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June 5, 2018

3 Reasons Why a Recession is Coming

If you follow the news, it might not seem like a recession is on the horizon but if you start to dig deeper it becomes clear that the economy is not a strong as it is being made out to be. Sure, unemployment is at or near all-time lows.

However, borrowing costs are starting to rise, uncertainty around trade policy is beginning to affect supply chains, and oil costs have been rising for the past six months. These factors can spell trouble for small business, which is the backbone of the economy and here are three reasons why a recession is coming.

Reason 1: Tax Cuts Have Yet to Spur Growth

Yes, we are less than sixmonths from when Congress passed a massive overhaul of the tax system. But the impact on the economy – up to now – has been marginal at best. Potential reasons include the fact that it takes time for companies to make sense of the new rules; especially those governing capital expenditures and borrowing costs.

However, if we follow the example of large corporates we see that many are using the tax cuts as an excuse to buy back shares. While the move gives investors more money to reinvest elsewhere, there is no guarantee these funds will be invested in the U.S. In fact, we live in a global world and one thing current economic models have failed to account for is the potential slippage due to investors moving their cash offshore.

For small businesses, the situation is a bit murkier as these companies don’t have dozens of shareholders and even if they did, the new tax laws favor C-Corporations over LLCs. As such, this makes it harder for many small businesses owners to take full advantage of the new rules to invest in a stable platform to update their online presence.

Keep in mind, this is a relatively low-intensity investment. Imagine you had a restaurant or a small manufacturing company and you needed to invest $500,000 to modernize your business. If you are registered as a C-Corporation, and your profit before taxes is $1 million per year, then the tax cut means you could realize a $140,000 savings.

Sure, this is nothing to scoff at but remember it will take roughly 8-months to feel the impact of the accumulated tax savings and further keep in mind that you’ll still need to get outside funding to modernize your business.

Beyond this, the real savings from the cuts will depend on moves taken by your state as some states will be forced to raise taxes to compensate for lost revenue from federal subsidies.

Reason 2: Uncertainties Surrounding Trade Policy

Even if you run a bakery, the fact is that your business is either directly or indirectly reliant on global trade. Maybe it is the raw materials you use for your business or the equipment, or it could even be your customer base whose jobs rely on exports and imports.

Let’s face it, the economy has become a complex network and while the U.S. has probably the most advanced economy in the world, it is not entirely immune to pressures from the outside.

As such, uncertainties surrounding trade policy are starting to creep into the mix for many companies. Maybe it is Harley Davidson, who recently announced they are closing one of their U.S. factories in favor of a new location in Thailand. Or maybe it is the potential impact that blowing up NAFTA would have on the fragile economy in Detroit, Michigan – the auto industry has become heavily reliant on the synergies between Detroit and Hamilton, Ontario just across the border.

While it is still early, these uncertainties are starting to impact the costs of thousands of products and goods and this could have a significant impact on small businesses across the country.

Adding fuel to the fire is the fact that while the administration is right to call out the trade imbalances and uncompetitive policies in other countries, they have little in the way of solutions. Business needs stability to thrive and the lack of a clear vision is not good over the long run.

Reason 3: Debt

We’re Americans, our lives are fueled by debt. Think about it, we borrow to go to school, we borrow to buy a car, we borrow to buy a house, and we even borrow to go on vacation – i.e. credit cards. While the era of easy money has made it easier for more people to borrow, it has also created a new class of people who spend most if not all their income on debt service.

Even in times of economic growth, this is a recipe for disaster as those trapped under a mountain of debt fall behind. But when the economy slows down, even minutely, the impact can quickly cascade out of control.

Take for example the precipitous rise of defaults in subprime car loans, or the looming crisis in student loan. Both have the potential to be worse than the subprime mortgage implosion of a decade ago and the point to the precarious nature of debt and indebtedness in the U.S.

While a recession might not happen tomorrow, there is little doubt that there will be another one. The only question is when. But keep this in mind, every day the economy appears to be firing on all cylinders the likelihood of a recession grows. As such, what are you doing to protect your business and your family?

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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