Weekend Economists Ring in the New! New Year 2015

[Demeter]

11. Why the US economic crisis is a depression and not a recession

https://www.creditwritedowns.com/2013/01/hitting-debt-ceiling-us-economic-depression.html?utm_source=rss&utm_medium=rss&utm_campaign=hitting-debt-ceiling-us-economic-depression

...The idea here is that we are in an interregnum period similar to the 1933-1937 period that will unfortunately come to an end. I’m going to spell this out briefly because it highlights my guiding macro thesis for the past few years on the US... I wrote a post in October 2009 entitled, “The recession is over but the depression has just begun“. Here are the most salient points from that post:

When debt is the real issue underlying an economic downturn, the result is a period of stagnation and short business cycles as we have seen in Japan over the last two decades. This is what a modern-day depression looks like – a series of W’s where uneven economic growth is punctuated by fits of recession…

So where are we, then? We have left the fake recovery and are entering a new era of growth that could last as long as three or four years or could peter out very quickly in a double dip recession…

As for the recent asset-based economic reflation, be under no illusion that these measures ‘solve’ the problem. The toxic assets are still impaired and banks are still under-capitalized. But the increased asset value and the end of huge writedowns has underpinned the banks and led to a rise in the broader market in a feedback loop that has been far greater than I could have imagined at this stage in the economic cycle.

The double dip or the economic boom?

So what’s next? A lot of the economic cycle is self-reinforcing (the change in inventories is one example). So it is not completely out of the question that we see a multi-year economic boom. Higher asset prices, lower inventories, fewer writedowns all lead to higher lending capacity, higher cyclical output, more employment opportunities and greater business and consumer confidence. If employment turns up appreciably before these cyclical agents lose steam, you have the makings of a multi-year recovery. This is how every economic cycle develops. This one is no different in this regard.

However, longer-term things depend entirely on government because we are in a balance sheet recession.

Get ready because the second dip will occur. It will be nasty: unemployment will be higher and stocks will go lower than in 2009. I am convinced that it is politically unacceptable to have the government propping up the economy…

So to recap:

A depression was borne out of high levels of private sector debt, the unsustainability of which became apparent after a financial crisis.

The effects of this depression have been lessened by economic stimulus and government support.

Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more stock market increases and eventually to asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery.

In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized

Because large scale government deficit spending is politically impossible, expect a second economic dip within three to four years at the latest.

...Personally, I would like to be proved wrong. I don’t want a depressionary relapse. But right now, it looks like we are headed in this direction.

About Edward Harrison

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.