Talk of recession is very much in the news of late. It may or may not happen immediately, but there are a number of indicators that all tend to occur as an economy moves from clear sailing to stormy weather. The purpose of this article is not to predict where or when a recession will occur, but provide some useful hints for what you can do to minimize the impact of a recession on you if you are involved in IT or related creative endeavors.

Of Hurricanes And Depressions

Before digging too deeply into that, it’s worth reviewing what exactly a recession is. You can think of the economy as having a lot of similarity to a weather system. A high pressure system brings with it warm days, clear skies and lots of growth. Periodically, you might get brief storms that provide a bit of rain, clearing the air of accumulated gunk, but they seldom last for long.

However, systems are chaotic, and the longer a high pressure system remains in place, the more chaotic the environment around it becomes. Eventually, that high pressure system collapses as the chaos bleeds off energy, at first slowly, but then with increasing ferocity. Vortices form as winds pick up, and you begin to get rotating cells as energy get transferred. These supercells pick up water if near the sea or dust if on land, which also adds energy to the system. In time, this chaos has become a full fledge storm, and may end up signalling a change in the weather lasting weeks or even months.

The economic system is not a weather system (it’s noticeably simpler, among other things), but there are obvious analogies. Energy exists in its own right, but also exists via proxy in the form of money. Energy flows in a weather system are denoted by wind, with higher winds becoming roughly the same as higher energies. Energy flows in an economic system are usually indicated by the velocity of money. In a healthy, growing economy, energy flows are undirected, money gets to most participants, though there’s a bias for those flows to tend to rise as energy in the system increases.

Over time, what develops is a feedback loop—hot air rises, gets higher and higher in the atmosphere (where the density of air is thinner), and cools, creating a dome as the cold air is pushed away from the warm central column of rising air. At the same time, the rotation of the earth imparts a slight spin to the whole. What had been mostly uniform air begins to take on structure, picking up moisture along with the heat, and at the center the pressure begins to drop. On land, you’d see this as a rising column leading to massive anvil or mushroom shaped clouds, not at all dissimilar to the shape of a nuclear warhead going off. At sea, with hot ocean water, this becomes a line of dark clouds that begin rotating.

In both cases, what you are seeing is the conversion of unstructured warm, wet air into a cohesive storm cell as the potential energy built up in the fair skies period begins to break down. Most of these cells get disrupted—the water is too cold, there’s not enough moisture, and so forth, and you get some cloudy skies and enough rain and wind (due to the weight of the cell bringing that air closer to the surface of the Earth) to maybe give the garden a nice sprinkle, before the kinetic energy dissipates and high pressure reasserts itself.

The economic analogy of this is a brief slowdown in the economy, what speculators like to call buying opportunities. In the weather system, the temperature cools down a bit reflecting the loss of energy in the system (mostly grounded in the Earth), until the sun has a chance to heat things up again. In economic terms, the sun is the availability of money (or more accurately credit) to as many people in the system as possible.

If the storm system is not disrupted, things begin to get serious. A low pressure cell forms as flows become more directed, first upwards then outwards. Winds begin to rise around that low pressure center due to the rotation of the Earth, and the distribution of energy increasingly moves towards the top of the system. That imbalance in energy creates instability, and this eventually forms into a storm.

A hurricane is fascinating because it is caused by the breakdown of stability, despite the fact that for a brief period of time it actually takes on a quasi-stable form of its own. The storm is dissipating energy, but there is more energy coming in than can be dissipated. It’s only when that incoming energy (warm air rising from warm water) is replaced by dry land that has far less energy emanating from it that the storm finally tears itself apart.

The build-up stages of a hurricane have a direct counterpart in the economy. Economic commentators usually call these bubbles. During bubbles, corruption begins to build up, as money intended for positive investment begins to make its way into increasingly questionable ventures – tulips, tranched mortgages, online pet companies with sock puppets. Conspicuous consumption replaces discrete displays of wealth. Certain technical skills become high demand, because even as the wealthy become ever wealthier, the actual return on investment into companies begins to drop. Unemployment (U-3) tightens to under 4%, but it is very uneven.

