That's "Depression", not "Recession".
And the last couple of weeks - since January 20th - confirms both that it will happen and that, just like the 1930s, it will be caused by government.
The difference between a Depression and a Recession is not quite so simple as the pundits would tell you. The conventional wisdom is that a Depression is just a long and deep Recession.
Recessions happen as a normal part of the Business Cycle. That is, the Frobozz Widget Company hires a few too many people and builds a few too many widgets. They get into trouble trying to sell them, and as a consequence they are forced to lay off some folks for a while and contract their operations. This causes unemployment to go up, wages to go down, and output capacity to shrink somewhat as the excesses are worked off.
Recessions happen because people are inherently optimistic and positive feedback mechanisms exist everywhere in the economy. When you're confident about your job, you spend more and save less. When employers are confident about the future, they order more raw materials, put on additional shifts and workers, and build more widgets.
But optimism, as opposed to a neutral stance, creates overcapacity. The simplest case can be seen in the weekend golfer standing on the tee of a hole that has water between him and the green; its 200 yards out. He knows that on a really good day he can hit the ball well enough to carry (that is, fly) 210-220 yards with his driver.
He also knows that 90% of the time (being a weekend hack like me) he will carry 180 and the ball will roll right into the drink.
If that golfer is being realistic today, he will pull out a 5 wood or a 3 iron and lay it up safely a few yards behind the water.
But if he's optimistic he's gonna call for the "big dog" and stroke one out there...... and in all probability, 9 times out of 10, the ball is going swimming.
It is the optimism of humans - we are an optimistic species, in the main - that leads us to tell the caddy "gimme the driver", even though the caddy knows (and we know) that the wry smile on his face conceals the fact that he already secreted another ball in his pants pocket for you to drop following the high-probability splash.
Now take that same golfer and tell him that "club rules" are that if he splashes one he cannot drop behind the water, but instead must hit it again from the tee, and things change after that splash. Will he hit the driver again? No, even though the odds have not changed! This is the feedback that happens in recessions; the inventory builds up some, layoffs start, and until evidence is seen that the slowdown is over production is cut back.
This is why, by the way, unemployment lags the economy. Going into a deteriorating economy employment continues to grow, and unemployment peaks a year or so after the slowdown is over. Simply put, once people get either optimism or pessimism going, it takes a little while before they change, and being "neutral" (that is, objective) is not one of human beings' stronger suits.
Depressions are a different animal. They come about because of structural problems in the economy, and are always credit-driven.
Credit began as a way for goods producers to get paid for things they needed to make the goods before the goods were made. That sounds circular, and it is. That is, the farmer who has land requires seed, fertilizer, water, sun and labor to produce wheat. Some of those things (labor) he can personally produce in limited quantities, but the rest are either things he must buy or are outside his control (the sun and of course weather - that is, rain.) It is the same for the builder of a television set - he requires plastic, electronic components, electricity to operate his machinery and people to assemble the sets, all of which he must pay for. The farmer with apples to sell must have a way to get them to the store, and he must pay the truck driver to get them there.
Trade credit evolved as a way to provide this short-term financing necessary to take raw materials and turn them into finished goods, or to get finished goods from one place to another. It is referred to as 'self-liquidating' because when the goods are made and sold forward the credit (debt) is retired as a consequence of the sale.
It didn't take long before people realized that credit could be used to finance consumption too. That is, your desire to own a car can be realized through the provision of credit. But this credit doesn't self-liquidate; the car is consumed as you drive it, and when you're done with the car its value is greatly diminished instead of remaining constant or being enhanced. This sort of credit effectively "pulls forward" demand - that is, it allows one to play "Wimpy" and have a hamburger today for which one will pay next Tuesday.
When this sort of financing becomes embedded in an economy there is a very real risk that it will expand almost without limit, based only on the optimism of the people involved. This in turn will create distortions in supply that are irrational and cannot be "worked off" with short layoffs and labor cutbacks.
Automobile demand is a good example. The last few years we've built 14 million cars a year. But our inherent demand to replace destroyed cars (rusted away, crashed, etc) is only 11 million or so. The other three million were "pulled forward" with creative financing - for a while.
