The “Brighter” Side of Recessions

A lot has been written about the negative aspects surrounding the economy during recessions. Less is however written about the corrective economic benefits of economic downturns. Recessions are by no means a good thing, but they do help to restore rationality and sanity to the markets which by their nature have a tendency to get carried away by the inertia of sentiment. So what, if any, are the silver linings around this cloud?

Firstly, SA’s resilience during the current difficult economic times has certainly boded well for the reputation of our financial markets and has gone some way to dismissing the notion that ‘West is best’!

Here at home the rolling electricity blackouts which saw many mines and manufacturers suffering production losses seem to have tapered off. The reduced demand for goods brought about by the recession has translated into reduced demand for produced goods and hence reduced pressure on the national grid.

Recessions often coincide with the bursting of market bubbles. Bubbles are best defined as periods of irrationality during which prices go up because… prices go up. The housing market in SA serves as a good example. Just the other day house prices seemed to be moving upwards indefinitely. Investors and speculators were ploughing into property with gay abandon as many saw it as the ultimate investment vehicle. Homeowners were gleefully patting themselves on the back for the massive (albeit unrealized) returns which they had derived from their property investments. The incongruence between price and value saw many individuals completely priced out of the market. Market corrections and recessions precipitate the movement of assets back to (or even below) their fair value levels, which allows individuals the opportunity to enter into the market.

The housing boom specifically also had another negative effect on consumer behavior. It created an unrealistic sense of wealth in which property owners believed that they were wealthier than in fact they were. With the confidence derived from their fatter balance sheets due to the overvaluation of their properties, these consumers were quite happy to take on more credit and to consume more than they actually could afford. Simply put, this wealth effect led to a situation in which consumers began to evaluate their spending power based on their balance sheets rather than their income statements.

Recessions have a tendency of providing an unwelcome reality smack in which unwarranted euphoria turns to realism. Out of these bad experiences consumers, businesses and lenders are forced to correct their attitudes. Needless to say that the lessons learnt will be painful - people will lose their jobs, businesses will be forced to trim down or possibly even go under and lenders will become subject to more restrictive and tedious regulation. Recessions provide us with a pause to reflect on our attitudes and practices. They also remind us of the importance of financial prudence and regulation going forward.

As global growth slows, the demand for resources (with the exception of gold) tends to decline. Less than a year ago, economists were comparing doomsday scenarios of what would happen to the world as we know it if oil were to break through the $200 per barrel level. Our national carrier was hedging its oil price at $140 per barrel. Then the recession hit, and the oil price now lingers around the $40 to $60 per barrel mark - once again illustrating the “role” which recessions play in tempering demand, sentiment and prices. Since gold is considered to be a safe haven, the commodity becomes particularly sought after during economic downturns. As the third largest gold producer in the world, SA stands to benefit from the increased global demand for the metal.

As the rest of the world, especially the developed world, conjures up ways of spending vast amounts of money in order to prop up their economies, SA is still lacking vital infrastructure. This situation is compounded by the upcoming 2010 World Cup. We hardly need to look for ways to beef up fiscal spending. The necessity for increased government spending will benefit the average citizen by expediting the rollout of much needed infrastructure – in essence the recession may very well catalyse service delivery!

The extent of the current recession has resulted in another unintended benefit to SA. Many skilled, unemployed individuals around the world have extended their search for employment to include our neck of the woods. Governments are becoming more protectionist and are looking out for their own citizens first, making it increasingly difficult for would-be SA emigrants to leave the country. Skilled South African expatriates are returning back home in large numbers in search of job opportunities. This migration of skilled workers to SA is helping to plug the country’s skills gap.

Most importantly, recessions are a reminder, albeit a brutal one, of the fact that economies and markets are cyclical.