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This is not the Great Depression

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October 23, 2008 – Comments (13)

 

The current credit crisis, recession, or whatever you want to call the mess that the world finds itself in right now has many moving parts and subplots, however when one thinks about it at the highest level it all boils down to one thing…risk.  The problem with the United States’ economy is not one of liquidity like it was during the Great Depression when there was a run on banks and the government responded too slowly.  Everyone’s favorite student of the Depression, Ben Bernanke, will make sure that there is plenty of money floating around out there.  You can be sure of that.

Unfortunately the government's flooding of the market with money will not in itself necessarily cure what currently ails our economy.  The problem that we currently face is actually a rapid, dramatic swing in sentiment from a complete ignorance of risk to extreme risk aversion.

During the bull market of the last several years, both banks and consumers levered up, consumers did so by taking on additional debt that banks made readily available and the Federal Reserve made too cheap, hedge funds levered up seeking to juice their returns, and worst of all investment banks levered up to 20, 30, and possibly even 40-1 because the SEC, Phil Grahm, and others idiotically decided to allow them to.

Leverage is great on the way up, but boy oh boy does it ever hurt on the way down.  Just ask all of those CEOs like Aubrey McClendon, Chesapeke Energy’s CEO who was recently forced to sell nearly his entire stake in the company that he helped build because of a margin call.  As companies delever, they are being forced to sell assets, some which are garbage and others which actually have value, into a risk averse market that has very few buyers.  

Making matters worse, banks are afraid to lend money to companies, and even each other right now.  They would rather use the liquidity that the Treasury and the Fed are pumping into the system to wind down their leverage to a more reasonable level than lend it to other parties. 

This rapid reduction in the velocity of money means that regardless of how much cash the government prints it won’t do much good until banks begin to lend again.  When banks don’t lend, many companies have problems.  Credit has been the lifeblood of our recent economic expansion.  When companies do not have adequate access to capital, things often grind to a screeching halt.

The painful deleveraging process is happening at the consumer level as well.  As consumer confidence falls to levels never before seen and the unemployment rate rises, consumers are pulling back on spending, some are even, gasp, saving money for a rainy day.  Unfortunately, those who are still willing to spend money like a drunken sailor often find themselves unable to do so as banks are unwilling to lend money, shutting down the home ATM by pulling HELOCs and actually having reasonable mortgage standards, lowering limits on credit cards, etc…

So this is where we find ourselves today.  The question is, what will fix this and how bad will things get.  I have been wracking my brain trying to come up with an answer to these questions and here’s what I think.  The only thing that will fix the risk aversion that we are currently seeing and restore confidence to both consumers and banks is…time.  

In time housing values will eventually find a bottom.  When housing does bottom, banks will no longer have to worried about the mortgage backed securities, and all of the other exotic products that were developed over the past decade because the bad ones will have blown up and good ones will remain.

In time banks will be so overcapitalized that they will eventually, gradually begin to lend again.

In time, the leverage that banks took on will be wound down.

During the period which all of these things are occurring, the United States, and probably much of the rest of the world will experience a recession, the length and depth of which will depend upon how long the deleveraging, recapitalization, and restoration of confidence take.  

People who claim that we are headed for another Great Depression have no idea what they are talking about.  The unemployment rate hit 25% during the peak of that period.  It currently sits at only 6.1%.  I know that the BLS and government employment numbers probably underestimate the level of joblessness, but still even in a worst case scenario few envision the unemployment rate hitting double digits.  If it does, that brings us the sort of pain that we had in the terrible, yet far from depression like 1982-1983 recession.

The Federal Reserve and the Treasury are hell bent on preventing a depression, they will print, print, print money until banks are choking on it and have to eventually lend it out.  Furthermore, the next President (which I strongly suspect will be a Democrat) will work with Congress and the Senate to spend, spend, spend money to prop up the economy.  The last thing that a new administration wants is a depression.  They will completely forget about fiscal restraint and the budget deficit and do whatever it takes to prop up the economy giving rebates to millions of people, earmarking tons of money for new infrastructure projects, on, and on, and on…

Is this the right thing to do?  I’m not sure that it is.  The likely outcome of this is that the current recession will be followed by yet another bubble of some sort as well as massive inflation, followed by another possibly more painful bursting.  But that will be someone else’s problem a few years down the road, not theirs.  Just ask Alan Greenspan.

