It’s Called a Depression

I’m going out on a limb here, and I’m going to suggest that we have already entered a depression.  The concept of a depression is even less objective than that of a recession,  but some suggest that a decline in real GDP of 10% or more is the criterion, which we have not attained yet.

I don’t think a 10% decline in GDP is the right threshold.  Depressions are different because of their widespread nature, often coming through financial systems that are in danger.

As it is now, many things are happening that are depression-like.  Here we go:

  • Record high levels of total debt to GDP
  • Many go hat in hand to the government.
  • The spreads of the bond market are at record levels since the last depression, and maybe comparable.
  • There is policy paralysis and confusion.  No one knows what to do (or leave alone), they act blindly or cower in fear.
  • Ultrasafe investments have record low yields.
  • Banks don’t trust each other.
  • GDP is shrinking, and unemployment is increasing at a rapid rate.
  • Financial businesses are failing and shrinking at high rates.
  • The government comes in to “help” the markets, and ends up replacing the markets.
  • The security of banks and other financial entities is open to question.

Will we get a 10% decline in real GDP?  I think so, but I am nowhere near certain on that.  What I am certain of is that the gears of finance are jammed.  The bond market is a shadow of its former self, and few are willing to take seemingly prudent risks.  I’m not sure the government can do much to affect this; it will work out over time, as debts are paid off and forgiven, as the last depression did.

I won’t be your host through this depression, should I live so long.  But knowing what things will be like if we are in a depression is a real advantage for those who invest or run businesses.  Be careful.


  • Gonzalo Lira says:

    You wrote, “But knowing what things will be like if we are in a depression is a real advantage for those who invest or run businesses.” Please elaborate, I’m very curious as to your ideas regarding investment in a Depression scenario.

    I fully agree, we’re in a Depression with a capital D—however, I think this one will be worse. Unlike the last Depression, today, the US has tremendous fiscal debt (at Federal, State and local levels), a serious balance of payment issue, and a population that is unwilling to pay for all the services that they demand from their government, yet expect those services and privileges anyway, regardless of the cost. This potentially spells the doom of the Republic.

    There is no reason to think that something that has happened before will never happen again. Has there been a Capital-D Depression before? Yes of course; several, in fact. Has there been a deflationary spiral brought about by the collapse of private credit, as we are beginning to experience? Yes. Have those deflationary spirals been followed by a currency collapse, as seems likely to occur on the day the foreign Central Banks stop buying Treasuries? Check. Social chaos brought on by financial hardship? Check again. End of a democratic republic and replacement by something not-so-pleasant in order to “reestablish peace and stability”? Unfortunately, check.

    I don’t think people realize how potentially threatening this coming Depression really is. Forget about the financial hardship—the real issue of this coming Depression is whether the Republic will survive at all.

    Sounds crazy? Sure. But if a year ago, someone had outlined what we’ve experienced in the last four months…

    (Parenthetically: You wrote, “I won’t be your host through this depression, should I live so long.” What do you mean? I hope nothing serious…)

  • pj says:

    That was scary David. Shit.

  • 1134 says:

    Wind speed of a hurricane is less important than its integrated kinetic energy. We should measure comprehensive damage to the wealth of nations, but how?

  • David:

    I appreciate and respect your use of deductive reasoning.

    What counter-arguments could you make that would say we will NOT experience a depression?

    My logical perspective is that the fundamental problem of this financial crisis is housing. This crisis began with housing and, arguably, it will end with housing.

    Following this line of reasoning, would you agree that the latest data revealing record drops in new housing starts and building permits would allow for excessive home inventories to fall?

    If so, wouldn’t a fall in home inventories (supply) stabilize home prices and provide the beginnings of a foundation to build upon?

    In my view, market sentiment is becoming excessively irrational; however, this irrational behavior is effectively wiping out the excesses of the housing and capital markets, which, ironically, is just the kind of environment needed to move forward…

    What are your thoughts?

    “Before the beginning of brilliance, there must be great chaos. Before a brilliant person begins something great, they must look foolish in the crowd.” ~ The I Ching

  • Louis Hill says:

    Hi David

    I think you are spot on.


