It's a Depression, Not a Recession

Today, dear reader, we’re going to let you in on a big secret.

Pssst…we’re in a depression, not a recession.

As we explained yesterday, economists have no sure way of separating the two. But they are profoundly different. In the few words that follow, we’ll explain why…and why this one deserves the “D” and not the “R.”

And since we always look on the bright side, here at The Daily Reckoning, we’ll also explain why this worst of times for most people can be the best of times for you.

But first, we turn to the news. We’ll see what a depression looks like – just from reading the headlines.

The Dow fell 121 points yesterday. That leaves only about 4,000 or 5,000 more to go…before the index reaches its depression bottom between 3,000 and 5,000. That could take a long time…depressions always take time. It might not happen before 2010…or even before 2020.

Oil held steady at $40. Oil seems to be stuck around the $40 level. The dollar/euro exchange rate seems stuck too – in the $1.28-$1.30/euro range. So too with gold – at about $900. Gold gained $9 yesterday…bringing it back over $900.

Credit card delinquencies are at a record high.

The Chinese are now buying more automobiles than Americans.

Disney profits fell 32% in the first quarter (Disney needs to get on board with the Gregorian calendar…why is it reporting 1Q results now?).

Panasonic reported a loss of $4.2 billion; it said it was cutting 15,000 jobs.

In the face of this depressing news, President Obama has said that if Congress doesn’t get off its duff and pass his stimulus plans the consequences could be “catastrophic.”

Naturally, the Democrats are mostly behind their main man. But the Republicans have ideas of their own. Instead of cutting Obama’s $880 billion boondoggle program, they’re adding more…such as $6.5 billion for medical research. They’ve added on some tax cuts too…bringing the total plan to nearly $1 trillion, according to this morning’s report.

What is amazing is not that both political parties favor boondoggles, they always have, but that anyone thinks that throwing money around like this will reflate the bubble economy. But that’s just what makes our job so entertaining – everyone thinks he knows what he is talking about…and no one has a clue.

At the foundation of their faith in the Obama stimulus plan…or any of the others for that matter…is a simpleton’s insight: that if private citizens stop spending government should take up the slack. But if it were that easy, there would never be any downturns…because politicians are all too eager to spend money, all they need is an excuse.

The typical recession is nothing more than the economy taking a little breather after a brisk walk. A depression, on the other hand, occurs after a long, uphill sprint – when the economy clutches its chest and falls down dead.

Even in a recession, the meddlers spring into action. Interest rates are lowered…government spending is increased (usually too late to make any difference) and the economy resumes its perambulation.

The policy makers take on a depression as though it were just a particularly bad recession. They cut rates further…and spend more money. But it has no effect – except to retard the necessary adjustments.

A depression is not merely a pause…it is the end. Unless the meddlers can work miracles – such as raising the dead – they will just make things worse. Because, while they are trying to revive a corpse, they are standing in the way of change.

*** Recessions are a natural feature of the inventory cycle. The economy gets a little over-stocked…and has to clear the shelves. Prices are cut. A few people are laid off. And then, after a few months, everyone is back in business… It’s “laissez les bons temps roulez,” as they say in New Orleans.

Depressions are a natural feature of a much bigger cycle. A part of capitalism that people love to talk about when the going is good…but despise when it turns against them. We’re talking about what Schumpeter describes as “creative destruction.” Everyone loved “creative destruction” in the late ’90s – when they thought it added to their balance sheets. Now, they beg government to save them from it.

What we are witnessing in the economy is creative destruction at work. And what we are witnessing in politics is a bunch of numbskulls trying to stop it.

What’s being destroyed? Trillions of dollars’ worth of asset values, of course. Millions of jobs. Hundreds of thousands of businesses.

In a recession, the basic plan or formula for the economy is still valid. The economy just needs a little time…and maybe a little monetary boost…before it continues growing. Typically, inventories are sold down…so a new burst of production can begin.

But in a depression, the problems are structural.

