Saturday, 1 August 2009

Recession or Depression?

Is this a recession or a depression? Being a student a history, I have to err on the side of depression. I do not embrace that position lightly. My opinion lies upon the bedrock of historical fact-based events and social trends which may provide an outline for what we are currently experiencing and what we will see in the future. A meaningful trend that Austrian-school arm chair economists, like myself, see is a structural breakdown in the US economy largely based on a long term massive credit expansion that has now reversed course. The contraction we saw in 1929-1933 also came after a credit bubble, where people were speculating in the stock market with 10% margin and consumer credit had been rapidly rising throughout the 1920s. I believe regular business cycles end in recessions and credit cycles end in depressions. We have climbed the peak of the credit mountain, and we are now sliding down the other side. This is an excerpt from Robert Prechter’s, Conquer the Crash, “A depression is characterized in part by a persistent, sustained, deep, general decline in production. Since a decline in production reduces debtors’ means to repay and service debt, a depression supports deflation. Because both credit and production support prices for investment assets, their prices fall in a deflationary depression. As asset prices fall, people lose wealth, which reduces their ability to offer credit service debt and support production. This mix of forces is self-reinforcing.” What have we seen in this current contraction in the US economy? Rapidly falling asset prices across the board (stocks, houses, oil, art, etc.) What is different about this current depression? The Federal Reserve Board’s response to falling asset prices has been aggressive. By bailing out financial institutions and providing liquidity to banks, the Federal Reserve is trying to rekindle consumption in the US economy. Because of the recent rally in the stock market and the so-called “better than expected” economic statistics the Federal Reserve has been able to convince some that they have the power to re-inflate the economy again. I think in the end the Fed’s actions will be of little consequence because they do not have the power to move the levers of social mood. Turning around the economy is not like flipping a light switch.

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