What Is Recession And How Does It Affect You?

Risevest What is a Recession and How Does It Affect You
Risevest What is Recession and How Does It Affect You

In the simplest of terms, a recession signifies moving backwards, the opposite of an advancement. Under normal conditions, we all would like to advance/grow in our endeavours. 

For an economy, growth means an increase in the value of services and goods produced — Gross Domestic Product (GDP). While economic growth means the price of goods and services will steadily become more expensive over time, for most people, it is a good thing. 

As the economy grows, companies make more money and can afford to pay current employees higher salaries, hire more people, thus creating jobs, and give shareholders more returns. This gives everybody more money to spend and continues the cycle of growth.

Economies generally grow most of the time. But sometimes, the value of goods and services in a country falls. An economic recession is when a nation’s GDP falls for two consecutive quarters. The US National Bureau of Research (NBR) defines it as a significant decline in economic activity spread across the economy.

In numerical terms, a recession would be if the GDP for the 1st quarter of 2022 was 1000, the 2nd quarter GDP was 900, and that of the 3rd quarter was 800. Experts consider recessions as an unavoidable part of the economic cycle. 

What causes recession?

There are several causes of recession. We will focus on the three likely causes of the impending recession the world currently faces.

A sudden economic shock

This means a serious problem that no one could have reasonably foreseen. A good example of this would be the global lockdown caused by COVID-19. The global shutdown caused factories, businesses etc., to close down, creating a huge shock to many economies.

Too much inflation

Inflation is the consistent and general increase in the prices of goods and services. Inflation is an essential part of economic growth. We need the price of goods and services to increase, so companies make more money, create jobs, create value for shareholders, pay higher taxes to governments etc.

Like many other things, inflation is good, but too much inflation is bad. Central banks generally set their inflation targets. In developed countries like the US and UK, the Central bank aims to achieve an average inflation rate of 2%.

When countries begin to see too much inflation, as we’ve seen all over the world this year, the price of goods rises so fast that the cash available to citizens cannot keep up. This is what causes a recession.

Excessive Debt

Many countries borrow to finance the difference between their expected revenue and budgeted expenses. However, when countries take on too much debt that they can’t afford to repay, this can lead to recession.

When countries can’t afford to repay their debt, they default. This means those who lent money to the government, e.g. large companies, banks etc., no longer have that cash to spend, invest, or in the case of banks, to lend to others.

When banks don’t have cash, they cannot lend to companies who need the money to grow their business and improve GDP. This causes GDP to fall and creates a recession.

Fun Fact: Global debt stood at $300 trillion as of 2021, about 356% of global GDP. For every $1 of goods/services produced, we borrowed $3.56. 

How does a recession affect you?

Business

The problem starts when sales and profits start declining. To cut costs, businesses stop hiring, stop buying new equipment and pause all development of new products.

Other businesses that supply those large businesses with equipment, raw materials and other services they require will see their revenues fall. To increase revenue, companies might reduce the quantity and quality of their products to maintain the same price. 

There are many examples in Nigeria of packaged products now having more air than content. If any of these companies have too much debt and cannot pay back with the revenue they have left behind, they might have to file for bankruptcy.

The government tries to support businesses during this challenging time, as we saw in countries like the US and UK during the first COVID lockdown. They offered loan programs to businesses of different sizes and in badly affected industries.

However, these loans are not always enough and sometimes they don’t come in time. Thus, the damage is probably already done before the loans come along.

Employment

Unemployment levels generally rise during recessions as companies see their profits and revenue shrink and have to reduce expenses to stay afloat. This causes many companies to have mass layoffs leaving many unemployed and those left behind having to do more work for the same or even less pay, creating more stress for them.

Those who are now without jobs find it difficult to get jobs because most companies have stopped hiring, so they too are under stress to earn money to meet their needs. This forces them to start businesses or turn to crime to survive.

Investment

Declining revenues and profits cause share prices to fall and companies to either reduce or completely stop paying dividends. The loss of their jobs or reduction in earnings will force some investors to sell their investments even if it’s at a loss to get cash further, causing companies’ share prices to fall.

In countries where people can take mortgages (loans to buy houses), a fall or loss in income can make borrowers unable to make their mortgage payments and make them lose all the money they have paid in the past towards their home in a foreclosure.

Borrowing

Borrowing becomes more difficult during recessions. As more people and companies cannot pay their bills, lenders make it more difficult to get loans. They increase interest rates and the  requirements individuals and businesses need to get loans.

Health

Many studies found that suicide and mental illnesses increase in recessions. One study found that death rates were higher for people who lost their jobs even 20 years after the job loss.

However, some researchers have found that recessions might actually be good for some people’s health. One group of researchers found that death rates during recessions were lower than rates recorded during economic booms.

Another group of researchers found that during recessions, the reduced economic activity reduced air pollution, which reduces diseases caused and worsened by air pollution. They also found that being unemployed reduced workplace and road accidents.

Researchers also found that the fall in personal income forced more people to reduce alcohol and cigarette consumption, reducing diseases linked to them. Another study found that reduced income means fewer people travel, thus slowing down the spread of viral diseases.

What can you do to prepare and protect yourself before a recession

Have an Emergency fund

An emergency fund is 3-6 months of your monthly expenses in a low-risk vehicle that you can quickly convert to cash at little to no cost. For example, if you spend ₦100,000 on average every month between housing, food, entertainment etc., your emergency fund would be ₦300,000 to ₦600,000. 

Ideally, you should put your emergency fund in a savings account that gives you some interest, so you aren’t losing too much to inflation. You don’t want your funds in any investment vehicle, so you don’t run the risk of losing money if there’s an economic downturn.

No rule says your emergency fund must stop at six months. If you can afford to have up to 1 year of expenses stored up, that’d give you even more legroom if something affects your primary source of income. 

However, experts generally recommend 3-6 months, so you have something for emergencies but not too much money tied down and not working for you. This advice goes for individuals and businesses alike.

Avoid Short Term Risky Investments

If an investment already has a low chance of survival during normal periods, it is even more likely to crash during a recession. Investments that are risky during regular periods would be extra risky during recessions.

You should avoid risky investments altogether as fear of recession rises, but if you must, ensure that you can afford to stay invested for at least five years which allows you to wait out any downturn in your investment.

Strive to be an Invaluable Employee

During recessions, companies might be forced to lay off some staff. While it is not a 100% guarantee, being incredibly good at your job reduces your chances of being laid off. If you weren’t already putting in your best, as recession looms, you might want to increase your effort.

Diversify your Investment Portfolio

Risky assets are harder hit during recessions. Although lower-risk assets like bonds tend to offer poor returns, they don’t perform as poorly as riskier assets like stocks in the short term. Commodities tend to perform better in the short term than most other asset classes during recessions.

Having exposure to a diverse pool of assets can reduce the losses you suffer during a recession. Check out the diverse offerings Rise offers today.

Silver Lining/Final Thoughts

Most countries have experienced few recessions in their lifetime. The UK had one recently in 2020. Nigeria has had 2 in the last five years. According to the NBER, the US has experienced 33 recessions since 1857. 

While the word recession can seem like it spells doom, many nations sustain recessions for short periods. The average recession in the US, for example, lasts for 11 months. Things should return to normal in no time.