One way of understanding this is just to look at balance sheets. Whether you are a business or a family, you can only afford so much debt. When you get too much, you have stop and pay it down. And when it becomes so great you can’t pay if off – because you don’t have enough income – you have to declare bankruptcy. A depression is when a whole economy declares bankruptcy…or should. Because it can’t pay its debts. Businesses, for example, have been built for a level of demand that no longer exists. It is not a question of waiting a few months. By the time consumers are ready to buy again, the whole economy will have moved on. Imagine, for example, a guy who built a nationwide chain of stores just to sell iPods to teenagers. The business may have been a great success – for a while. And he took out huge loans so he could expand…and take advantage of the demand. But then comes a depression. He says to himself: ‘I’ll just get some more financing…and wait it out.’ But who’s going to lend to him? By the time the kids begin buying again, iPods will be like vinyl LPs. His business is history. His lenders have lost money. The loans should be written off and the business should be destroyed, not mummified and preserved.

A depression is when the whole economy changes its business plan, in other words. And that takes time…and creative destruction.

How much time? Well, in the United States alone there is about $6 trillion too much private debt…$1 trillion too much output capacity…and millions of “excess” workers. How long will it take to retrain, retool, and re-absorb these excesses?

We don’t know. The last depression took about 20 years…and a major war (talk about creative destruction!) Then, the United States was making the structural shift from a Japan-like capital investment-led economy…to a post-WWII consumer-led economy.

In Japan itself, its post-WWII capital investment-led boom hit a wall of creative destruction in 1990. Now, 19 years have gone by…and it is still adjusting to the new world economy.

All we know so far is that this depression has wiped out more than $30 trillion of dollars’ worth of investors’ capital. We suspect it will wipe out another $30 trillion worth before its creative destruction is over.

Our guess is that it will also destroy the U.S. consumer-economy model…and the dollar-based world monetary system. That’s the destructive part. For the creative part…and how you can get ahead during a depression…stay tuned…more tomorrow.

*** On a recent afternoon, your editor took his computer and decided to get a cup of coffee on the Place du Colonel Fabien, in Paris. In the shadow of the Communist Party headquarters, at the Café des Dames, he marveled at the human race.

They need to turn up the heat, he thought to himself – this part of Paris is a melting pot where nothing seems to melt. Instead, people come…and remain as they were.

The Chinese here speak Chinese…and dress like Chinese. There is even a local public school where the little kids wear identification tags – in case they get lost – written in Chinese.

There are Indians, Kurds, Arabs, Africans… There are fine featured Africans –perhaps from the Sudan or upper Nile…Eritreans maybe…and Black Africans from the slave coast…

…all speaking their own tongues…wearing their own clothes…and doing as they do back home. One bar is full of Arab men…only men…smoking, drinking coffee. They are there all day long. Another bar is full of Turks…or maybe they are Kurds. Again, the bar is full all day long… Still another bar is full of Africans, speaking an African language. When women in African outfits walk by the on sidewalk…the men come out and talk them up. When women walk by the Turks, Arabs or Kurds…no one moves.

There are also plenty of Europeans. This is a working class neighborhood – or, it used to be. The remnants of the working class look a little worse for wear and tear. Old women shuffle along, dragging their vittles behind them in baskets with wheels. Old men, shoulders hunched over, often nothing more than ‘coats on a stick,’ as T.S. Eliot put it, trudge along…

There is a Jewish school around the corner. Young men dressed in black, wearing yarmulkes, run down the street at 4PM, after the school lets out. Occasionally, the Arabs and the Jews get into dust-ups. But that is because groups of Arabs come into the city from the suburbs, looking for trouble; at least, that’s what people say.

There are also many Eastern Europeans in this quartier. They are big people…strong and solid. Several men – who seem to be Ukrainian or maybe Russian – have set up a camp in the narrow park between two streets. They pitched a tent and sit out in front, drinking and smoking all day long. One day, part of the tent looked like it had been ripped off. But the men were still there…huddled in front of it, even though the temperature was barely above freezing.

There’s also a red-haired young man who maintains a silent vigil in front of the metro stop. He is a strapping, well-formed fellow …good looking, but with a sour look on his face. He sits…sometimes he stands…even in the coldest weather. He is there in the morning. And there in the evening.

Red headed men tend to go crazy. We have no statistical evidence…just an observation. When we see a fellow with a certain kind of red hair…he is almost always mad. The next time we see him, we will ask for his opinion on the macro-economic picture.

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning