coming in from other countries. Historically, tariffs have been used to protect domestic industry from competition abroad or even just as a means of additional income for the state.

“[The trade war] is a very dangerous series of developments, and most economists are not impressed with the way this challenge is being handled by U.S. policymakers,” Seaman said. “Historically, trade wars have had very negative effects on the global economy, including the Great Depression of the 1930s.”

But how much is a trade war with China really bound to affect the current state of global economics?

According to The Wall Street Journal, tariffs are “putting upward pressure on costs for multinational companies, forcing them to look for ways to offset it.”

Essentially, it’s getting harder for businesses to work with China at a reasonable cost because of the tariffs on Chinese goods, forcing them to spend time and money trying to move industry out of China and lowering the rate of business confidence, a measure of how likely businesses are to spend money and stimulate the economy, in the process.

At the August 28 economic forecasting conference at Georgia State, Michael Drury, the chief economist for an international commodity trading company, called the new rounds of tariffs on China an “own goal.”

Drury explained that the impact of tariffs placed on Chinese goods will be felt by hardest the consumer. China will just “raise the price of the good by whatever the tariff rate is and send it along,” and U.S. consumers don’t have a choice because most of these products are manufactured in China.

An increase in the price of consumer goods has the potential to slow the economy down because the more a good costs, the less disposable income a consumer will have available to put back into the economy.

In short, the trade war has the potential to slow the global economy because of rising prices on consumer goods and a decrease in business confidence — potentially pushing the global economy further towards recession.

 

How a Recession Could Impact Students

Here’s the good news: Seaman said that even given the current warning signs, a recession is unlikely and if any recession were to occur, it is unlikely to be lengthy or severe.

However, in the event of a recession, he sees the impact being the greatest for graduating students.

“An alarming prospect is that students who first enter labor markets, when those markets are weak, have often had a hard time catching up and often suffer long-term lower earnings prospects in contrast to students who first enter the full-time labor force when the economy is strong,” Seaman said. “Such negative effects have, at times, lasted primarily five years after first entering the workforce, and then dissipated over time, but there is a risk of such negative ‘scarring effects’ lasting much longer.”

He also noted that this can impact student debt.

If there is a recession, Seaman recommends restructuring any student loans you have to be paid as a percentage of your earnings. This helps ensure that debt payments don’t overwhelm you if you’re earning less than anticipated.

Additionally, Seaman noted that many students choose not to go into the workforce at all if their graduation lines up with a period of recession. He said that applicants for graduate school go up during a recession and students choose to further their education and avoid the income-related risk of entering the workforce.

For students who are not set to graduate in the near future, the greatest economic impact of a recession will be on their side jobs. It’ll be harder to find work to support expenses while still in school.

However, a recession is unlikely to affect the price of tuition at Georgia State. And, even though the HOPE Scholarship is funded by lottery proceeds, which are likely to fall during a recession, “the HOPE Scholarship program is generally protected,” according to Seaman.

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