¹²What Is A Depression Anyway?
By David A. Rosenberg | 3 September 2010
We believe that the economy is in a modern day depression. And, below we illustrate why that is the case and why it has nothing to do with the level of ISM, which we see heading below 50 in the next few months in any event.
A depression, put simply, is a very long period of economic malaise. A series of rolling recessions and very modest recoveries over a multi-year period of general economic stagnation as the excesses from the prior asset and credit bubble are completely wrung out of the system. In baseball parlance, we are in the third inning of this current debt deleveraging ball game.
To say we don't have a form of economic depression on our hands is pure denial— it's only not the 1930s version. It's a mini replica of Japan for the past two decades. Ask Richard Koo— he wrote the book on it. To be sure this may have been Bush's "Great Recession", but it is now Obama's "Not So Great Recovery"— great WSJ op-ed column on this today by Michael Boskin (Summer of Economic Discontent). Also see Elaine Chao's Another Unhappy Labor Day.
Finally, Dallas Fed Bank President Fisher hinted at a speech yesterday that the Fed has done enough and that there is little in the arsenal that can deal with the high level of economic uncertainty that at this stage is best left to shifts in regulatory and fiscal policy. Not much to argue there— are interest rates or bank cash reserves really an impediment to a growth revival? Problem is that we have gridlock in Washington that will impede the passage of pro-growth polices and we don't seem to have a huge backing at the Fed for QE2 barring a collapse of some sort. So the bulls will manage to ride the periodic piece of good economic news, no matter how spurious as in the case of the unexpected uplift in ISM, but they don't have a sugar daddy policymaker to hold their hands anymore. The Fed, as was the case in 2007 and 2008, is going to be reactive, not proactive.
You know you're in a depression when interest rates go to zero and there is no revival in credit-sensitive spending.
The economy is in a depression when the banks are sitting on $1.3 trillion of cash and yet there is no lending going on to the private sector. It's otherwise known as a liquidity trap. Depressions usually are caused by a bursting of an asset bubble and a contraction in credit, whereas plain-vanilla recessions are typically caused by inflation leading to Fed tightening (ie, increased short term credit rates) and excessive manufacturing inventories. You tell me which fits the bill today.
Basically, in a depression, secular changes take place.
When almost half of the ranks of the unemployed have been looking for a job fruitlessly for at least six months, you know you are in something much deeper than a garden-variety recession. True, we can't see the soup lines; the soup lines are in the mail— 99 weeks of unemployment cheques for over 10 million jobless Americans. Don't be lulled into the view that we are into anything remotely close to a normal economic cycle.
Attitudes towards debt, discretionary spending and homeownership are altered for many years, or at least until the scars from the traumatic experience with defaults and delinquencies fade away. That is why, as per last week's data releases, we saw existing home sales slide to 15-year lows and new home sales to record lows despite the fact that mortgage rates have tumbled to their lowest levels in modern history. There is no economic model that would tell you that declining mortgage rates should lead to lower home sales.
In a depression, radical changes occur in terms of social norms and spending behaviour.
In recessions, people don't cancel their life insurance policies— as one example. But in a depression, tragically, that is what happens— almost 35 million Americans now have no such coverage, up from 24 million only five years ago. This reflects the focus by households on paying down their debts and reducing household overhead at all costs, and how companies have bolstered profits, ie, by eliminating benefits such as life insurance.
More fundamentally, in a recession, the economy is revived by government stimulus. In depressions, the economy is sustained by government stimulus. There is a very big difference between those two states.
After all, we are now in a situation where every 1-in-6 Americans is now receiving some form of government assistance— more than 50 million Americans, from food stamps, to Medicaid, to extended jobless benefits, are on one or more taxpayer-supported programs. That transcends the definition of a recession.
In a recession, everything would be back to a new high by 33 months after the initial decline. This time around, everything from organic personal income to employment to real GDP to home prices to corporate earnings to outstanding bank credit are still all below, to varying degrees, the levels prevailing in December 2007.
Let's be clear: After all the monetary, fiscal and bailout stimulus, the economy should be roaring ahead, as would be the case if the economy were coming out of a normal garden-variety recession. The fact that there has been no sustained response to all these efforts by the government to turn things around is a testament to the view that this is not actually a traditional recession at all, but something closely resembling a depression.
That, my friends, is exactly what the bond market is signaling, with Treasury yields rapidly approaching Japanese levels.
For all the chatter about whether the recession that started in December 2007 ended sometime last year, here is what you should know about the historical record. The 1930s depression was not marked by declining quarterly GDP data every single quarter. In fact, the 'technical' recessionary aspect to the initial period following the asset and credit shock goes from the third quarter of 1929 to the first quarter of 1933.
What is important to know is this; in that initial four-year economic downturn, from 1929 to 1933, there were no fewer than six— six!— quarterly bounces in GDP data.
The average gain in these up-quarters was 8% at an annual rate! But because they proved not to be sustainable, the National Bureau of Economic Research (NBER) refused to declare that the recession officially ended, even though the stock market rallied 50% in the opening months of 1930 on the belief that the downturn was about to end. False premise. And guess what? We may well be reliving history here. If you're keeping score, we have recorded four quarterly advances in real GDP, and the average is only 3%.
I can understand how emotional the debate can get over whether or not we have actually just stumbled along some post-recession recovery path or whether or not this is actually a depression in the sense of a (more or less sustained) downward trend in economic activity merely punctuated with noise that is influenced by recurring rounds of government intervention. The reality is that the Fed cut the funds rate to zero, as was the case in Japan, to little avail. Then the Fed tripled the size of its balance sheet— again with little sustained impetus to a broken financial system. Government deficits of nearly 10% relative to GDP, or double what FDR ever ran during the 1930s, have obviously fallen flat in terms of providing any lasting impact to the economy.
This is going to sound like a broken record, but it took a decade of parabolic credit growth to get the U.S. economy into this deleveraging mess and there is clearly no painless "quick fix" towards bringing household debt into historical realignment with the level of assets and income to support the prevailing level of liabilities. We are talking about $6 trillion of excess debt that has to be extinguished either by paying it down or by walking away from it (or having it socialized). Look, we can understand the need to be optimistic, but it is essential that we recognize the type of market and economic backdrop we are in.
The markets are telling us something valuable when (after a period of unprecedented government bailouts, incursions and stimulus programs) we had a 2-year note auction that saw the yield dragged to new record low of 0.46%. Instead of lamenting over how attractively priced equities must be in this environment, market strategists and commentators would bring a lot more to the table if they tried to decipher what the macro message is from this price action in the Treasury market. Conducting stock market valuation analysis based on unrealistic 'consensus' earnings assumptions does nobody any good, especially when these estimates are in the process of being cut.
If the Treasury market is correct in its implicit assumption of a renewed contraction in the economy, then we could well be talking about corporate earnings being closer to $60 or $65 in the coming year as opposed to the current consensus view of almost $90. In other words, we may wake up to find out a year from now that whoever was buying the market today under an illusion of a forward multiple of 12x was actually buying the market with a 17x multiple.
How's That For A Reality Check?