The economy in this analogy can actually stay in this form so long as there is still money driving it, primarily in the form of consumer spending and loose credit, however, neither of these things are inexhaustible. Trade and tariff wars push the prices of goods up faster than wages can rise, basic services such as healthcare and education become increasingly unaffordable, energy prices rise, and so forth. Eventually the amount of disposable income available to a given household drops below a critical threshold, and consumer spending begins to soften.

Those at the top of the hurricane vacuum have adjusted their spending and investments to take into account a flood of money coming from below. In an economy, though, it takes time for that wealth to make it from the bottom, and so the first signs that there are problems usually come long after the problems have become entrenched. Reinsurance activity begins to climb, as bets that were made on the assumption that the economy would remain strong begin to go bad.

When a hurricane hits landfall, several things happen. Deprived of the energy necessary to continue, the storm begins to come apart. Billions of metric tons of water, held aloft by heat and winds, begin to return to the earth at significant velocity as rain and hail. Turbulence rises, forming tornadoes, and most importantly, heat dissipates.

Carrying the analogy over to the economy, the same dissipation of energy (velocity of money) takes place. A stock market rout occurs because bets that are made assuming the market will continue up fail, and the bettors are forced to cover their positions by selling existing stock, which puts downward pressure on the nominal value of those stocks. Ordinarily there is a floor – at some point someone will buy at the lower price, but because mostly everyone was on one side of the trade, the number of people on the other side is not sufficient to stem the tide.

This is a catastrophic collapse, and it typically occurs across multiple financial classes more or less simultaneously. Hedge funds, which typically make money by agreeing to be the counterparty in a trade for a fee, suddenly lose liquidity (this is a credit default swap in a nutshell, by the way). This in turn sends the cost of credit soaring, because everyone is suddenly needing it to cover their own long positions. In 1988, the credit market froze, as the demands for credit on the various central banks exceeded their ability to provide it.

Most businesses today do not operate on a pure cash accrual basis. Instead, they make use of a rotating line of credit for handling expenses such as payroll, and pay off that line of credit as new revenue comes in. This smooths out the flow of money in the system and makes it easier to survive when revenues fall short in a given month. Interrupt that flow, and most small to midsize companies will be unable to pay payroll for more than a few months, especially as demand, already tepid, also collapses rapidly.

What happens next really depends upon the company. Public companies will typically be in a bind, because they do not want to give the market, already panicking, a reason to dump their stocks too, so cutting dividends at that point is usually not something they want to do. Rather they will start triaging projects – putting those close to completion on a fast track, then mothballing projects that are currently underway that are likely not going to produce a return in a short enough time-frame.

Contractors and part time employees will be cut first, because they are the cheapest to let go (and the least likely to litigate). After that there will be severance packages and voluntary separations, aimed primarily at those people that the company’d like to at least keep goodwill with (potentially to rehire them when the economy improves). The severance package phase is usually short (and in general is a good deal if you can get it) as subsequent cuts usually will be involuntary and uncompensated.

Prior to the black swan event, there’s often a flurry of Mergers and Acquisitions (M&As), done primarily because the ability to borrow is still there. As credit tightens and companies become more dependent upon money on hand, M&A’s also dry up, as does investment funding in general.

For early employees, such buyouts are often watershed events, but for those hired later in the cycle, payouts are frustratingly small. Once past a market collapse, however, options are considerably bleaker. Most M&As are done for the sake of acquiring either key technology or market share, and technical or support personnel in particular may have a limited shelf-life in an acquiring company after the acquisition.

The one point that may be raised here is that with unemployment so low, companies may be reluctant to reduce their head count. It’s a thin reed to depend upon, however. Layoffs occur primarily because a company is convinced that demand itself will be down for an extended period of time, and are frequently myopic when it comes to how much time and effort it took to hire a given person in the first place. What’s more, it’s not uncommon for companies to play an arbitrage game – hoping that they can get cheaper talent when demand picks up for the same skill-set (or that the same talents will be available on a chip).

Waiting Out The Storm

If you’re lucky, your company will survive. Recessions can be total and catastrophic, but most tend to be rolling – moving from sector to sector, leaving people in one sector to pick up the pieces and move on even as another is entering into the maw of the storm itself.

