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Alix McCabe: Remember in Disney's classic, The Lion King, when Mufasa looks out over his kingdom and tells young Simba, "Everything you see exists together in a delicate balance."? Well, the natural world isn't the only place that features that balance, that cyclical nature. Our economy operates in a similar way with good times and bad times locked into an eternal dance where one leads and the other follows. And that is a concept well worth exploring on...


Audience: Wheel of Risk.


Alix McCabe: Welcome to Wheel of Risk, proudly presented by Allianz Trade. I'm your host, Alix McCabe. On every episode, we spin the wheel, land on a new worry, and then tackle it head on by bringing you expert insights and advice to help you keep your business solvent, secure and well ahead of the competition. Before we get going, I have a small favor to ask.

Could you, our amazing listeners, take two minutes to fill out a short survey about our podcast? We'd love to learn more about you and what you want to hear more of. You can find the survey link in the show notes of this episode.

Today, I am excited to welcome a veteran voice back to the podcast. Dan North is our senior economist for North America at Allianz Trade and a longtime friend. Dan, thank you so much for returning here on Wheel of Risk.


Dan North: So happy to be here. Thanks, Alix.


Alix McCabe: So you know the drill by now. As we said, you're a veteran, so let's start by spinning that wheel.


Dan North: All righty, here we go.


Alix McCabe: That was awesome. Well, I hope you're a fan of Disney movies, because you landed on: the circle of life, a deep dive into the cyclical nature of the economy.


Dan North: Oh, boy.


Alix McCabe: Watch out for those pesky hyenas and let's get to it. Despite what you might think, based on how often the terms been mentioned in the media since the pandemic, the economy is actually no stranger to recession. It's part of a boom- bust cycle that dates back centuries. In fact, America has experienced as many as 48 recessions since the Articles of Confederation came into force way back in 1781. But it's the boom part of the cycle that often tends to get overlooked. Dan, why don't we begin with some definitions. The word has been getting thrown around quite a lot lately, but what exactly is a recession? I've heard you even compare it to a day at the beach.


Dan North: Well, let me give a definition that a lot of people think is the proper definition, which is, "Two consecutive quarters of negative GDP growth." That's an old rule of thumb, a sort of a more accessible kind of analogy might be something like this: so you're at the beach, the tide's coming in, that's an economic expansion or a boom period, and when the tide goes out, it's starting to recede, as in recession. And it's important to note that when an economist says a recession is starting, it still means the tide is high, the business is good, but it's just that it's starting to get worse, recede. And similarly, when we say a recession is over, it still means the tide is low, business is bad, it's just starting to get better.

Now, as I mentioned, the old definition was based purely on GDP, but really the correct proper definition is more like this, quote, "A significant decline in economic activity that is spread across the economy and lasts more than a few months." End quote. So, that's much more flexible. Now you can use a variety of measures, not just GDP. You can use measures such as employment, income, consumption, housing, industrial production, et cetera, and it gives a much broader view of the economy.


Alix McCabe: Got it. So, we're looking at much more than just GDP now.


Dan North: Yep. You have now, with this definition, flexibility to look at a lot of things and also change the timeframe if you want. Maybe not two quarters. For instance, when COVID came along there was a recession for two months, so it's much more flexible.


Alix McCabe: So, what's the role of the Federal Reserve in all this?


Dan North: Okay, so the Fed has a dual mandate, or two goals, to balance inflation and unemployment. So for instance, if unemployment is too high and inflation is too low, the Fed would lower rates to stimulate the economy. But in times like now, where we have very high inflation and very low unemployment, the Fed raises interest rates to fight inflation and cool the economy. Now, the problem with the Fed is it actually exacerbates the business cycle a little bit, because it seems to always go too far and hold too long. They may indeed raise rates too high and then wait so long that they're sure they've killed inflation, they might also have killed the economy in the meantime.


Alix McCabe: Got it. Fed fundamentals aside, what other indicators do you watch in times of uncertainty?


Dan North: Well, there's several of them. One is what's called the Treasury Yield Curve. That's basically long- term interest rates and short- term interest rates. And that's driven by the bond market. And typically long- term rates are much higher than short- term rates, because if you're going to lend money for 10 years, you're going to demand a higher interest rate than just four, three months. But in times like this, the Federal Reserve is jacking up short- term interest rates to the point that they become higher than long- term rates. And that's what we call the Inverted Yield Curve.

