Welcome to the Depression

Minyanville ^ | 26 Jan 2009 | Bennet Sedacca

[BGHater]

Recession:
A recession occurs when a nation’s living standards drop and prices increase. This downturn in economic activity is widely defined as a decline in a country’s gross domestic product for at least 2 quarters.

Depression:
An economic condition caused by a massive decrease in business activity, falling prices, reduced purchasing power, excess of supply over demand, rising unemployment, and other negative economic factors.
- Bloomberg financial definitions

Truth or Dare: Recession or Depression?

As unpopular as it may have been, I have been writing about the impending recession over the past several years. I am rather used to being called a "perma-bear" as it relates to the asset-based, over-leveraged mess we call our economy.

Truthfully, it's been no fun whatsoever to call 'em as I see 'em. An outlier view has been a necessary evil, however, and one that I've been proud to have had the guts to provide.

I will now turn to what, in my view, is the biggest risk of all: We're in a recession - and the economy can actually shrink. And shrink it has, is, and will likely continue to do. The question now: Are we going through a traditional recession, or a once-in-a-lifetime depression?

I actually hoped the unprecedented credit unwind would end up in a nasty recession; but I fear a depression is either upon us or will soon be upon us. To be truthful is essential in markets and life: To face head-on the bad news which isn't at all fun or exciting to face.

I hate to say this, as unpopular as it may be: Welcome to the depression. For my reasoning, please read on.

Putting the Recession Question to Bed

GDP estimates for 2008's fourth quarter are due to be released on Friday morning at 8:30 a.m., with estimates coming in the -5.5% range, which follows a -0.5% number in the prior quarter. Many believe the economy will turn around in the second half of the year, when the Obama administration’s fiscal stimulus plan makes things all better.

I couldn't disagree more. We have seen these stimulus plans before: Dropping $500 checks into the mail has produced more savings and debt repayment - but not a flow of steady consumption by consumers. Seriously, with new claims for unemployment benefits now averaging over 500,000 per week, the economy losing 600,000 jobs per month, and leverage still piled up on top of leverage, I think the odds of the economy being in growth by the end of 2009 (and possibly the end of 2010) is nothing more than a pipe-dream.

GDP Quarterly Change Since 1994

Are We in a Economic Depression?

There are several criteria that an economy must meet to be in a depression:
 

• Massive decrease in business activity
• Falling prices
• Reduced purchasing power

• Excess of supply over demand
• Rising unemployment
• Other economic factors.

I would like to address these factors one by one in an attempt to determine if we have actually landed in an economic depression - one that sadly may be global in nature.

The Chicago Purchasing Managers Index


The Chicago Purchasing Managers index has fallen off a cliff. The index is a monthly regional index of Midwestern manufacturing activity. An index reading below 50 (we are now at 35.1) means manufacturers are reporting deteriorating business conditions.

Richmond Federal Reserve Manufacturing Survey


Just in case you would like to believe that the Chicago manufacturing number is a fluke, get a load of the chart above, which covers states like Virginia and North Carolina.

Furthermore, if you thought manufacturing alone was under attack, you may wish to reconsider. As the US economy has become more of a service economy and less of a manufacturing economy, many have pointed to the ISM Non-Manufacturing Index for hope. Sadly, that index is plummeting as well.

Everywhere we turn, no matter the industry, no matter the country, the answer is the same: A massive economic slowdown so pervasive that nothing seems to be able to stem the tide.

ISM Non-Manufacturing Index since Inception (1997)


What about falling prices? No matter where we turn, the prices of everything -- from equities to commodities (with the notable exception of gold) to esoteric securities  to real estate -- are falling. I could fill the next 5 pages with gory details, but anyone who opens their brokerage statements knows what I mean.

There used to be "inflation in the things that we need and deflation in the things we want," but that saying is no longer apropos. Everything is falling in price, which is, at best, deflationary; at worst, it signals the depression we may very well be in.

Rising Unemployment - the Really Big Problem

Reduced purchasing power is evident (thus the question of whether supply exceeds demand can be bracketed). The charts above are quite simply proof these issues exist.

The really big problem: unemployment. Like the old saying goes, "It's a recession when your neighbor loses his job; it's a depression when you lose yours." As I write this, Caterpillar (CAT), the international leader in heavy equipment, just posted an abysmal quarter; it's laying off 20,000 people.

Many would have you to believe this is a domestic issue. Nothing could be further from the truth. Since much of Caterpillar's business is conducted outside the US, it confirms my suspicions that the economic issue is indeed global; anyone hanging their hat on an economic recovery due to a 1933-style infrastructural improvement had better take a look at Caterpillar's news release.

Just to give you a flavor for how far-reaching the unemployment situation is, the following companies have recently announced job cuts and layoffs - all are global, best-of-breed and industry leaders: Caterpillar, Kimberly-Clark (KMB), Pfizer (PFE), Royal Bank of Scotland, ING (ING), Harley-Davidson (HOG), Philips International, Microsoft (MSFT), Deere (DE), Starbucks (SBUX), United Airlines (UAUA), Schlumberger (SLB), Xerox (XRX), Toyota (TM), Sony (SNE), Union Pacific (UP), Bentley, Reebok, Fiat and Clear Channel (CCO).

