Are You Ready For a Real Recession? By Charles Hugh Smith

We’re way overdue for a recession that the Fed can’t just kiss like a little kid’s boo-boo and make it all better. From Charles Hugh Smith at oftwominds.com:

In a real recession, what seemed safe and rock-solid melts into air.

We haven’t had a real recession in forty years (1981-82) and so only those who were in the workforce back then have any experience of how far and how fast things we think are solid can unravel. What’s a real recession? In the most basic terms, a real recession is an organic, i.e. unmanipulated by central banks, completion of the credit cycle, also known as the business cycle.

The credit / business cycle is intuitively easy to understand. When the cost of borrowing money (a.k.a. the cost of capital) declines and credit standards loosen so more enterprises and households can qualify for loans, the incentives to borrow and spend / expand increase. Lenders start making more money because they’re lending more, and borrowers expand their enterprise, buy assets such as bigger homes and retailers sell more goods and services to borrowers who can now access new sources of credit–home equity lines of credit, higher credit card limits, etc.

All of this credit expansion is self-reinforcing. Free-spending consumers boost sales and profits, lenders are expanding as borrowing soars, enterprises expand to meet new demand, and so on.

Then diminishing returns set in. To maintain the gushing river of profits from expanding credit, lenders loosen standards to the point that marginal enterprises, speculations and households all have access to low-cost credit. Since asset prices skyrocketed as credit pushed demand higher, new investments are increasingly at risk of becoming unprofitable. Those who overborrowed are increasingly at risk of defaulting should their income slip even slightly.

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