Posts Tagged ‘Recession’
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

Greece and Sovereign Defaults

These charts sum things up rather well:

The first is courtesy of Stratfor – whose material is highly recommended:

Another take:

Failure being devastating does not ensure success

Bronte Capital has an excellent outline on Models for the Greek Default which clearly outlines why Europe is so concerned. In our interconnected world, it is not just Europe that needs to worry.

When Argentina defaulted not only did the government default but they forced a private default. If you had a debt in US Dollars in Argentina prior to the default you were forced to pay it back in Peso. Indeed it was illegal to make payment in US dollars.

Likewise if you had a US dollar asset you got back Peso. A dollar deposit in Citigroup in Buenos Aires became a peso deposit. If you really wanted to keep your dollars you needed to make your Citigroup deposit in New York.

The forced private sector default was necessary for Argentina. The Argentine banks all had lots of US dollar funding. If you devalued without forcing their default then they would all have uncontrolled defaults (a true disaster) and the country would lose its institutions. Telefonica Argentina would have failed too – failing to replay USD debts.

The same applies in Greece.


Now if you are Irish or Italian or Portuguese (or even Spanish) you know the rules. You get to get your Euro out of the PIGS and into the core (Germany) as fast as possible. So max all your credit cards (for cash), draw all your bank deposits and load them in the boot of your car and make the drive to Switzerland or Germany. Somewhere safe. Otherwise you are going to lose half the value the day that the rest of the PIGS do a Greece.

And this bank run – a run including tens of thousands of Italians driving their Fiats – will surely blow apart every Italian bank. And their Euro-skeloritic compatriots will sign the death knell for for all their banks too.

If you are going to go the devaluation route you are going to have to do it all at once. Like the big-bank weekend (maybe coinciding with a week long bank holiday) in which all core European countries get their own currency back.

Read the whole thing.

Even if you do not believe we are heading towards a depression, possibly the Greatest Depression, there could still be cause for alarm. Cardif Garcia details the effects of Great Stagnations from the Archives:

Another take by the Bank of England:

There could be some tough times ahead, even if we get through this without a depression.

History repeats

The Greater Depression

It has long been noted that there are patters or cycles to many aspects of our existence. In human affairs it has led to the saying that history repeats, or more accurately rhymes.  A glance at the Memoirs of Herbert Hoover seems to confirm this. Although for reasons that will become apparent, let’s hope the cadence breaks down.

The Great Moderation

Not for nothing did Reinhart Rogoff call their book This Time is Different. 1929 had its version of our Great Moderation.

“Impulses to progress were so very great that, with the growing optimism, they gave birth to a foolish idea called the “New Economic Era.” That notion spread over the whole country. We were assured that we were in a new period where the old laws of economics no longer applied.” Page 5

With us the old laws might have applied, but we have better ways of managing the economy and superior knowledge. Or so some thought and are trying to prove.

Credit expansion

The role of credit expansion in creating the misery to come can hardly be exaggerated. Hoover puts it succinctly:

“It was difficult for the public to believe that such griefs and tragedies lay hidden in so obscure a process as credit inflation when forced on an already optimistic people. It set the stage for wicked manipulations and promotions of stocks. Its collapse brought hunger and despair to millions of homes. It destroyed the savings of millions of families.  It also furnished ammunition to radicals for attacks on the whole American system. The exhibition of waste, fraud, and greed which flowed from this artificial credit inflation appears in their literature as a typical phenomenon of our free civilization; whereas it was the exception.

There are crimes far worse than murder for which men should be reviled and punished”. Page 14

A glance at the ratio of total public and private debt to GDP in the US shows there has been a considerable credit expansion. In effect we have been maintaining consumption by borrowing money, effectively bringing consumption forward. Once the ratio of debt stops increasing, there will be a decrease in demand and a recession. If government steps in to ensure debt keeps growing then it simply delays the inevitable realignment at the cost of making the adjustment worse.

While much of modern economics seems to strenuously avoid the implications of credit expansion, Herbert Hoover was in no doubt of its effects. He was also clear as to its causes:

“We were due for some economic readjustment as a result of the orgy of stock speculation in 1928-1929. This orgy was not a consequence of my administrative policies. In the main it was the result of the Federal Reserve Board’s pre-1928 enormous inflation of credit” Page vi.

While there can be self serving element to memoirs, with attempts to justify performance. There is ample evidence of just how serious a problem Hoover regarded the credit expansion to be. In 1926 he said:

“No one doubts the extreme importance of credit and currency movement in the “business cycle.” Disturbances from this quarter may at once interfere with the fundamental business of producing goods and distributing them. Many previous crises have arisen through the credit machinery and through no fault of either the producer or consumer. . . . That the Federal Reserve System should be so managed as to result in stimulation of speculation and overexpansion has received universal disapproval.