  • chas says:

    Right on the money. Too much debt in the system that needs to be purged. The Keynesian Krugman sheepishly believes (as others do) that WWII got the U.S. out of the Depression. Wrong. Total credit market debt in the U.S., in 1929, was around 260% of GDP. By 1942, it was around 150% of GDP. In others words, A LOT OF DEBT was cleansed from the system, and that allowed the Keynesian Roosevelt to do the spending required for the war. This time, however, the story is different. Total credit market debt in the U.S. is fast approaching 400% of GDP. So, you see, there is no way that the Keynesian Obama, following on the Keynesian Krugman recommendations, will be able to inflate public spending. They are so toasted with their silly recommendations of spend, spend, spend, print, print, print. Thank God that this depression will expose these Keynesian potheads as economically incompetent and ideologically primitive. But we’ll still have to suffer the consequences of years and years of Keynesian demagoguery. Hey, if this idiocy brought prosperity, Argentina, Zimbabwe, Peru and lots of other fiscally irresponsible third world countries would be powerhouses by now. Right? Long live the Austrian School of Economics. Menger, Böhm-Bawerk, Mises, Hayek and this new and bright generation of Austrian economists are right in relation t o the nature of the business cycle. Let’s get rid of central planning, let’s get rid opf central banks.

  • I don’t mean to be rude (consider it as a dissenting view :) )but I think that’s a totally ridiculous suggestion. It MAY turn into a depression but, unless the government does something stupid (like enact massive tariffs on China,) we are nowhere near a depression. GDP growth is still nowhere near depression levels (even if you assume they will be adjusted downward later.)

    It probably looks like a depression to you because you are engaged in financial activities and we are in a severe financial crisis.

    Most of what you describe could have applied to the Panic of 1907 yet it was nowhere near a depression. Similar to then, the financial economy looks really bad but the rest of the economy is only signalling a somewhat severe recession (typical of 1974 or 1982.)

    People are also ignoring some positive results that are unfolding right now. The collapse in commodity prices should contribute positively to GDP.

    Furthermore, speaking as a contrarian, it seems hard to believe that we are in a depression when the market consensus is for one. Practically a day doesn’t go by without someone in the media saying that we are facing a Great Depression. When was the last time the consensus called a depression (or anything else) in advance? How many would have said Japan would enter a long deflationary depression in the late 80’s or early 90’s? How many knew of the Great Depression in 1929 or 1930 or even 1931? How many thought the Asian Tigers would collapse in advance?

    As far as I’m concerned, we we have is a depression in the financial economy and all businesses engaged in it. This is no different than how practically the technology sector was in a depression 8 years ago. The rest of the economy, although weak, is definitely not in a depression.

  • Terry says:

    Your recent posts–all very pessimistic–have suggested that you would come to this conclusion. Your bullets could apply to almost any major financial crisis (1987 market drop, 1998 LTCM). Leaving aside a set GDP drop number to define a depression, I do not believe we will have a drop in GDP or the markets (90% in the Great Depression) for period long enough (at least 10 years) to call it a depression. As for me, I don’t think we’ll see a 10% GDP drop–probably half that–and I expect the economy to start moving upward when the housing market stabilizes–2010 or 2011.

    That said, here’s my challenge to you: Create another list of reasons we’re not (or not likely) to go into a depression. The contrast would make a good discussion piece.

  • Stuart Gray says:

    “it will work out over time, as debts are paid off and forgiven, as the last depression did.”

    Sorry to disagree, but the “Great Depression” did not ‘work out’ because debts were paid off and forgiven but because we fought and won WWII and emerged unscathed.

  • bkm says:

    I agree with david. For the simple reason that our debt levels are huge. The economy is completly trapped. The credit markets are currently forecasting a depression worse than the last one. The speed at which this is happening is truly amazing. I have been a broker or trader for over 25 years and I have never seen anything like this. There are bonds out there that are trading below their recovery rate! How can that be? That’s what happens in a deflation.

    The problems facing the economy now are larger in scope AND multitude than the last depression.

    US debt to GDP – higher
    Aggregate debt to GDP – higher
    Trade deficit now
    US unfunded liabilities that can not be met
    Debtor nation to foreigners
    Derivitives- CDS’s
    A much larger % of US own homes and own stock, therfore the pain is much more widespread.
    …just to name a few

    The deleveraging has begun and will continue for some time. When the defaults start to esculate and then stabilize we will have found our bottom. The damage will be severe causing an extreme aversion to risk of all kinds. When we return to growth it will be slow for this reason.

    btw. I leased a machine at 8% last year, now they want 17% on a 5 year deal. WOW

  • winslow says:

    Whatever we call the future is a matter of conjecture. It is just a semantic. What is that the economy is not chugging along and the FUTURE at this time does not look all that fact, it is getting worse. We are all hung up on a nice division line between recession, depression. Right now, there is no fundamental that is working in business. Will it get worse, no one really knows

  • gaius marius says:

    @ 7 — contra but respectfully — per roubini, consumer spending will likely be at an annualized rate of around (-5%) in the current quarter. in q3 the YoY real rate of retail sales per calculated risk was (-8%). if that is not depressionary, what is? i agree that while such rates have not yet been sustained long enough to affirm a depression, the rate of collapse is unfortunately has made the prospect altogehter likely.

