Elon Musk: The recession is here, you just don't know it yet

But I think we probably are that are in a recession and that that recession will get worse. So there's a lot of concern about the health of the U.S. economy right now. Many economists are predicting the country will soon slip into a recession. No disrespect to economists, but their track record for predicting the economy isn't too good. A much better way to get a sense of the health of the economy is by listening to the people that lead companies.

Nobody leads more large high-profile companies than Elon Musk, whose two largest companies are Tesla and SpaceX. Take Tesla, for example, which, as an automaker, is extremely tied to the health of the global economy. As the CEO of Tesla, Elon gets a unique perspective of what's happening in the economy that is unmatched by virtually anyone. This is why when he made the bold call of saying the U.S. has already slipped into a recession and it's only going to get worse, it definitely got my attention.

It should be getting your attention too because this has the potential to affect everything from stock prices to home values. In this video, we are going to listen to Elon explain why he thinks the economy is in for a bad stretch, what he is doing to prepare, and what he thinks the fallout of this economic slowdown will be. Now, let's get into the video.

So, Elon, shifting gears to the economy, um, you know we saw this surprise report of negative 1.4 percent GDP growth in Q1. Interest rates have been rising, that increased the cost of the consumer of getting loans, things like that. We've had a stock market correction, really a crash in a lot of growth stocks and software stocks. What, from where you sit and the data that you see, where do you think the economy is headed right now? Do you think we're in a recession or is it just a risk? How do you assess our current economic situation?

Well, predicting economics is always difficult, um, and I want to assign probabilities to these things. Um, but ironically, I did last year. People asked me what I think about the economy. I said, well, I think we might enter a recession in approximately, uh, uh, spring of 2022. But I think we probably are in a recession and that that recession will get worse. Um, but you know, these things pass and then there will be boom times again. Um, so it'll probably be some tough going for, I don't know, a year, uh, maybe 12 to 18 months is usually um, the amount of time that it takes for a correction to happen.

What about the general state of the economy? Does that weigh on you when you think about this? I mean, you just described it; you have a super bad feeling about the economy. Are you still in that position? I just said to you earlier, Joe Biden has just come out and said that a recession in America is not inevitable. How do you feel about the economy?

Well, I think a recession is inevitable at some point. Um, as to whether there is a recession in the near term, um, I think that is more likely than not. It isn't a certainty, but um, it appears more likely than not. It's one thing for a business leader like Elon Musk to talk about how he sees the economy slowing down. As the old saying goes, talk is cheap. It's an entirely different thing for them to actually start to put actions behind those words.

It was recently revealed through a leaked internal memo that Tesla will be laying off 10 percent of its salaried staff in an effort to conserve cash and reduce expenses. Since this information came to light through being leaked in the press, there were some questions about whether it was accurate. However, it turns out the reports were true. In the past week or so, a ton of former Tesla employees have taken to business and employment-oriented online service LinkedIn to post about how they fell victim to these staff reductions.

Even worse, at first, it was just thought these layoffs would be salaried non-production workers, meaning people who don't actually make and produce the vehicles. It was explained that this would be a way for Tesla to reduce costs while not impacting the number of vehicles the company can produce. However, it has also come to light that some of these layoffs also included production workers.

Now, don't misinterpret what I'm about to say. I'm a huge fan of Elon Musk and do have a ton of respect for what he does. However, with that being said, he does have a reputation for, let's just say, exaggerating a little bit. For example, the infamous situation when he said he was taking Tesla private at 420 per share and that he had "funding secured," when in fact he did not have funding secured. At first, I brushed off these comments from Elon as maybe exaggeration.

However, Elon Musk wouldn't have made the decision to lay off workers, especially production workers, if he didn't truly believe we are entering a dark period for the economy. One of the biggest signs that a business is seeing an economic slowdown is when that business starts to slow hiring or even actually begins to lay off people. That is especially true when those workers are production workers, workers who ultimately determine how many products a company is able to produce.