And every time that happens, it's followed by a recession, something like three to five quarters later. This is the bond market saying to the Federal Reserve, "Hey, you've already gone too far." Other things we look at are weekly jobless claims, a measure of the labor market, consumer confidence survey, new orders for manufactured good, that is stuff in the pipeline, hours worked, building permits and temporary employment. There are quite a few, really, to look at.


Alix McCabe: Actually, Dan, it's interesting, you're the one who taught me about the Inverted Yield Curve and how that is a key indicator over the years. You love that curve.


Dan North: Yeah. And it's commonly watched by a lot, because again, this is the bond market which acts so rationally and so coherently saying, "You've messed up the interest rate structure," to the Fed Reserve. "You've driven rates where they shouldn't be." And it's, "You've gone too far already, and as a result, a recession is coming."


Alix McCabe: Pretty clear indicator. Dan, why is a recession actually a necessary part of the economic cycle, would you say?


Dan North: Well, recessions, like the one we're potentially heading into, occur as a result of and a cure to an imbalance in the economy. Now, in this case, we have record high inflation. It recently hit a 40- year- high. That's a huge imbalance, and a recession could restore that balance. Another example was the Great Recession, the recession before this one, there was a big imbalance in the housing market. Housing prices had gotten very, very high due to speculation and mortgages gotten very, very risky. So, we had this recession where, basically, the mortgage market melted down and that rung out the wretched excesses that were there in the housing market at the time. So, they restore imbalances.


Alix McCabe: Okay, understood. Looking back at other recessionary periods in recent history, is there a common thread that you can point to?


Dan North: Yeah, there sure are. In the most recent recessions, and I'll say going back into the '70s and sort of the modern era, they have all been accompanied by the Fed raising interest rates to fight off inflation. But most of them have also had other imbalances, such as the one I just mentioned, in the Great Recession, the subprime housing. Before that was the wildly overinflated tech bubble and the SNL crisis, et cetera. There's always a Fed raising rates and there's always another imbalance.


Alix McCabe: The circle of life, so to speak.


Dan North: That's it.


Alix McCabe: How do periods of recession tend to play out in terms of their impact on businesses? Is there, I assume there'd be an associated spike in, say, bankruptcies or insolvencies.


Dan North: Yeah, that's absolutely right. So, bankruptcies and slow pay increase dramatically, especially leading up to the recession. They're almost a leading indicator of a recession, not just during it, but beforehand. And in cases like now, when a slowdown is accompanied with rising long- term interest rates, you get an even sharper increase. In fact, nationally, bankruptcies are already up 24% year over year.


Alix McCabe: What other concerns accompany a recession?


Dan North: Really, to me, the biggest part is the human toll of a recession; plays out in the form of job losses. It's really a big societal impact, which is why you always hope a recession is short and shallow. To me, really the most important measure of the economy is employment. After all, who cares about whether GDP was 1% or 1. 2% last quarter? You don't care. You care if you have a job. So, really that's, I think, is the most important thing.


Alix McCabe: Yeah, businesses are facing a lot of tough choices, particularly in times of recession. So, what sort of behavior do you usually see from clients or buyers when recession is approaching?


Dan North: Well, unfortunately this gets right back to what I was talking about, about employment. So, if you're a business that's suspecting a slowdown is coming, well the easiest thing to do is also the most unpleasant, and that's to lay people off. It's the quickest but hardest option-


Alix McCabe: That's a downer


Dan North: ... to cut costs and preserve margin.


Alix McCabe: Are there any other measures a company can take?


Dan North: Well, if you're a business and you suspect a slowdown is coming, there are a couple of other things you can do to insulate yourself. One is you might try pulling in credit terms from your buyer. You might call them and say something like, "Hey, you've been paying in 45 days, and that's been great. That's worked for us for years, but we'd really like to bring that into 30 days now." Or maybe you call up and say, "Hey, you've got a $ 100,000 line. But given what we see coming, we maybe would like to pair that back to $ 75,000." And one other thing that a company could do to protect itself would be just to get a trade credit insurance policy.