I'm not saying that everything is all peachy, just that it isn't as bad as the doomsday, get your canned food and guns ready, end-of-the-world crowd say it will be.  Keep averaging into the market a little at a time, buying stock in quality companies at exceptional prices.  Eventually things will turn around, even the Great Depression ended and this is no depression.

Deej

P.S.  I am not taking anything for granted and I am doing as much research as I can on this subject.  I am about to start another book on the Great Depression called The Forgotten Man.

13 Comments – Post Your Own

#1) On October 23, 2008 at 3:11 PM, goldminingXpert (29.76) wrote:

this is not *yet* the Great Depression. Just fixing your headline.

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#2) On October 23, 2008 at 3:30 PM, climate (73.42) wrote:

This is not Great Depression.  This is worse.  Let's call it Financial Armageddon.  All the money the government pump into the banking system will flood the bank.  Still they will be eaten up by the mortagage defaults, credit card defaults and business loans.  We haven't seen the big layoffs yet.  Government will find that they will eventually bailout not only banks, corporations and small business.  They will have to bailout the consumers too.  No government in the world can do this willout massive money printing.  And massive money printing is just equal to a partial default and brings hyperinflation.

Can you see the picture? someone has to pay the bill.  Debts eventually has to be repaided.  It is just a matter of who is repaying.  We all lend to each other to make us feel richer.  We all have no cash.  

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#3) On October 23, 2008 at 3:33 PM, TMFDeej (99.46) wrote:

I knew that this post would bring the bears out of thw woodwork.  Come on, gold you can do better than that.  I am trying to keep an open mind and I enjoy a good debate, back your statement up with some facts.

Deej

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#4) On October 23, 2008 at 3:37 PM, TMFDeej (99.46) wrote:

Hi climate.  I think that we are somewhat on the same page here.  This is what I just said on the subject:

"The Federal Reserve and the Treasury are hell bent on preventing a depression, they will print, print, print money until banks are choking on it and have to eventually lend it out.  Furthermore, the next President (which I strongly suspect will be a Democrat) will work with Congress and the Senate to spend, spend, spend money to prop up the economy.  The last thing that a new administration wants is a depression.  They will completely forget about fiscal restraint and the budget deficit and do whatever it takes to prop up the economy giving rebates to millions of people, earmarking tons of money for new infrastructure projects, on, and on, and on…

Is this the right thing to do?  I’m not sure that it is.  The likely outcome of this is that the current recession will be followed by yet another bubble of some sort as well as massive inflation, followed by another possibly more painful bursting.  But that will be someone else’s problem a few years down the road, not theirs.  Just ask Alan Greenspan."

I suppose that my point is that the U.S. will recover from the current economic downturn without things getting as bad as they were in the Great Depression.  Unfortunately, the massive government intervention that we are seeing and will continue to see will likely have some unintended consequences...like it almost always does.

Deej

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#5) On October 23, 2008 at 4:05 PM, Tastylunch (29.54) wrote:

Well I don't have facts to back up my thoughts but figured I'd share my line of thinking right now anyway.

I'm more of the mind that this more Japapnesque recession, zombie banks propped up by the gov't, L-Shaped "recoveries" and loss of sole international economic dominance. If American consumes really are becoming savers again this country may need a decade or more to rebalance our economy's porducers/service ratio and to pay down a portion of that enormous debt we are piling up.

I think you may see the London Stock Exchange  or the Hong Kong exchange become the new premier international exchange instead of the NYSE...especially if the dems load up on new regulations in 09. Sarbanes Oxley is already preventing tens to hundreds of new issues every year and those foreign ADRs seem to be chosoing .Pk listings already (thus they already have one foot out the door) over dealing with SOX...