    i would suggest that — while the financial crisis shares features with many financial crises, including 1907 — the economic features have unfortunately little in common with such sanguine views. the financial crisis was a trigger, a detonator, for something else.

    mr merkel’s emphasis on total debt-to-GDP is essential in my view — that is the lodestone by which we’ll find our way out of this. and it is further essential to understand the consumer aspect of this crisis — economic historian david livingston recently wrote a must-read essay on the convergence of thirty years of declining real wages (and its converse, record profits) with unprecedented consumer debt loading via a scheme of securitization that amounted to a credit market version of the investment trust of the late 1920s.

    that scheme has collapsed completely, and much as with the collapse of blue ridge and shenandoah in 1929 there is simply no going back — debt will now have to normalize now vis-a-vis incomes at tighter-than-normal underwriting standards as grossly inflated balance sheets are reduced, and that promises a very dark march ahead.

    nothing of the kind was afoot in 1907 or 1987 or 1998. it is now. that must be understood to understand the economic fallout.

    i still think it’s an open question as to whether government can find a way to transfer (through TARP and what will surely be its successors) enough private debt onto its own balance sheet to mitigate the most apocalyptic visions of liquidation — but early returns are obviously terrible, and there very probably isn’t enough balance sheet capacity to take on the entire pile which must be resolved. hopefully they don’t annihiliate the currency in so doing.

  • Sivaram has a point. It’s hard for someone in the financial industry not to have his perspective clouded by the grim prospects for the sector. Same with the auto industry or the housing industry. The real economy as a whole though doesn’t seem to be on the verge of depression. As Sivaram noted, the collapse of commodity prices provides a tailwind (if $4 gas was a headwind, than sub-$2 gas is a tailwind), and the government has been early in providing fiscal and monetary stimulus, with probably a few hundred billion more in fiscal stimulus on its way early next year.

    There are also a lot of companies outside of the financial sector that have lots of cash on their balance sheets that they can put to work. Everyone isn’t over-leveraged.

  • vince says:

    Everyome seems to have forgotten about china and india and even russia. In the 30’s, the world did not have so many pistons of economic growth that we do now. Sure China is only 1/3 the GDP of the US and india is amaller, but there are close to 3 billion people in these two countries that are for the most part still living in poverty. Furthermore, these economies are not leveraged. They have savings. The same with Japan which is 1/2 the GDP of the US. Everyone I know owns stocks and at work, we are constantly talking about the dropping market and running around scared. These falling markets are affecting the mood because so many people are invested and the markets are so pervasive in our lives. I think we need to chill out. Unless you are trying to time the bottom to buy stocks, I bet we would all be better off if we just ignored the markets for a few months and focussed on our families and work/businss. I question the value all this daily discussion/analysys of the markets. I think it does more harm than good.

  • Ben says:

    I’m just trying to make sense of this stuff so sorry if it is a ramble.

    I hear the “anti-depression” crowd suggest that the crisis will be contained to the financial sector. Hey, after all, commodity prices have plummeted, gas is cheap, things must be looking up. Then the “pro-depression” crowd points out that the collapse of the financial sector can’t possibly be contained because business models throughout every single sector in the economy have become tied to cheap credit.

    And, it certainly looks like without massive government intervention to force banks to hand out credit cards and keep us all shopping, easy credit is going to be a fairy tale we tell our grandkids about.

    But if cheap credit is gone (how much less credit overall I wonder)…what kind of an economy are we left with? Are we seeing the end of tech bubbles? Silicon Valley? If America doesn’t have that kind of engine of growth how on earth is it going to be able to meet its obligations?

    All the basic questions in this mess still are a mystery to me:

    How much of a credit crunch has their been, really?

    How much less credit will be available in the future, to businesses, to consumers.

    Is this credit destruction irreversible?

    To what degree was the strange brew of hedge funds, investment banks, private equity and whatever else central to our economic growth in the past 20 years (i.e. are we really going to miss them that much?)

    Can the taxpayer step in and provide the guarantee of safety necessary to keep credit flowing?

    IF the credit really is gone, how long will it take to build consumer demand up again?

    I think I’ll stop now,
    Too many questions…

  • Mike C says:

    I don’t know. All this Depression talk just seems extreme and excessive to me, and it seems to me that many (but not all) that are now postulating the Depression scenario are the same people that were arguing stocks were “cheap” in 2007 based on the Fed model or some variation. It just seems like many have swung from being way too bullish when risk was high too maybe way too bearish presently.

    Hussman talks about the Great Depression comparisons in this week’s commentary, and when considering his views on the subject I think it is important to note that he was one of the few voices who correctly identified the risk in stocks in 2006 and 2007 while many were going through analytical contortions to argue stocks were undervalued

    “If we seriously need to talk about the Great Depression (I personally believe that it is an outrageously dire comparison)…”

  • “These falling markets are affecting the mood because so many people are invested and the markets are so pervasive in our lives.”

