Hype is at the Root of
the "R" Word
Yet another recession - several thoughts run through our collective minds.
First and invariably, by the time the wise men announce a recession, we are already far down the slippery slope of economic adjustment. In the latter half of 2001, even before the shockwaves set off by terrorists in the U.S., we'd already had six to nine months of extensive layoffs, huge profitability drops and stock market dips. And then the authorities announced that we may be heading into a recession. Gee -- what caught their attention?
Second, even when confirmed, recessions generally create a modest decline in the GNP -- usually in the 3% range. But ask yourself this: If the decline in economic activity is 3%, then why are companies announcing layoffs of 25% to 30% of their workers? Why have profits of our companies been decimated, if not moved in to the loss column? How is the economic laity supposed to reconcile these apparent contradictions?
It's time to look again at what causes recessions. Do consumers suddenly decide they do not want any more cars, furniture, houses, food or wine? Is our appetite for material goods sated? Is a recession simply an adjustment to the excess capacity we built up in the hyper-enthusiasm of expansion? Has the money supply been drawn down or credit become too expensive?
Maybe in some cases. Maybe to some degree. But these explanations do not seem to fit our current situation. To be sure, the catastrophic events of September 11th have exacerbated the decline, but it would be an oversimplification to blame those events for something that was well under way long before the attacks.
The terrorist attacks will change the depth and characteristics of the economic slowdown. They will probably drag down otherwise little affected sectors as well. But mostly they will serve to turn up the contrast and volume of our perceptions.
As we look at our situation, we must separate all that from our understanding of the forces that push us into . . . and bring us out of . . . recessions. Clearly the denizens of the dismal science have their theories; but business people too have a legitimate, and often more pragmatic, view of the macro-machinations of our economy.
Consider our current predicament. This particular downturn features low interest rates, low inflation and continuing high consumer demand. In fact, housing demand has stayed high in the downturn and new car sales responded very well to 0% interest incentives. True, consumer confidence has been shaken recently, but by and large, all the traditional villains were absent as we began to slide inexorably down at accelerating rates.
How come? To simplify, this recession began with a swift and substantive adjustment of values. We counted our paper earnings amidst unrealistic optimism about the overnight restructuring of our distribution systems through some ethereal form of e-commerce. We were collectively dreaming in fast forward.
Then suddenly we woke up. We became more cautious, more skeptical of the hype. Our capital shrank and the shrinkage fed on itself. In a very short time, it seems, we've become disillusioned with everything. Our erstwhile confidence is turning on itself like a snake swallowing its tail. And the result is just about as useful.
The stock markets, as susceptible as any human organization to group think, didn't cause this recession, but they certainly reflected the feverish - and unsupported - dot-com explosion. The basic cause is our disillusionment with an unrealistic dream that was reinforced by the wise men of Wall Street who broadcast the illusion and recklessly forecast the impossible.
Some might argue - economists come to mind - that such an explanation captures only a small piece of the whole picture because it involves only a few hundred billion dollars in a multi-trillion dollar economy. In fact, though, everything happens at the margin. Substantial activity at the margins of the economy creates massive ripple effects.
Others might come back with the notion that what we've seen in the last 12 months has been unusual, well beyond the normal ebb and flow. It was based on a fundamental rethink of value in light of the transformation of the communications industry thanks to the emergence of dot-coms and related infrastructure builders.
But is it unusual? Is it new? Remember, for instance, the unbelievable inflation of real estate values that preceded the recessions of the early 1980s, and then the '90s. Just like this year, at those times, as prices rose, the inferred valuations simply were not sustainable either.
Clearly, the trigger for recessions is hype: the inflation of prices or perceived values in certain sectors of the economy. The cause of the economic slowdown across the broad base is psychological - activity at the margin intensified by mass perception. Because hype works in reverse too.
It is almost as if we all carry around economic binoculars. When we look at things through one side of the lens, everything appears larger than life. Then, at a signal given by the markets or the media, we all reverse the lens, and everything looks worse than it is. Both perceptions are clearly wrong. The difference is that in the latter case, the destruction of capital and savings is palpable.
Whatever the reasons for the slide, whatever the perception of its depth, one thing does remain true: ultimately, the economy always recovers. Always.
That said, the when, where and how of the turnaround are difficult to pinpoint because recovery is non-linear. It is always led by sectors quite different from those whose inflated prices and perceived values precipitated the decline. Real estate, the villain of the piece in the recession of 1991-92, did not lead us out of the wilderness a decade ago; it was the technology dreams that grew larger than life.
In the same way, when we recover from the current recession, it will not be thanks to the technology dreams that led us into the decline. Rather it will be something else quite different and separate.
So the advice the "experts" give us -- buy shares of companies that had incredibly inflated prices because their prices are now dramatically lower -- should be considered with extreme skepticism. What will drive certain growth in markets will be, in part, fundamental and old-fashioned, hype-resistant values such as cash flow and earnings. But it will also include a healthy does of a psychological mindset that we have reached the bottom of the cycle and are ready to pursue another impossible dream.
That - the next industry hype cycle - will start only after we are firmly on a recovery path. And it will be as doomed to flame out in a few years as every one of its predecessors has. The form may be different, but the substance will be the same.
Bob Ferchat -- former chief executive of companies such as Bell Mobility
and Northern Telecom Canada -- and Tony Carlson are the principals of I-Magin-ation
Inc., a Mississauga-based company focused on developing innovative content
for the Internet. Their book series, Soft Focus - an analysis of why
big companies miss technology opportunities that are staring them in the face
- is available through their website at