Alix McCabe: Right. What sort of behavior do you usually see from clients or buyers when recession is approaching or looming?


Dan North: Well, we get a couple of pretty interesting signals. For instance, a buyer might ask one of our clients for a bigger credit line, and really what that means is they're asking for a bigger credit line now, while we can still get it, because we might see a slowdown or recession coming. It's not necessarily because they think sales are going to be great, they want to be able to have more credit so they can spread out their payments. We also see a spike in, what we call, past dues; that is very slow pay, and that's another indicator of things deteriorating.


Alix McCabe: So, companies asking for larger credit lines, also slower payments.


Dan North: Yep.


Alix McCabe: Those are things that we see.


Dan North: That's it.


Alix McCabe: I imagine having some insight into your client's payment patterns can be a true advantage for companies.


Dan North: Yeah, this is where Allianz Trade can really help, because we know when companies are getting weak. We have a huge worldwide database of companies. Also, our policyholders report to us every month that slow paying, those past dues. Every month our clients tell us who's paying them late, how far behind, for how much. And that's, again, is a pretty good leading indicator. That's very important proprietary information that no one else has.


Alix McCabe: Yeah, super helpful. I'd love to try a little thought experiment, if you're game? Okay?


Dan North: Mm- hmm.


Alix McCabe: Imagine there are two companies, and those two companies are the same in every way except one has trade credit insurance and the other doesn't. They're both facing the exact same tough economic conditions. How would company A weather a recession differently from company B?


Dan North: Okay, well, for company A, trade credit insurance provides an extra line of defense during recessionary times. There's the primary protection, which is the ability to recoup lost or late payments. And there's also a secondary benefit, which is the intelligence, which is both a protective measure to avoid making bad deals, and it can potentially be a growth engine, because now we can spot good customers as well. But company B, conversely, is going to be at a disadvantage and recessionary times you want to have every advantage you want. So, suppose company A and B sell to the same buyer and that buyer defaults and won't pay anybody, won't pay A or B. Well, company A is protected. Company B, on the other hand, is stuck out in the rain with nothing. And remember, it only takes a few bad receivables to knock a company out of business.


Alix McCabe: Okay, got it. So, company A has added protection, intelligence and a potential avenue for growth.


Dan North: What trade credit insurance can do, is provide an extra line of defense during recessionary times. The primary protection is the ability to recoup late or lost payments, but the secondary benefit is the intelligence we have. It's both the protective measure to avoid making bad deals and spot risky customers and it's potentially a growth engine as well, because we can now spot who the good customers are and we can approach them for bigger sales expansion.


Alix McCabe: We've been talking a lot about indicators and sadly that music is an indicator that we are almost out of time for today, Dan. Before you go, I wonder if you can break out your crystal ball and make some predictions about where the economic circle of life will take us next?


Dan North: Okay.


Alix McCabe: Great. So, where do you see the economy headed in 2024 and beyond?


Dan North: We're in an era where rising interest rates are the dominant feature of the economy. The Fed's raising rates to fight inflation and slow the economy and so far it's working and it's likely to continue doing so. It's likely that the tide is going to start going out, business conditions are going to start to get worse for a while, but then they will get better. And in the meantime, there are ways you can proactively protect yourself.


Alix McCabe: Based on what you've seen play out in past recessions, are there any final lessons or words of reassurance you could share with business owners?


Dan North: Well, when recessions come, they hurt. They feel terrible while you're in the middle of a recession, and it's like they'll never end, but they do. The average recession, since World War II, has lasted 11 months. And remember, they serve an important role to correct imbalances in the economic system and therefore pave the way for further economic growth going forward.


Alix McCabe: Dan, you're like our very own Rafiki. That's a Lion King reference in case you didn't get it. Thanks as always for coming on the podcast to share your sage wisdom with us.


Dan North: Thank you very much for having me.


Alix McCabe: My guest today has been Dan North, our Senior Economist for North America. I'm Alix McCabe, and this is Wheel of Risk, brought to you by Allianz Trade. Thanks so much for listening. If you learned something, we'd appreciate if you could leave us a positive review. To find out more about how a partnership with Allianz Trade can benefit your organization, please visit allianz- trade.us/ podcast. That's A- L- L- I- A- N- Z - trade.us/ podcast. Talk to you soon.