2023 Are We At The Edge Of Recession

Fears of a recession in 2023 is on the tip of our tongues. Whether we care to admit it or choose not to believe it, the possibilities are real.

But are we on the edge of the cliff or is there a lifeline hanging somewhere?

The topic of a recession is not new. We first heard this word uttered in 2020 when Australians were pushed into mandated lockdown. Businesses had to close or operate in a limited capacity, while others worked from home.

Many Australians were either out of work, working less or left unchanged. We were able to escape a major crisis due to the government stepping up and providing stimulus support.

But this led to another problem known as quantitative easing. More free money injected into the economy is a potential catalyst to inflation. However it was necessary at the time, and the government did the right thing.

Where they got it wrong you may argue was that the money went to a lot of people who did not need it. Not to mention businesses that did not need it either, driving up underlying profits.

During this time there were also media articles that the inflation experienced was “transitory”. To more financially aware pundits, many would ridicule this statement. They would argue that inflation is hardly transitory and it would be here to stay.

Fast forward to present day, we are in an environment of rising inflation that many of the population have never experienced. And the fear of a recession looms overhead.

Beginnings Of A Recession

If you have basic knowledge about finance and how the economy works, quantitative easing is easy to understand. The government basically prints new money and floods it into the economy.

In theory it is supposed to stimulate the economy during bad times, but at the same time devalue the currency. The argument is that the stimulus provided to the economy will provide far greater benefits, making the down-side insignificant.

By definition, the creation of more money supply will cause inflationary pressure. This is because there are more money chasing fewer goods.

While some people were using extra cash for retail spending, consumer savings rate actually hit record highs in 2020.

So what really is the cause of inflation this time round? Is it that Australians are spending more than they have been, and that demand out strips the supply?

Or is there some other factor that is the cause for all this? My answer is because of supply chain disruptions and wage growth.

There are two main drivers of inflation.

1. Cost-Push inflation
2. Demand-Pull inflation

Supply chain disruptions caused cost-push inflation. That is because the costs to produce, deliver, store products were rising. When prices to produce products rises a business still has to remain profitable.

They do this by passing the costs on the consumers by increasing the prices of their products. The end result means that consumers now have to pay more for the same goods or service.

While this was going on, wage growth was also making a move. With borders closed, many businesses had trouble hiring staff that they had previously let go.

In order to attract candidates for a job role, they had to make their offer more enticing. What better way to do this that to offer higher wages.

Now with people getting paid more, they have more money to spend. However, I would not conclude that these higher wages caused more spending.

Cost-push inflation was already lurking in the background.

Australia’s Escape From Recession

Australians have been relatively lucky, as we have managed to be recession free for the last 30 years. The last one being in 1990, where interest rates were at all time highs. In January 1990 interest rates were at 17%.

So why hasn’t Australians had a recession for 30 years? Firstly, we were able to avoid a financial crisis in the 2008 sub-prime mortgage crisis because Australian banks weren’t making risky loans.

Another reason is also because of our largest trading partner, China. Australia’s economy was largely buoyed by large resource exports to China.

Australia was able to escape recession for the past 30 years due to China buying our valuable commodities, notably iron ore.

However, Australia’s relationship with China has not been the best. Many imports of our products such as wine, lobster, timber and barley have been banned.

They have however left more valuable commodities such as iron ore, gas and wheat untouched. So you could say that China still needs our resources, but with China’s economy slowing down we cannot rely on that for the longer term.

So we face a question, is Australia at a turning point and at the edge of a recession?

Targeting The Wrong Area

Inflation is not a bad thing. If anything, we want moderate inflation as it shows that an economy is growing. But too much and we get hyper-inflation or worse stagflation. These scenarios would not only lead to a depression, but a great depression.

The RBA target rate of inflation has been 2-3% yearly. However, I would expect to see this inflation target reached again for many years. It is more likely to be at the 4-5% range moving forward.

The question now is, how do we combat inflation to keep us out of a recession?

We know that the RBA has been rising interest rates aggressively over that last few months. They would rather the economy suffer a short term recession than experience a longer one.

By rising interest rates, the RBA is restricting the amount of money available for people to spend. It also makes businesses access to capital a lot more expensive.

The result is less spending and less investments, which will in turn lead to reductions in economic activity.

But the issue with raising interest rates is that the problem was not caused by over spending, where demand is greater than supply. It was caused by cost pressures faced by businesses, which is the other cause of inflation.

Raising interest rates are affecting homeowners that have recently taken on mortgages in the last few years. Many who are on fixed loan agreements about to expire which will roll over to higher repayments.

These are not the people who were spending their money in the first place. According to CPI figures and retail figures from the Australian Bureau of Statistics, spending is still strong.

So if interest have increased dramatically so quickly, why are we still seeing such strong economic activity?

We are not targeting the right areas of the cause of inflation. If you look at CPI, it only includes the main categories such as housing, food, energy and clothing. The main areas that are causing inflationary pressure are the necessities.

We cannot blame the RBA for this, as they are in a very tough position. They only have one weapon at their disposal, and that is a lever that can either only go up or down.

Key Takeaways

• Inflation left unchecked may lead to worse off conditions. It is better to quickly grind an economy to a halt than risk a prolonged recession.
• Interest rate rises are targeting the wrong people, but the RBA should not be blamed for that. They only have one weapon in their arsenal
• Governments should find alternate solutions to target the rising cost of inflation more effectively

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