Posts Tagged ‘Depression’
Economic Depression

David Stockman explains why an economic collapse is all but inevitable:

You can’t live beyond your means because it’s pleasant. It’s not sustainable. Clearly the level of debt that we have is not sustainable. We have a whole generation – the Baby Boom – that’s about ready to retire, and they have no retirement savings. We have a federal government that is bankrupt, literally. Its [debt is] $16 trillion and growing by a trillion a year. Something’s going to give. We can’t pay for all these entitlements. There won’t be the revenue generation in the economy to do it.

So as a result of that, we are deluding ourselves if we think we can just continue to spend.


Austerity isn’t an elective course. Austerity is something that happens to you when you’re broke. And yes, it is painful and spending will go down and unemployment will go up and incomes will be impaired, but that is a consequence of the excess debt creation that we’ve had for the last thirty years. So austerity is what happens when you break the rules.

And somehow we have this debate going on. They’re making a mistake. They chose the wrong strategy. Do you think Greece chose the wrong strategy with austerity? No. No one would lend them money. That’s why they ended up in the place they were. Do you think that Spain today is teetering on the brink because they said, “Oh, wouldn’t it be a good idea to have austerity?” No, they had a gun to their head. They were forced to do this because the markets would not continue to lend, and even now their interest rate is again rising. The markets are losing confidence, and unless the ECB prints some more money and bails them out some more, they are going to have austerity. So the austerity upon us is the backside of the debt supercycle we had for the past thirty years. It’s not discretionary.


The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an “interest rate.” That isn’t a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he’s still in a positive spread. And you can’t have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That’s essentially what we have today.


I would stay out of any security markets. These are unsafe markets at any speed. It’s all tied together. As I was saying when the great margin call comes and they start selling the Treasury bond, they’ll take everything else with it. Real estate is priced off Treasuries. Mortgaged-backed securities are priced off Treasuries. Corporates are priced off Treasuries. Junk bonds are priced off Treasuries. Everything. The stock market will go into a panic. We don’t know when the timing will come – we’ve never been in a world where there is $15 trillion worth of central-bank balance sheets, like we have today. The only thing I think you can conclude is preservation is the only thing you are about as an investor. Forget about yield. Forget about return. Just keep yourself liquid and preserve your capital, because you can’t predict the day when, as I say, the great margin call in the sky comes down.


When the financial markets reprice drastically, it’s going to have a shocking effect on economic activity. It’s going to paralyze things. It’s going to finally cause consumption to come down. It’s going to cause government spending to be retracted.

You know, the Keynesians are right. Borrowing does add to GDP accounts. But it doesn’t add to wealth. It doesn’t add to real productivity, but it does add to GDP as it’s calculated and published – because GDP accounts were designed by Keynesians who don’t believe in a balance sheet. So they said, “If the public sector and the household sector are borrowing, let’s say, $10 trillion next year, run it though GDP, you’ll get a big bump to GDP.” But sooner or later your balance sheet will collapse. They forgot about that one. So my point is that we’ve gone through a thirty-year expansion of the balance sheet, an artificial growth in GDP; now we’re going to have to be retracting the collective balance sheets. That means that GDP will not grow. It may even contract, and no one’s prepared for that.

Hat tip John Dinkum Wagner. Watch the video here

John also highlighted a reader comment:

Every major country in the world, except China, is unable to pay its bills without going deeper into debt. All while interest rates are at dead nuts lows. Low interest rates should only be earned on the safest of plays, but loaning to a broke country is clearly not a safe play. Once broke, a default can occur at any time, or it can be delayed until hyperinflation. That’s it. And once the whirlwind effect of inflation pushing up interest rates starts, the existence of the major currencies of the world, except the Chinese Yuan, will be measured in months.

Image courtesy of itulip

A Great Depression

This made sense to me:

Guest Post: Underneath the Happy Talk, Is This As Bad as the Great Depression? So even though the government’s spending on the “war” on the economic crisis dwarfs the amount spent on the New Deal, our economy is still stuck in the mud.

Given that the government has done so much, but we are still mired in a situation which in many ways is comparable to the Great Depression, it is not a very radical statement to say that the government is doing the wrong things to address the downturn.

I hope that the economy recovers. But the above comparisons are worrisome, indeed.

The whole post is worth looking at.

Inflation and stock prices

How does inflation destroy stock market values?

Distorted prices

There are grounds for believing that initially stock prices rise in line with inflation. But as the inflation gets out of hand and turns into hyperinflation, it destroys price relativities and hence price signals. This eventually collapses the economy and destroys the ability of companies to make money. This in turns results in the stock market collapsing in real terms.

