Arguments against the depression outlook
Feb 24, 2009
Below is an excerpt from
a commentary originally posted at www.speculative-investor.com
on 22nd February, 2009.
Over the past two months we've explained why we think a great depression is on the cards. We are not 'doom-and-gloomers' who relish the prospect of an economic debacle; in fact, we very much hope that our depression prediction proves to be way off the mark. Our analysis of the economic situation is simply heading where logic takes it.
This is a case where we would like to be proven wrong and are diligently looking for reasons why we could be wrong. Unfortunately, at this stage we haven't come across a good counter-argument. The consensus seems to be that things won't get anywhere near as bad over the next few years as they were during the 1930s because, well, because they just can't. Our retort is that the economic situation is far more precarious today than it was during the months following the 1929 stock market crash, so why is it so hard to believe that another "great depression" lies in store? To support our view we cite the following:
The credit expansion of the past 10 years was much bigger than the credit expansion of the 1920s, leading to the situation where debt is a higher percentage of GDP than it was at the outset of the 1930s depression.
Due to the greater magnitude of the more recent credit expansion and much faster growth in the supply of money than occurred during the 1920s, there is a more troublesome mismatch between production and consumption today than there was at the outset of the 1930s depression. Another way of saying this is that more money was ploughed into ill-conceived 'bubble activities' during the past 10 years than during the 10 years leading up to the depression of the 1930s.
In misguided efforts to help rejuvenate their respective economies the governments of today are making the same mistakes that were made during the 1930s, only more rapidly and on a grander scale. For example, governments are: trying to prevent prices from falling to their natural levels, encouraging and propagating the further expansion of debt, propping up failed business ventures, increasing the burden that the government itself places on the economy, creating a more uncertain environment and thus reducing the incentive to invest for the long-term, and taking actions designed to reduce savings at a time when inadequate real savings is a big part of the problem.
There is about one quadrillion dollars of financial derivatives that have to be accounted for today that didn't exist during the 1930s. We don't think the derivatives issue is close to being the most important economic problem out there today, but it adds to the overall risk.
So, what are we missing? Why don't the above points suggest that another great depression is a high-probability outcome?
We suspect that those who believe a great depression to be almost out of the question will attempt to substantiate their optimistic view by noting that according to the official GDP number the US economy only shrank by 1% (around 4% annualised) during the final quarter of last year. Our first reaction to such an argument is that given the plunges in house prices, auto sales, employment and the PMI (Purchasing Management Index), as well as the virtual collapse of the banking industry, you would have to be very gullible to believe that the US economy only shrank by 1% last quarter. In any case, if we are currently at the equivalent of Q1-1930 then there should currently be MINIMAL evidence of depression in the official statistics. Note, for instance, that the US economy appeared to be doing so well during the first few months of 1930 that President Hoover declared the downturn to be over in April of that year. If anything, the surprise over the past couple of months has been the almost total ABSENCE of economic recovery signs. Our view has been that there would be an economic 'false dawn' during the first half of this year followed by a resumption of the deterioration, so the relentless weakness is a little disconcerting. It is also worth noting that GDP numbers will tend to understate changes in the overall economy. The reason, as discussed in previous commentaries, is that despite its name the GDP calculation yields an estimate of NET output, not gross output. Specifically, it fails to count the intermediate stages of production and thus weights consumption spending -- the most stable part of the economy -- at more than double its true weighting.
We suspect that those who believe a great depression to be a very remote possibility will also point to the inflationary policies of central banks, in which case they should explain exactly how counterfeiting money could make an economy stronger. In a recent article entitled "Printing Like Mad", Frank Shostak explains that creating money out of nothing can only make things worse. Where is the logical flaw in Shostak's argument?
We reiterate that we WANT to be wrong. We do not want to live through a depression, but logic tells us that a depression is a likely outcome. We eagerly await the counter-arguments.
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