We employed hundreds of thousands of people building cars that cannot be sold on a permanent basis. That's a problem.
These distortions cannot happen without active government involvement. Without allowing willfully false statements on 1003s (mortgage documents) you cannot grant $500,000 loans to people who make $8/hour. It simply can't happen, because the inherent risk of default on those loans is so high that absent fraud nobody in their right mind will fund those loans and honest regulators will step in and stop the stupidity before it can get out of hand.
But when these distortions become embedded in the economy as a consequence of government mismanagement, willful blindness and even active complicity in the frauds then you've got a major problem because now laying people off for a few weeks or months won't solve anything. The excess capacity that gets built into the economy is too great and creative destruction has to take place - that is, we must actively destroy that excess capacity to get out of the mess. Worse, since "pull forward" financing has taken place we've got an even bigger problem - the companies that overbuilt wind up bankrupt as they can't service their debt, and the bankers who wrote that credit go under as well.
Thus we need some sort of "systemic reset" to get out of it, lest the spiral become embedded - and the economy experience a Depression.
Since pessimism and optimism are "sticky", the correct approach is always to take the pain fast and hard.
It is also politically impossible to stand before the people and say "My fellow Americans, you're going to lose your job while we retool this economy." Anyone who does that gets voted out of office immediately - but it is precisely what has to happen.
To "structurally reset" our economy something different has to happen. The government can't spend its way out, and it definitely can't borrow its way out, because doing either simply tries to replace private sector demand with public sector demand. This sounds good until you realize that public sector demand comes from the private sector - that is, the government spends tax dollars (whether today's or tomorrow's), and therefore it can only contract the private sector or do yet more "pulling forward"!
Yet the pull-forward is why you're in trouble in the first place; ergo "more of the same" will not and cannot work.
A structural change must take place.
One simple (but not politically popular with the lobbyists!) way to do this would be to pass The Fair Tax. Such a tectonic shift in Washington DC's finances would immediately tie the government's funding to GDP, eliminate the game-playing in the tax code and make The United States the tax haven of the world, bringing in millions of jobs from other nations as multinational corporations rush from places like Bermuda to the United States.
It is precisely that sort of "structural reset" that is required to get an economy out of Depression. We took "the long way" to the goal last time around in the 1930s, and unfortunately the "structural reset" took the form of World War II, which shifted production to war goods for an extended period and, when they shifted back to civilian output "the old way" was forever gone.
Let's hope our policymakers can be persuaded to adopt a creative solution such as The Fair Tax rather than a destructive one such as armed conflict. All the platitudes and BS games out of DC (and statehouses) will not work, and the longer we churn around with them the more damage we as Americans (and indeed, as citizens of the world) will suffer under.
In today's news The Employment Report showed unemployment at 7.6% (up from 7.2%) and almost 600,000 jobs lost last month. About one-half of the job loss occurred in the last three months; this is a secular change and signals that we have suffered the sort of structural shift that marks Depressions rather than Recession.
Embedded in the report, however, is the truly bad news. My preferred unemployment rate, U-6, which includes "formally unemployed" plus those "marginally attached" to jobs and those in part time jobs who want full-time employment but can't find full-time work, rose from 13.5% to 15.4% in January (raw, un-adjusted figures.) This rate is up from 9.9% in January 2008, a 55% (!) increase in one year. Unfortunately, this print confirmed one of my predictions in my 2009 "Look Forward" Ticker, and it happened in January (!) - I had predicted U-6 to exceed 15%. Ugh; I may have been far too conservative with that prediction and sadly, meeting this prediction this soon means that U-6 is almost certainly going north of 20% this year.
The "stimulus" game-playing and book-talking from players in the market such as PIMCO is ridiculous. These clowns continue to believe that "continuing what we've done before, but with more gas" will solve the problem. They're wrong.
A structural reset of some sort must take place to get the economy out of this mess. Attempts to "protect" the old structures that are no longer functional will, at best, produce short-term gains that will soon be shown to be a chimera and simply leave yet more debt overhang in the economy, and prove ineffective.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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