Distorted corporate behaviour

Comments about the South American experience suggest companies have to have multiple books to survive. They sometimes have management accounts in a foreign currency. They need to know the different inflation rates for their inputs and their outputs, which can differ considerably. Companies that are not on top of this do not survive. Also many companies make more from their speculation than actual productive enterprise.


Indeed part of the harm of hyperinflation is probably the extent to which people devote their energy to speculation. A society can not thrive on people flipping cans of sardines to each other any more than they can survive on flipping houses. Even if for some time it appears to be a profitable activity for participants with benefits to society as a whole. Speculation has a role in a capitalist economy, but except under exceptional circumstances, will be detrimental if it becomes the primary focus of most people and corporations.

Collapsing margins

The market ticker has introduced an alternative mechanism for the movement in stock prices as inflation takes off. His model is based on collapsing margins. Basically as inflation takes off the foreign exchange rate collapses. This makes imports more expensive. In the case of the USA commodity prices rise. Rising prices for oil, agricultural and mineral commodity prices feed through to the cost of production. Companies then have to decide how much of this increase in costs they pass on to the customer.

Generally companies can be expected to wear part of the increase in production costs by reducing their margin or profits on their products. The proportion varies depending on factors specific to the firm, industry and market. There is a considerable body of literature on where the burden of a tax will fall. Exactly the same analysis holds for other increases in the cost of production. The burden will often fall in part on the company.

Decreasing margins are normally not associated with rising share prices. Indeed, share the share price is meant to reflect the stream of profits the firm is expected to produce. If margins are being squeezed then the stream of future profits are also likely to be squeezed. Eventually this should impact on the stock market. Exactly when reality impacts on share prices is indeterminable at the best of times. When prices are being manipulated in the manner they appear to be in the USA, then it is probably even harder for outsiders to predict. Insiders may be able to predict it much of the time, but not when it eventually collapses, unless it is when they initiate it. Some of those manipulating the prices will be able to predict movements.

Reduced discretionary consumption

Of course the rising prices of necessities in the USA will also affect company profitability. Money flowing overseas to pay for higher oil and other commodities is money that will not be saved, invested or spent domestically. Suggesting firms heavily reliant on domestic demand will be adversely affected on the demand as well as the cost of production side. This will make it even harder for those firms to pass all of the effects of rising input prices.

The Future

Too many problems

It does seem that the end game for the USA is not going to be pleasant. For what it is worth much of Europe and Japan are also up the creek without a paddle. It is almost inconceivable that one of the grey swans (known unknowns) will not initiate another other round of the GFC. Then there are the Black Swans (unknown unknowns).

Developed countries

The developed world is in the early stages of a depression. How deep and how long it lasts can be influenced by our politicians. But not the fact that there has been a credit induced boom that has distorted prices and production. Squandering money is not sensible at a time like this. Resources will be needed to feed the people and provide them with power.

The UK had difficulty feeding itself during the war. It has since increased its population and paved over much of its agricultural land. Agricultural productivity has increased, but will it be enough to enable them to maintain their current rates of obesity? When Margaret Thatcher had her millions of unemployed she had increasing North Sea oil revenue and relatively low levels of debt. These advantages are gone. It will be a bumpy ride.

Developing countries

Countries producing things for Westerners will also have to restructure their economies to produce things for other people. Capital will have to be written off, even if new production facilities are created. During the last depression the US fared particularly badly. It was the workshop of the world. It also implemented the most Herculean efforts to stave off deflation and maintain employment. There are grounds for believing it was these very efforts that helped make the depression as long and bad as it was.

Obama, Bernanke and their ideological kin around the world are making similar mistakes to Hoover and Roosevelt. They could be making the Greatest Depression.

Further Research

Recommended books:

Recommended posts:


This article focuses on inflation. Reinhart and Rogoff present a very good case for expecting declining prices as the credit expansion goes into reverse. The argument against them is that we have never been in a world of fiat (un-backed paper) money before.

Personally I think the paper money printing component will be dwarfed by the reduction in credit.  The circulation of money will slow. Inflation will only come in later when money printing on the part of the authorities finally results in people getting rid of their currency as fast as they can. But this can take years. People have been conditioned to value their paper money. The psychological change will not come quickly. As Adam Smith said, there is a lot of ruin in a nation. But when things reach a tipping point, they will move with bewildering rapidity.

Of course, the politicians could prevent the worst of the inflation. But they would have to be willing to let the economy right itself. This I do not believe they will do, at least not until much damage has been done. There is no real evidence for my views. No one does or can know. Although some will be proved right.