Recessions are also by definition deflationary. They reduce demand by reducing available purchasing power and credit, and supply (and actual price) then follows. It’s rare for a distributor to reduce the direct asking price for a product. Instead, you see larger and larger discounts. A $350 television set gets discounted to $250, then $150, then $99 because the distributor wants to move excess inventory. The notional “price’” of the television set remains the same, but once an item begins its slide into discount territory, it almost never makes it back to its base manufacture suggested retail price.

With people out of work, there are comparatively few mechanisms available for getting money back into their hands. Tax relief can work, but in general such tax relief generally puts most of the money back into the hands of the wealthiest, rather than to those who have lost their jobs and hence are paying comparatively little taxes (or none at all). Unemployment “benefits” are taxes levied on companies precisely to handle the scenario of workers being let go, but quite frequently the payment out of this fund gets political quickly, and as often as not it is intended only to supplement, not replace, lost income.

It has been said that recovering from a recession comes down to re-establishing trust. While that’s true, it’s also somewhat simplistic. A recession resets values, and stress tests businesses, and in many respects the next recession will be one of the most rigorous stress tests that most business have faced in the last 100 years.

In the next couple of years, retail as it has existed since the 1920s will disappear. Most retail outlets are struggling to stay competitive against online retail in the midst of a boom. They will not survive the bust. Many malls will shutter their doors permanently, leaving large numbers of empty, decaying buildings. Manufacturing is disappearing, and even that manufacturing which is onshoring is replacing labor intensive work with robots. Most of those robots will not be manufactured in the US, because the US has been ceding its competitive edge in this space for a while.

Retail bank branches will be next. There are very few activities today that cannot be accomplished online within banking, and in many places, the daily transactions managed through retail bank outlets do not even justify the staff expenditures. The same holds true for sports retailers, arts & crafts, office supplies, bookstores and other specialized outlets. What remains are general stores, grocery stores, restaurants, general services (from haircuts to nails to tattoos) and clinics of various sorts.

The Low(er) Unemployment Recession

Bubbles tend to attract job seekers into a field because the pay is good, whether or not they’re actually all that interested in the job. Before 2000, there was a mass inrush of people into web development an e-commerce, seen as the next big gold rush. By 2004, fully a third of the people who had entered the field had gone on to other things, most outside of tech. Even once the economy began recovering in 2005, those who left the field found that getting back in was considerably harder, because their skills had not advanced to keep up with changes in the field, and what was hot in 1999 had become fairly passe by 2006.

Ironically, this may have been part of the reason that technical hiring recovered fairly quickly – there were considerably fewer qualified people in the field, and the ones that remained tended to be more senior. When the 2008 recession hit, most people in IT barely felt it.

The situation may prove similar in 2020 (or when the recession hits). There’s something of a bubble in tech right now (especially in data science and AI), and a recession will winnow out those who are in it just for the money. However, the skills needed to be competent in that field are fairly advanced: most people have at least a Masters degree, and the AI/tech field currently has absorbed most of the STEM PhDs produced by universities globally. These aren’t skills you readily jettison.

Additionally, demographics actually favors a comparatively weak job loss in the technical field during a recession, as the field is also undergoing significant retirements among the Boomers and older GenXers. A recession will only exacerbate that.

Outside the tech field, the situation may end up being more dire, though again it will depend upon sectors. There’s a considerable drain likely to happen in the oil economy – depressed oil prices are keeping people from going into the field in the numbers necessarily to sustain it, while a lot of expertise is retiring. Travel and tourism may decline somewhat (as the recent Thomas Cook implosion suggests), while the automation of manufacturing is accelerating. Restaurants (excepting breakfast) are in a best of/worst of scenario – we’re in the golden age of quality restaurants, but most of the sector is overbuilt.

The upcoming recession is likely to be structural in nature, replacing one model of the economy (the one that grew up as part of the command and control structures after World War II) with another (the post-oil, internet-mediated economy that’s been apparent in a few big coastal cities but hasn’t quite reached the rest of the country). Within the latter arena, a recession will likely have the effect of trimming supply overhang. Within the former, the recession will likely be far worse, increasing urban / rural tensions to the breaking point.