    Another good point.

    “I hear the “anti-depression” crowd suggest that the crisis will be contained to the financial sector.”

    Speaking as just one member of the ‘anti-depression’ crowd, the crisis isn’t contained to the financial sector — it just won’t get as bad everywhere as it is getting in the financial sector, e.g., I don’t think United Technologies is going to be laying off a big percentage of its workforce as Citigroup is.

    “Hussman talks about the Great Depression comparisons in this week’s commentary…”

    John Hussman is one of the few fund managers coming out of this year looking like a champ. His AUM will surge, and deservedly so.

  • It’s interesting the last few comments mention Hussman’s article. I thought of it immediately when reading this post.

    In fact, I went ahead and posted some of the main points from both posts to draw and compare…

    “Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic.” ~ Charles Sanders Peirce

  • Paul from Florida says:

    What does it say about command economic policy in general if the very idea of if we are in a depression or not, is discussible?

    Speaking of autos, take Detroit. Didn’t we ‘invest’ trillions to ‘save’ the cities so that they would become income generating workers paradises? Did someone forget Detroit? Newark, et. al.? Or did the much simpler, smaller than our national economy, Master Plan fail? Where was the accounting? Who was fired? Where were the lessons learned? Or, did we have a Government Policy memory hole out of a Orwell book?

    So now, the same big tent of monetary button pushers, now out with slide-rules and in with econometrics are going to come through? They didn’t for Detroit and company.

    It seems like the Big Three might go out of business. I can understand why Washington is reluctant to deliver 25 billion to the Big Three. But, why can not our economic masters in Washington, the Fed, supply the particular solutions to the Big Three. After all they are competent to run the country. Right? Hello? Bueller? Anyone? Not a endangers snail, nor child is left behind. Certainly turning around a auto company is small potatoes for these elites.

    So, which is it? Is Washington the all seeing, plus or minus, or are then just a bunch of Jesuitical bunko artists, sucking up the hindmost out of the productive class?

    If it is the latter, as I feel, then the Clown Posse, some more better than others, are driving the bus.

  • webster hughes says:

    Here’s what I think happens:
    1) The US government continues massive borrowing at low interest levels for extended period of time. This is possible because of high global risk aversion, deflationary concerns, leap of faith that the US government will pay back that money, and temporarily stable dollar due to improving trade imbalance (reduced US consumer spending and increased demand from China and India).
    2) Massive US government deficit spending is used for bank bailouts, corporate bailouts, municipal bailouts, pension/insurance bailouts, public infrastructure, direct stimulus, consumer debt modification, healthcare, subsidies (eg agriculture and energy) etc.
    3) Results of this massive deficit spending are that banking system is effectively nationalized but continues to function, public services are scaled back but continue w/o interruption, consumers reduce spending but muddle through without social unrest (thank you Barak Obama), businesses continue producing (with government help that enables artificially high wages), and US technology continues to advance.
    4) Meanwhile, urbanization of China/India greatly increases demand for US goods (technology, services, agriculture). Coupled with government help and technology/productivity advances, the US economy is able to produce more and sell more globally. Corporate bailouts and consumer stimulus packages means businesses and agriculture will likely readjust to higher output, higher prices, and higher nominal wages (i.e. inflation).
    5) Throughout this process, US public debt will grow due to massive borrowing and the US private debt will decline due defaults, downsizing, and reduced private credit availability. The US government will continue this program as long as possible – namely until a combination of inflation and higher government borrowing rates make it unfeasible.
    6) At that point, we’ll have a massive government debt, an inflated economy, and maybe even a trade surplus. At that point, the government will raise taxes, and may be able to privative its corporate investments (TARP, etc) and buy back US Treasury debt at greatly reduced price.

    The buyers of government bonds at today’s prices will lose big money. Equity and debt market investments at today’s prices will produce reasonable nominal returns but get whacked by inflation over the long-term. I think the best investment today is high-quality US farmland.

  • gaius marius says:

    @ 15 — But if cheap credit is gone (how much less credit overall I wonder)…what kind of an economy are we left with? Are we seeing the end of tech bubbles? Silicon Valley? If America doesn’t have that kind of engine of growth how on earth is it going to be able to meet its obligations?

    i revisited just yesterday an interesting view of the depression of the 1870s — which was notable for some similarity to our current situation, particularly the collapse of a land bubble. the massive trusts were born of this collapse, and did so by going in self-financed and sitting on massive cash piles. this cash was employed to maintain operations while the world was ending, and then to hoover up what remained of the credit-dependent competition.