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All this talk about a recession may come as a surprise to most people considering, in many respects, the United States economy is booming. Employers are adding hundreds of thousands of jobs a month and would hire even more people if they could find them. U.S. job openings remain high; in fact, the most recent data release shows that there is nearly double the number of job openings compared to the number of unemployed workers.

The current unemployment rate is 3.6 percent, hovering around the lowest unemployment rate in decades. At 3.6 percent, the unemployment rate is a far cry from the 10 percent unemployment rate that the country peaked at during the Great Financial Crisis. Consumers are spending, businesses are investing, and wages are rising at their fastest pace in decades. Pretty much every CEO is talking about how strong the demand is for their goods and services.

So, on many measures, things seem like they're going great. But that's actually part of the problem; things may actually be too strong and the economy may actually be overheating. Let me explain. Demand for cars, homes, restaurant meals, and for the workers to provide them has outstripped supply, leading to the fastest inflation in 40 years. This has the United States Federal Reserve and its chairman, Jerome Powell, very worried.

One of the main goals of the Federal Reserve is to target low inflation, or in their own words, stable prices. They have actually come out and said the target annual inflation rate for the country is around 2 percent on average. Well, let's just say the Fed isn't doing too good a job of achieving this goal. The most recent inflation data release showed inflation was a staggering 8.6 percent, the highest inflation rate in four decades.

In order to combat this historically high inflation, the Fed has one big tool in its belt: raising interest rates. But how exactly does rising interest rates slow down inflation? As interest rates rise, it becomes more costly to borrow money, and each dollar that a person or business borrows now has a higher interest cost associated with it. This means that all else being equal, people and businesses can borrow less money.

Put even more simply, higher interest rates mean that there are fewer dollars floating around in the economy looking to buy goods and services. The hope for the Federal Reserve is that as they raise interest rates, it will bring demand for goods and services more in line with supply, with the ultimate goal being a slowdown in inflation. However, there is another large side effect that comes with raising interest rates and decreasing demand for goods and services: that side effect is the economy slowing down.

So the Federal Reserve is literally a walking tightrope, essentially doing a balancing act. They want to decrease demand enough to slow down the economy and curb inflation, but at the same time, they don't want to increase interest rates too much and negatively impact demand to the point that it sends the economy into a nasty recession. Policymakers at the Fed argue that they can cool off the economy and bring down inflation without driving up unemployment and causing a recession.

But many people are skeptical that the Fed can engineer such a "soft landing," especially in a moment of such extreme global uncertainty. While everyone is hopeful the soft landing of the economy can be achieved, if history is any indicator, things aren't looking too good. The last time the United States was in such a challenging predicament was during the late 1970s and 1980s. Inflation was running rampant, gas prices were skyrocketing, and the cost of living was rapidly rising for the average American family. Inflation was the number one concern of the country.

In order to "break the back of inflation," the chair of the Federal Reserve at the time, Paul Volcker, had to dramatically increase interest rates. Over time, these interest rate increases accomplished their goal of bringing inflation under control. However, that goal wasn't accomplished without the economy paying a pretty severe price. The United States economy suffered from a so-called double dip recession: two nasty recessions essentially back to back.

Only time will tell if this is going to be any different. However, things aren't all doom and gloom. There was an interesting tidbit in this interview that deserves attention. Let's listen to what Elon Musk had to say.

Now, the thing is that recessions are not necessarily a bad thing. Uh, they, they, you know, um, what I've now been through a few of them. And what has happened is if you have, um, a boom that goes on for too long, you get misallocation of capital. It starts raining money on fools, basically. It's like any dumb thing gets money, and I'm sure you've seen a few of those. Um, so at first, at some point, it gets just out of control, and you just have a misallocation of human capital where people are doing things that are silly and not useful to their fellow human beings.

And then those companies, there needs to be sort of an economic enema, if you will, um, to actually have everyone sort of shift uncomfortably in their seats. [Laughter] I mean, listen, it's got alliteration. Um, too shall pass. Eventually, the economic enema does its job; it clears out the pipes, if you will. Yes. And, um, and sort of the companies go "Minecraft," and the ones that are doing useful products are prosperous.