Behind these alarms was my knowledge that the Federal Reserve Board had deliberately created credit inflation …The Federal Reserve Board, during 1925, had undertaken credit expansion by open market operations and by lowering discount rates.” Pages 6 & 7

“The consequences of the Federal Reserve Board action were disastrous to our economy. It induced unwise investment in European loans and bank advances. Worse still, it stimulated speculation in common stocks on American exchanges by making large funds available to those who wanted to borrow on small margins.” Page 8

Further evidence of his views are provided in a letter dispatched on December 23, 1925:

“It does not appear to me that the speculative purchase of large amounts of securities upon credit can be otherwise than dangerous, because it absorbs the credit funds of the country; because of the tendency of speculative fevers to extend into the commodities; and also because it must result in a collapse which will carry losses into every part of the country. .  . This gigantic expansion of credit upon which it has been carried . . . lends gravity to the situation, for its inevitable collapse would be even more dangerous to commerce and industry by virtue of its widespread character. .”

On the Mississippi bubble of 1927-1929

One trouble with every inflationary creation of credit is that it acts like a delayed time bomb. There is an interval of indefinite and sometimes considerable length between the injection of the stimulant and the resulting speculation. Likewise, there is an interval of a similarly indefinite length of time between the injection of the remedial serum and the lowering of the speculative fever. Once the fever gets under way it generates its own toxics. This renewed action to inflate credit was begun by the Reserve Banks

The central role of credit expansion in 1929 and now seems to support the idea that history rhymes. Reinhart Rogoff’s book suggests the rhyme has been going on for eight centuries.

Obama, Gillard and Keynesians make things worse

While the phrase “never waste a crisis” was uttered in the US, it applies to Australia as well. The evil it encapsulates is clear in the following quote:

“I give more attention to the campaign of 1932 than might be otherwise desirable, because I then accurately forecast that attempts would be made to revolutionize the American way of life. The effort to crossbreed some features of Fascism and Socialism with our American free system speedily developed in the Roosevelt administration. The result was that America failed to keep pace with world recovery. Instead we continued with subnormal levels of lessened productivity, high unemployment, and costly relief measures until our man power and industries were absorbed by the war eight years later, in 1941.

That our administration policies were right is amply evidenced by the fact that after the world turned toward recovery in July, 1932, the twelve nations retaining their free economies, and pursuing our policies, fully recovered, within two or three years, to levels above the boom year of 1929.” Page vii

Dr Steve Kates gave an excellent paper on this very subject in the Productivity Commission in around 2008. His evidence was0 irrefutable, Keynesian policies extend rather than relieve downturns. The lost decades in Japan ought to be evidence enough. Although peoples cognitive failings mean that Keynesians will twist and distort reality to support their ideology rather than admit they are wrong.

The next section demonstrates why we must hope that there are limits to how closely we follow the past.

Revolution and War

Hoover clearly outlines the consequences of the economic adjustments associated with the last Great Depression:

“The immediate effect of Central Europe’s collapse was the terrible unsettlement of all economically sensitive nations everywhere. Among the dire consequences were Britain’s suspension of payments to foreigners, abandonment of the gold standard by scores of nations, trade wars, political revolutions in more than a dozen countries outside of Europe, and disaster for the American economy.

The eventual effect of this gigantic catastrophe was to kindle political and social revolutions in all the defeated nations of Central and Eastern Europe. Communism reached its dread hand into those areas, and Fascist dictators arose as the antidote. In the end, these forces were to plunge the world into a Second World War”. Page vi

With the number of countries likely to be adversely affected by the coming crisis, it is inevitable that some will follow the pattern of the 1930’s. If they include countries with a martial history and sufficient size, their neighbors could have problems. It is probably not the best time for the West to disarm, something their budget woes will almost certainly result in their doing. Politicians will disarm rather than dismantle the Welfare State.

Relevance of when Wall Street crashes

Prior to reading the memoirs I certainly thought the Great Depression started because of the Wall Street crash. Hoover makes a good case that this is not so:

“A study by the National Bureau of Economic Research states: “Several countries entered the phase of recession in 1927 and 1928, long before the date usually taken as marking the crisis in the United States, that of the Wall Street crash of October, 1929

The report enumerates Bolivia, Australia, Germany, Brazil, India, and Bulgaria as having entered the depression phase before the American stock market crash.” Pages 2 & 3

Hoover adds:

“Large areas of the world are not very sensitive to economic tides— such as China, Russia, Central Asia, and Central Africa. Eliminating these countries, the economic situation began to decline in more than four-fifths of the economically sensitive peoples of the world before it began in the United States.” (page 3)

When the history of what could prove to be the Greatest Depression is written, they may conclude that is started some time ago. We could be living through the economic equivalent of the English summer of 1939:

“When the sun shone down on a happy, careless people, who worked and played, reared their children and tended their gardens in that happy, easy-going England that was so soon to be fighting desperately for her way of life and for life itself” Mrs. Miniver (1942)