Interest rates are rising.  Investors are panicking.  “A crash like the dot.com” (link), “Worst inflation in 40 years” (link), “Recession is coming” (link), as if the world is coming to an end.

I understand the sufferings felt by people.  My intention is not to invalidate the pains.  But in this article, I want to make a point:  I increasingly feel that, if we enter a recession, maybe it has benefits.

How Did We Come To This Point?

You cannot clap with one hand.  Today’s problem is not solely caused by geopolitical tragedies in Ukraine or supply-chain problems in Asia.  There are domestic problems within the U.S. that contributed to today’s struggles. 

In February 2021, I realized that inflation might become a major concern.  Back then, U.S. headline inflation (i.e., CPI-U) was still under 2%.  Few investors were taking inflation seriously.  To document my thoughts, I wrote Some Thoughts on Inflation (published in February 2021).  And I quote my own write-up:

• The monetary base has expanded from ~$600 billion (1999) to ~$2 trillion (2009) to ~$5.2 trillion (Feb 2021)… The M2-to-GDP ratio has expanded from ~45% (1999) to ~60% (2008) to ~90% (Feb 2021)… Money must find a home, just like a flood of water must seek reservoirs to “park itself.”
• Instead of “goods and services inflation,” we are now (Feb 2021) dealing with “asset inflation.”

A decade of near-zero interest rates created a gigantic asset price bubble.  Asset valuations were frothy.  Apple’s market cap, if it was a GDP figure, made the company the world’s fifth largest country after the U.S., China, Japan, and Germany.  What is considered acceptable was also changing.  Lavish office parties at unprofitable start-ups were normal scenes.  A generation of entrepreneurs, many of whom think it is ok to burn their shareholders’ equities to “buy” revenue.  Next time you receive a $20 voucher from a ten-year-old unprofitable start-up, just think about it.  Sound logic was thrown out of the window.

These are economic imbalances.  They, more or less, have something to do with the ultra-low interest rates that we have had for too long. 

A “Necessary” Recession

In my view, there are two types of recessions:

• “Wasted” recessions:  an economic downturn that is both caused by and reveals further a major problem in an economy, and that problem is not going to go away after the recession.
• “Necessary” recessions:  an economic downturn that is brought on by a pre-existing imbalance in the economy, and because of the recession, the economy gets rebalanced.  

Bad recessions go to waste.  Good recessions improve the long-term health of an economy. That is the difference. 

With this perspective in mind, it is not difficult to see the point I am trying to make here:  if we get a recession, it is likely to be a “necessary” recession.

Maybe it has benefits.

To bring back normal interest rates:  Red-hot inflation hurts everyone.  Widespread pains evoke an overwhelming consensus among most people that the inflation problem must be dealt with now.  Instead of criticizing the Fed for raising rates by too much, people’s reaction becomes this:  hmmm… it’s odd… one committee member voted against a better 75bps hike, preferring still a 50bps hike.  How quick people’s minds can change!  How lucky the Fed is now!  Finally, the Fed receives people’s support to bring interest rates back to a normal level. 

To deal with offshored supply chains:  This is a geopolitical topic and a politically sensitive one.  Let me put it this way.  If you hold the belief that the U.S. has offshored its supply chains by too much, now, this potential recession and the pain it will inflict on society will likely persuade more people to join your camp, to advocate the idea that the U.S. needs to bring supply chains closer to home. 

Conclusion

By the next next recession, I speculate, U.S. policy makers will congratulate themselves:  Whew!  We had raised interest rates by enough in the prior cycle, so now we have ammunition to deal with the challenges in front of us. 

So, I argue, if we get a recession this time, maybe it has benefits.

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