But there's certainly a lesson here that if one is making a useful product and has a company that makes sense, make sure you're not running things too close to the edge from a capital standpoint; that you've got some capital reserves to last through irrational times. Because in the past when there's been a recession, um, it has gone, it's amazing. It's flipped like a light switch. I mean, David, do you remember this from the PayPal, you know, ex-PayPal days when we raised 100 million dollars in March of 2000?

And we literally, we had, the demand was so high, we had people like VCs, like just literally without even a term sheet wiring money into our account. "Um, we'll send the term sheet later." They literally were like, we like sleuth out our bank account number and wire money in, and we're like, "Where'd this come from?" And it's like, um, so it was like there was literally fire hosing money in March of 2000. And then in April 2000, the market went into free fall.

And it went from money—raising money was trivial to even good companies could not raise money in a month. Um, so it's just important to bear in mind that, you know, PayPal almost went bankrupt in 2000. Uh, we came close. Um, but thankfully, we would raise that 100 million dollars in March 2000, without which we would be, uh, could we really game over basically. Um, and we kind of saw it coming.

So we got that, the X.com finity merger done in like three weeks and raised 100 million dollars because we were like, "Oh hell, we see this coming to an end pretty soon." And then a month later, it was like, you know, a nightmare basically. Um, and, uh, anyway, so it's just important, make sure if you're a healthy company you've got some capital to get through things. Um, and then what's your costs? And if it is a recession, which it more likely than not is a recession—not saying it is, but it probably is—then just, uh, make watch your cash flow and get positive cash flow as soon as you can.

These comments from Elon Musk run pretty counter to the popular narrative. Here on YouTube, doom and gloom videos get a ton of clicks on YouTube. That's why many YouTubers in the finance space make videos making it seem like a recession is the end of the world. However, Musk makes the argument that recessions aren't entirely bad. Instead, recessions are a normal part of a healthy functioning economy. In some respects, recessions can actually be a good thing.

When the economy is strong and debt is cheap, investors have a ton of money to invest, and this is especially true among venture capitalists and technology startups—an area Elon Musk knows very well. In recent years, there has been more money in the hands of venture capitalists than high-quality technology startups. This phenomenon, where there is more money that needs to be invested by professional investors than there are high-quality businesses, leads to what investor Howard Marks refers to as a "race to the bottom."

And in the tech sector, where Elon has spent his career, this race to the bottom takes the form of companies being valued at completely unreasonable valuations. During normal times, many of these businesses wouldn't get funded at all, but because there is so much money floating around, investors are willing to invest in lower-quality businesses. As Elon puts it, some of these businesses probably shouldn't even have been able to get funding in the first place.

An example of this is the ultra-fast delivery startups that have popped up everywhere in New York City, where I work. These companies promise groceries delivered to your apartment in as little as 10 minutes. The names of the various delivery companies are plastered on subway turnstiles, bike docks, buses, and the backpacks of cycling couriers zooming by. These companies are spending tens of millions of dollars advertising here in New York City alone.

Interestingly enough, these companies are actually losing money on every delivery they make. You may be asking yourself, how can a company stay operating if it's losing money every time it provides its service to a customer? Well, there is an answer to that question. All of these companies are backed by venture capital dollars. Many of these companies were founded in the past couple of years during that so-called race to the bottom.

During a recession, these are the kinds of businesses that will likely go out of business first because let's think about it: do people really need things delivered to their doorstep in just 10 minutes? Probably not. During an economic slowdown, people will just walk to the grocery store to save money on the delivery fee. When these types of businesses go out of business, this results in the reallocation of resources.

Musk talked about the software engineers and other very talented workers that used to work for that failed company. Now they go to work for a different company that is serving a more useful purpose in society. So while recessions are not very fun when they're happening, it's important to keep the long-term perspective in mind.

So there you have it. Let me know what you guys think of this video in the comments below. Make sure to like this video and subscribe to the Investor Center because it is my goal to make you a better investor by studying the world's greatest investors. Talk to you again soon.