OK. Are you depressed yet? If you think that list is scary, consider this: All those layoffs have been announced since last Thursday.

To get a sense of just how bad things have become, I offer up these rather sobering charts:

US Initial Jobless Claims


The difference between this cycle and past cycles is the persistence of the high numbers of laid-off workers and the rather high absolute number.

Sadly, I don't expect this trend to change for quite some time, with a terminal unemployment rate between 12-20%. Once again, depression-like numbers.

US Continuing Jobless Claims


While the reported unemployment rate in the US creeps toward 7.5%, it's nowhere near the highs reported in the early 1980s, let alone the rates of prior depressions. The $64,000 question is whether or not we can trust the numbers being reported. As a cynic, I certainly do not. Whether it's the flawed "Birth/Death Rate Model," which arbitrarily adds jobs via "hedonic adjustments," or other manipulations of the unemployment rate, it's nearly always understated.

A recent study showed that, when we add in "discouraged workers" -- those who have given up looking for a new job and have run out of unemployment insurance -- then add part-time workers who want to work full-time, the US unemployment rate is closer to 13.5%.

And with economic activity dropping off a cliff, the 13.5% number seems much more logical to me than 7.2%.



Unemployment Rate, Courtesy of Shadow Government Statistics


According to the data from John William’s website, www.shadowstats.com, the rate stands at 13.5%.

The main point I would wish to deliver here: An economy built on so much leverage, deteriorating so quickly, is going to collapse, no matter what the stimulus (bailouts, buyouts, TARP, Stimulus packages, quantitative easing, mortgage market manipulation, etc).

The economic avalanche is upon us. And if you've ever witnessed an avalanche, there is no way to stop it.

In fact, with Ex-Fed Chairman Paul Volcker as President Obama’s economic advisor, I would expect some tough times ahead. Mr. Volcker has a tough-guy reputation (recall he snuffed out double-digit inflation in the early 1980s - I was there to see it, and can tell you it wasn’t fun) by raising short-term rates to near 20%, causing an ugly recession, double-digit unemployment, and pain for all asset classes. The tough decisions he made, however, paid off with a 26-year bull market for Treasuries, which I believe is now over. Finally, I believe Mr. Volcker will be the real force behind the Treasury Department's actions - not Tim Geithner.

In short, buckle your seatbelts. I continue to avoid credit, under-weight equities, and to batten down the hatches. Unfortunately, I believe the worst is yet to come.

[Pelham]

The stock market crash may have been incidental to the Depression. The real damage to the economy, at least in the opinion of Schumpeter, and Friedman & Schwartz was the collapse of thousands of banks in the years 1930-33. Banking collapse caused the money supply to shrink by one third and credit became impossible to get.

[FFranco]

It started in America.

[Pelham]

You mean you were only paying attention to what was occurring here.

[wbill]

Wartime rationing wasn’t really part of the Depression. True, true. I really just told the story more to make a point of where things are today, vs where they were years ago. It's hard, at least for me, to believe that 1) Something as commonplace as a Safety pin was unavailable and 2) That people couldn't afford them anyway. In that same vein, my grandmother told me about knitting diapers (called "soakers") for my father. I can't imagine what it was like to need to hand wash knit diapers. Bleah! Things are a whole lot better with disposables, now.

Even pennies lost their copper and became zinc. yep. In '43 they were made out of steel, and '44 out of spent shell casings (I think....)

But the causes of this current downturn are eerily similar to what led to the Depression. I agree with you there, as well. Populist pres, running on a "Tax the Rich" strategy and protectionist policies, banks in turmoil. However, I disgree with many posters on this thread that are saying "The depression is already here!".

I don't have a lot of room for drama queens and doomsayers. There's still a long way to go before we're reliving the 30's, and honestly, society is substantially different (more robust financial safety nets, for one. Europe hasn't just finished dismantling itself via WW I, for another), so I don't see 25% national unemployment on the horizon. Could it happen? Sure, but not next week, or even this year.

For what it's worth (exactly nothing)....my opinion is that we're somewhere around the bottom right now. We'll bounce around here for another year or so, then things will start to pick back up again. Usually, when all of the Doomsayers crawl out from under their respective rocks, that's when things start to turn around....just like when all of the Pollyannas come out and say "Stocks are all going to the moon! This time it's different!" I start putting money into cash and hoarding canned foods. :-)

[Toddsterpatriot]

Even pennies lost their copper and became zinc steel.

[GregoryFul]

Oh, come on! I’ve been using credit cards for years - because of convenience. I pay them off in full every month - no fees, interest, & etc. Friends & relatives do the same thing. Using a credit card is not a solid indicator of living beyond one’s means and drowning in debt as some would have you believe.

[April Lexington]

Oh, come on! I’ve been using credit cards for years - because of convenience. I pay them off in full every month - no fees, interest, & etc. Friends & relatives do the same thing. Using a credit card is not a solid indicator of living beyond one’s means and drowning in debt as some would have you believe.

Welcome to the 1% of Americans who understand consumer debt!