Ultimately, as with any storm, the trick is staying hunkered down until the worse is over.

Recession Preparedness

Given all this, what can you do to prepare, as a knowledge worker (or company) in particular, for a recession? For individuals, there are several recommendations that I’ve found helpful over the years:

Acknowledge The Fact. Knowledge work is cyclic. Remember that you’re riding a storm when the times are good, and that storm will eventually exhaust itself. By admitting the possibility that you could be out of work for more than a year, you can at least have contingency plans in place.

Save And Keep Cash On Hand. One of the most terrifying moments of the 2008 collapse was when it looked like credit had frozen. The economy not only within the US but globally had reached a state of panic that there was simply no credit available – no credit cards, no access to bank savings, business lines of credit were unavailable. As with any emergency, it’s not a bad idea to keep $2K to $3K in cash to hand, in twenties or smaller denominations, so that you can have access to some money until things work out. Remember at this point that paper money is very dear, so spend that as grudgingly as you can until the situation eases and be willing to haggle – remember that others are in the same position that you are.

Diversify. If possible, try to keep multiple income streams going. That second stream may not even be in the same kind of knowledge work that you regularly do, but it can make the difference between surviving and facing foreclosure in a worse case scenario.

Understand The Law. Collecting unemployment can be difficult for knowledge workers, as the program tends to favor those who have been with a single company for a long period of time, and all too often knowledge workers tend to be project based, especially consultants. Spend some time with an accountant or lawyer to understand what your options are, so that if layoffs come, you can manage to bring in something even if its not what you had been getting.

Talk With Your Manager. This is hard, but is frequently fruitful, especially before pink slips start flying. Discuss the idea of variable wages or benefits, such that as cash-flow becomes an issue for the company, there’s a policy in place for reducing compensation instead of firing outright – one that applies equally to everyone. To a certain extent this is being done today through the mechanism of bonuses that are tied to company performance, which allows for some flexibility in getting through during hard times. It may not completely stop pink slip-itis, but it may extend the time before everyone gets called into the cafeteria by several months.

Incorporate. This is related to diversification above. Unfortunately the stigma about being unemployed is a strong one in the knowledge economy. Spend the money and form a limited liability corporation. It allows you the opportunity of consulting on projects even if a company is not currently hiring for full time workers, it keeps you in good grace with the income tax folks, and it allows you to legally claim work on your resume even when no one is walking in the door. It’s easy for a prospective employer to check whether the LLC is legitimate, and it’s often a way to develop management experience even when you’re a company of one or two. This also means setting up separate accounts for business, which also makes it easier keep taxes low, by keeping some income available in the accounts for business purposes rather than it being treated as personal income.

Reduce Spending Reasonably. As a rule of thumb, whenever you make a purchase or go to an event, you should evaluate it from the perspective of whether or not it is monetizable. A conference where you can network is a business expense that’s not only tax-deductible but may result in more work, a trip to Cabo may be a great stress reliever, but should probably wait.

Explore Gaining More Education and Training. If you do find yourself out of work, consider going back to school to get an advanced degree or technical/management certification. Often, especially for older workers, there are funds available in many states for retraining purposes. Again, do your homework early and plan your approaches before the pink slips come, as such retraining options may not necessarily be available later in the recession.

Start a Business. While this may seem like the same thing as incorporation, it’s a somewhat different focus. There has never been a time in the history of humanity where there are so few barriers to entry for a business as there are today. If you have an idea for a certain software package, a podcast, a book, webinars, novels, even the production of models for 3D printing, now may be the time to do it. The one thing that a recession gives you is control of your own time. Use it wisely.

Network, Network, Network! One of the biggest dangers of a recession for the knowledge worker is that it can become very easy to become isolated. Knowledge workers tend to be introverts, and as such the temptation to disappear into code or a book or some other similar effort without any real goal is strong. Fight that goal. Get involved with an open source project. Go to meetups. Start a blog. Provide services to a charity, or a political cause. Recessions do not last forever. Eventually things will start to pick up, and in a significant number of cases the next work that you have may very well come from someone you worked with on an open source project or a political campaign when things were quiet.