You are right though this isn't the GD or GD 2. This will be called something different because it is something different. If for no other reason I doubt unemployment will ever get as high as the GD's max (or at least the Bureau of Labor will never report it that way). You can also bet the gov't will be aggressive earlier than they were in the GD hiring if unemployment cracks nationally 13-15% (creating more debt, higher taxes and here we go again).

I don't think we are on track for hyperinflation at this point though, probably just really bad inflation. The asset destruction has been pretty severe and isn't over yet. When you have guys like Icahn, Kerkorian, Pickens losing 75% of what they got, a lot of that money is just gone forever. If the dollar is no longer the world's reserve currency at some point you may see more asset destruction in real money terms if foreign money pulls out of US equities and assets (eventhough I would think that would also end up being inflationary in the longer term as the money supply of dollars would increase...)

Whatver happens I think this mess has evolved into a paradigm changer for America now, it's sad  because it really didn't have to be. Not the end of the world but perhaps the end of an American era. Still the future is yet to be written.

That's just my unprofessional two cents.

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#6) On October 23, 2008 at 4:11 PM, climate (73.42) wrote:

Take a look at the bank balance sheet.

Asset = Liabilities + Shareholder equity

As mortgage defaulting, the asset side is strinking. They are facing a problem of shareholder equity going to zero. 

Lending the banks more money will not fix the problem, it will just push shareholder equity to negative.  Since banks are limited corporation,  they will likely default if the SE goes negative.

You can give the bank asset.  But be sure, you are now in a 1 for 1 situation now.  1 dollar of injected cash will counter only 1 dollar of devalue of asset.  No multiplier effect here.  I doubt US gov has that much money.  I actually think, the world, as a whole, don't have so much money.  It is because all our cash are trapped in assets that are currently massly overvalued.

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#7) On October 23, 2008 at 4:17 PM, climate (73.42) wrote:

please read my blog if you have time, it is

http://financial-armageddon.blogspot.com/

 I have just start it today and would certain appreciate it if you take time to read it (and comments).  Hope you'll find it interesting.

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#8) On October 23, 2008 at 4:18 PM, MikeMark (29.89) wrote:

Great post Deej. Time is indeed the answer. Some problems just aren't solved with money.

As far as depression or recession goes, that's all just semantics anyway. We are certainly talking about economic decline. Possibly for quite a while. Japan's has lasted greater than a decade.

Interestingly, this has all happened many times before. It isn't something to fear, it's just part of human action. Recognizing that will give you the ability to stand apart and find the place where you want to put your effort.

What I've discovered lately is that my reading has been off. I've gone back to studying economics.

Recommended reading:

Tomorrow's Gold by Mark Faber.    This has an overview of many economic cycles from various time periods and geographic locations.

Economics for Real People by Gene Callahan.    This is an Introduction to the Austrian School (of Economics). Reading it will give some insight into what the Fed is attempting and whether it will really have a good effect.

 

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#9) On October 23, 2008 at 6:22 PM, nuf2bdangrus (< 20) wrote:

The velocity of money has halted.  Everybody is hoarding cash, and they will until they are choking on it because there is so much of it they demand higher yield.  BTW, the solution to the problem is higher, not lower rates, and the higher rate will get the velicty of money moving.  Every transaction has a lender and a borrower.  We're so focused on the borrower, we forget about the lender.  PAy the lender a rate of return, and the money will start moving again.

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#10) On October 23, 2008 at 6:23 PM, mickeyc21 (29.82) wrote:

Hi Deej

All your points are accurate but the conclusion is wrong. You've bought into the Keynesian madness that creating fictional money can solve problems. Production solves economic woes and when we get back to making things in the US we will do just fine.

This is likely to be a long time as we have literally shipped entire factories overseas. Our producitve capacity is awful for such a large country. I am talking about real things: finance, insurance and real estate are intended as things to help the "real economy". We have let them BECOME the economy. We have a small bright spot in Silicon Valley but this is 2% of our economy. This is also a supporting industry. Banner ads are almost  all paid for by the three industries mentioned.

