Economic Collapse or Chicken Little Syndrome: Is a Depression Coming?

I took care of a patient the other day. This young guy came in, tired and achy, wanting detox. He looked disheveled and probably hadn’t showered in a few days. He made poor eye contact and seemed embarrassed to be there. He explained that he was addicted to methamphetamine and needed help quitting.

I see plenty of people who have suffered from addiction, but this patient was different. Most patients have a mental health problem and self-medicate with their drug of choice. This guy denied ever having a mental health problem. In fact, he was a high performer, a business man, who ran into trouble. He had used meth as a young man but then quit. He only got back into it when he had a business deal to get done.

His employer had given him a seemingly impossible task, one that would demand long hours, and huge effort. He felt like this was asking too much, but he was worried about what his boss would think. He knew that when he had used in the past, he would be able to stay up late and focus on things better. Meth is a stimulant, which promotes wakefulness and focus. It also causes a host of other problems. Overuse would be bad, but he determined that he could use a small amount at regular times in order to get the energy to get his job done. He wasn’t able to do so.

Once he started using again, he got things done, but then was using more, and then getting less done. Later, he was only using due to the feeling he got and then he suddenly crashed, and wound up in the ER. His stimulant helped him for a brief time, but then ruined his life.

A Stimulant for the Economy

Our economy is a delicate thing. It’s huge, to be sure, but there aren’t many ways to get it back on track when it is having trouble. The Fed can have an effect on interest rates, lowering them to stimulate the economy, and raising them to slow inflation. It’s easy to do, but difficult to know when to do it. And for how long.

For many years, interest rates were what we today would call high. The Prime interest rate was somewhere between 6 and 12% for most of the years between 1965 and 2005, when it took a sharp decline. It’s been historically low since then.

When the Fed causes the interest rate to decrease, it revs up the economy, like a stimulant. But it’s addictive. Like a drug, people get used to low interest rates. They forget what it was like before. The economy adapts to the low rates. Housing values swell to unrealistic levels. To take away the drug causes withdrawal. We are just beginning to experience this withdrawal right now. New mortgages are starting to decrease as people decide they can’t pay back the higher rates. They feel the new rates are so high that they can’t pay. They have no frame of reference for what it was like to have a 15% interest rate, like we did in the late 70s.

Like addicts without our drug, we do crazy things. We stop buying everything but the necessities. We hide money. Some people turn to crime. People pull their money out of stocks and then banks, and first it is a recession, then depression. Our economy winds up needing rehab.

I say this like it’s a terrible thing, but recession is a normal process. Like a forest that relies on a fire once every few years to thrive, the economy needs a downturn at times. But, the higher you go, the farther you fall. We have used this low-interest rate drug for so long, revved up the economy so much, that a crash is inevitable. It was starting in 2019, but then the pandemic put everything on hold. The Fed injected the stimulant again by reducing rates as low as they could. Now, they have no choice to increase rates again, causing a much more painful drop.

What should I do?

Don’t just stop investing. That’s the worst thing for you (and the economy). You need to try to find liquidity in your assets. If you will be able to hold your properties for the next 5 years, then keep them and consider refinancing at the still low rates if you haven’t already. If you don’t think you’ll be able to hold them due to rents decreasing or otherwise, now is the time to sell. There is still plenty of value in property right now, but it has a risk of dropping out.

Having cash is great. During good times, a rule of thumb is to have 5% of your holdings in cash. When planning for a recession, you should increase this to 10 or 20%. For a depression, it’s 30%. Cash means cash in hand or in the bank, not illiquid mutual funds or bonds with a withdrawal date. It needs to be something you can access right away.

Get rid of underperforming assets now, while people are paying stupid money for investments. When a depression happens, people will be trying to sell a bunch of property to make ends meet. The demand will be low and the supply so high that values will plummet. You’ll have the cash to grab up all the goodies and watch the values go up for the inevitable next boom cycle.

The sky is not falling, but I predict in the next 2 years, we will see a big downturn. Don’t panic, but do prepare.

Dr. Equity