Finally, Don’t Panic. My sense is that the next recession will be structural in nature, signalling the boundary between the older industrial economy and the newer cognitive economy. A lot of what we’ve taken for granted throughout the twentieth century – brick and mortar retail, command-and control corporate hierarchies, the primacy of oil and the automobile, even the nature of jobs – is disappearing, and in its place is growing a new economy in which everything has some intelligence, where the distinction between political regions will become more fluid than ever, and where new challenges and struggles will likely emerge.

What should companies do? The advice is actually pretty similar.

Prioritize. Determine which projects are close enough to completion that they can be wrapped up relatively quickly, and prioritize getting these done over initiatives that may be six months to a year out.

Triage your R&D. Research and Development will be your competitive edge once the economy begins to recover, but again, focus on those that have relatively good chances of short term viability, then start moving longer term projects that likely will be both expensive and have a longer to market profile into temporary storage. To the extent possibility try to keep those people who may be driving these projects occupied and focused, as they may very well go to your competitor if they are just pink-slipped.

Use Bonuses As A Cushion. Bonuses are generally contingent upon profitability, but drawing down on bonuses (in a consistent fashion across all parts of the company) rather than mass firings can let you retain staff for longer. This also requires expectation setting, and if your senior sales staff are still pulling down six and seven figure bonuses while your creative and knowledge worker staff are being shown the door, this will almost certainly hurt you when it comes time to attempt to rehire those workers.

Be Upfront With Workers. If the company takes a loss, workers should be aware of this, and should understand what the company will do in response. All too often, workers in previous recessions discovered that they were being fired because of news reports on their way into work. Many of those same workers were difficult and expensive to hire, and they will most likely be long gone if you treat them badly on the way out the door.

Have Credit-Freeze Contingencies in Place. Most companies in this day and age rely heavily upon rolling lines of credit to even out their capital expenditures, which is especially useful when accounts receivable doesn’t receive payments in time. Your CFO should have contingencies developed in cases where those credit lines get frozen or a similar catastrophic event like this occurs. Remember that before they were called Depressions, these recessional events were known as Panics, because that’s what everyone was doing.

Consider Supply Chains and Shipping. On a related note, develop strategies in case your supply-chains or shipping are disrupted. When a major South Korean shipping firm went bankrupt, many ports were either seizing ships that landed or were not permitting them to land, resulting in several tense weeks where a significant percentage of the raw and semi-finished materials needed by many companies were visible from shore but could have been on the moon for all the good that it did for those companies. Recessions bring disruptions, period.

When? Who Knows …

The final question – when will the next recession hit – is not an easy one to answer. There are a number of signs that typically presage slowdowns, from the Producer Manufacturing Index dropping below 50 to the inversion of the yield curve to a slowdown in shipping and a drop in consumer confidence that have all occurred in the last couple of months, and these are often seen as early precursors. Additionally, a recession is only called after two quarters of consecutive shrinkage (often euphemistically referred to as negative growth). None of these are clear indicators in and of themselves, but the more such signposts do show up, the more likely that something is coming.

Also note that a stock market crash is not the same thing as a recession. In 1985 the Dow Jones Indistrial Average dropped 500 points (about 22% from its highs) in a day. There was a wobble in the economy after that, but it really wasn’t until 1987 and the S&L crisis that the economy went into a (fairly mild) recession. Given the overleveraged state of the current markets (it is FAR above the long term average) it is likely that the equity markets will go into free fall at some point, but knowing precisely when it will happen is much like trying to predict when and where an earthquake will strike.

My suspicion, and one that’s supported only by anecdotal evidence to date, is that 2019Q4 will have a marginally positive GDP for the quarter, which means that it will be 2020Q3, starting in June, before it’s even possible to declare that the US economy is in a recession (recessions are declared after two negative quarters of growth). Politically, there may also be some pressure to not even acknowledge this.

However, whether acknowledged or not, the likelihood of a sharp downturn in economic activity increases dramatically the further you get into 2020, and is near certain by 2021Q1. Regardless of when it hits, however, the best action is to assume that it will happen at some point, and prepare accordingly. Just as with any other form of disaster preparedness, you really can’t go wrong being ready.

#recessionWatch #recessionPrep #economy #systemsTheory #theCagleReport