If this gets labelled a recession or the nasty "D" word gets used is almost irrelevant. We have bigger problems than we had at the start of the Great Depression. Going into a savage downturn as the world's biggest debtor as compared to the worlds biggest creditor just doesn't compare. This is in no way comparable to the Great Depression as so many are claiming.

Basically your argument is that what caused this blow up - plenty of under priced money - will solve the crisis. It has never worked in history and I will be willing to say loudly and proudly "I was wrong!" if it works this  time.

The implication running through your article is that the GD was caused by tight money policies. This couldn't be further from the truth. Peter Schiff explores this fallacy in this article. Keynes and indeed all other socialist and communist ideologies were strongly in the ascendancy during this period and they simply won the propaganda war.

By the way, what embedding code do you use?  

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#11) On October 23, 2008 at 11:44 PM, awallejr (82.72) wrote:

Deej you are a beacon of hope.  When everyone says buy buy buy you know you are at a top. When everyone says sell sell sell, guessing the bottom is near.

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#12) On October 24, 2008 at 1:51 PM, TMFDeej (99.46) wrote:

Thanks for the comments everyone.

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I'll definitely hop on over and check out your blog, climate.  Thanks for reading mine.

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Thanks for the book suggestions, MikeMark.  I am absolutely fascinated by economics and may end up adding them to my long queue of things to read.

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Hi Mickey.  My argument is not necessarily that flooding the market with money will sove this problem, just that it will prop things up for the time being.  I think that the government will eventually be able to reflate some sort of bubble, which will temporarily put off what would have been an even worse recession.

Of course, the unintended consequence of doing this will likely eventually be an extremely high rate of inflation followed by the bursting of another even larger bubble.

Time will tell though.

As far as Schiff goes, I just purchased his newest book "The Little Book of Bull Moves in Bear Markets : How to Keep your Portfolio Up When the Market is Down" and I will eventually read it.  I also read hist last book "Crash-Proof."  While everything that he predicted came true in the short run, anyone who listened to his advise and bought the things that he suggested, like gold and foreign stocks would be getting absolutely crushed right now.  He is way too much of a gold bug for my taste and he does not appear to be above bending history to suit his needs.

Anyhow, I am trying to learn as much about the Great Depression as possible to figure out if my current understanding of what caused it is correct.

As far as embedding images goes, I use the "img" tag

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Thanks awallerjr.

Deej

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#13) On October 24, 2008 at 2:03 PM, badfish1968 (81.05) wrote:

To use a bad metaphor, an economy that was running on steriods for years and has now been taken off of them will obviously contract. If the recovery is done through "natural methods", it will be slow. If it is done with more steriods, it will, eventually, once again collapse.

But we dont care because we want it now, and that is core of the problem.

Greenspan said in his testimony (paraphrasing) that he believed the banks would work to protect their shareholders. I was absolutely floored by the naivete of this statement, especially coming from a man in his position.

Shareholders dont want to be protected. They want to be rich, and right now. Greed and instant gratification with no effort drives our culture--Liposuction over the gym, let's say--and ANY publicly traded company's sole goal, whether they are a bank or make widgets--is share price and/or dividends. The CEO of a bank who has a way to drive up share price--even if it isnt sustainable--will do it and take his parachute before the fit hits the shan.

I am a fervent capitalist, but I believe in both sides of it--let contract and come back. But dont rely on the fine moral character of yankee traders, bankers and brokers for your safeguards! Sorry, but we need SOME regulation and accounting transparency because Wall Street is proving AGAIN (Enron, Arthur Andersen, et. al) that even if it could, it has absolutely no interest in self-policing.

Finally, the difference between recession and depression is important. Outside of Deej's point fo 25% UE, how about a market losing 90% of its value? And outside of denotations, the connotations of the words are significant, especially in terms of panic. And if you think panic doesnt matter, you haven't looked at the market, uh, ever.

--The fish, smelling worse than ever :)

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