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Are We in the Early Stages of a Depression?

Posted by Larry Doyle on July 23, 2009 8:48 AM |

At the request of a reader (hat tip to kbdabear), I have been asked to comment on a report produced by Sprott Asset Management of Toronto, Ontario entitled It’s the Real Economy, Stupid. The writers, Eric Sprott and David Franklin, believe:

We are now in the early stages of a depression. The economic indicators we follow to track real economic activity are all signaling a slowdown of massive proportions. You wouldn’t know it reading the mainstream papers of course – they all focus on the relative decline in the slowdown’s intensity. Reading about the slowdown ‘slowing down’ is not the same as growth however, and does not warrant excitement in our opinion.

Are we in the early stages of a depression or are we merely experiencing the worst recession since the 1930s? Let’s define these two economic terms.

Recession? Depression? What’s the Difference?

The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.This definition is unpopular with most economists for two main reasons. First, this definition does not take into consideration changes in other variables. For example this definition ignores any changes in the unemployment rate or consumer confidence. Second, by using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected.

Recession: The BCDC Definition

The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it is called an expansionary period. By this definition, the average recession lasts about a year.

And how is a widely feared depression defined?

Before the Great Depression of the 1930s any downturn in economic activity was referred to as a depression. The term recession was developed in this period to differentiate periods like the 1930s from smaller economic declines that occurred in 1910 and 1913. This leads to the simple definition of a depression as a recession that lasts longer and has a larger decline in business activity.

The Difference

So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe.

By this yardstick, the last depression in the United States was from May 1937 to June 1938, where real GDP declined by 18.2 percent. If we use this method then the Great Depression of the 1930s can be seen as two separate events: an incredibly severe depression lasting from August 1929 to March 1933 where real GDP declined by almost 33 percent, a period of recovery, then another less severe depression of 1937-38. The United States hasn’t had anything even close to a depression in the post-war period. The worst recession in the last 60 years was from November 1973 to March 1975, where real GDP fell by 4.9 percent. Countries such as Finland and Indonesia have suffered depressions in recent memory using this definition.

In reading Sprott’s and Franklin’s review, they focus on the negative assessments of the following economic data:

1. capacity utilization: “US industry used only 68.3% of available capacity in May 2009, according to a monthly report from the Federal Reserve. That represents almost one third of all US industrial capacity sitting idle. Prior to the current recession, the lowest rate recorded since the Fed started this series of records in 1967 was 70.9% in December 1982.”

2. tax revenues: plunging by 22% (federal tax revenues) to 57% (corporate tax revenues)

3. retail sales: continual declines, which will only exacerbate the pressures on the commercial real estate market.

4. unemployment: 9.5% unemployment rate, 16.5% underemployment rate and headed higher with real concerns by every government official and analyst that it will stay high for a protracted period.

5. U.S. housing market: any credible economist knows we have upwards of a full year’s worth of housing inventory on the market currently, another significant amount of shadow inventory on the banks books (homes waiting to be sold but not currently listed), and rising delinquency and default rates.

6. rail car loadings: continuing to decline

7. equity markets: 30% off March 2009 lows, but still 37% from their overall highs. What are they telling us? In my opinion, we need to focus on the overall volumes being traded on the exchanges and realize that upwards of 70% of the total volumes being traded are executed via high frequency program trades. What does that tell me? A LOT of investors are not involved.

Fed Chair Bernanke is compelling people to reenter the markets (equities, bonds, real estate) by keeping short term rates low for an ‘extended period.’

That is a nice segue into the major premise of my thoughts here and in all of my writings.  We are in the 20th month of this economic downturn. The Great Depression of the 1930s lasted a total of 9 years with more than a few false starts along the way.

Professors Carmen Reinhart (University of Maryland) and Kenneth Rogoff (Harvard University) have put forth the BEST analysis I have seen on the topic of the great recessions over the last century. Their focus is comprehensive and includes the factors addressed by Sprott and Franklin.

What do we learn from Rogoff and Reinhart? These severe economic downturns run from five to seven years!

I do not disagree with Sprott and Franklin.

The risks in our economy remain exceptionally high. The stock market is in the process of defining winners and losers but overall is being supported by massive liquidity injected into the overall economy by Uncle Sam (Fed and Treasury).

What may cause the next leg down in the economy? Commercial real estate defaults which will impact a large number of banks (community, regional, and money center) and insurance companies.

Recession? Depression? Let’s just say by either definition, we have a long way to go.


Related Commentary

1. “Aftermath of a Financial Crisis” from our Recommended Weekend Reading ; July 11, 2009

2. Does the U.S. Need Another Fiscal Stimulus
by Martin Feldstein
The Washington Post; July 12, 2009

  • Pip Daddy

    Well the truth is, if everyone knew the truth we’d be in a much worse situation then we are.

    Our economy is a closet bursting open with all the toys we have left out, and the American public is our mom checking to see how the room cleaning process is going.

    IDK how long they can keep this equity rally going.

  • Aaron kramer

    Another element to consider when analyzing the Depression and Recession argument, in the context of GDP, is what GDP is comprised of. Typically Nominal GDP is viewed through this equation, GDP = consumption + gross investment + government spending + (exports − imports). After calculating the Nominal GDP you subtract inflation (GDP DEFLATOR) and you are left with the REAL GDP. The REAL GDP is the actual growth in the economy and, I would argue, normally but not always reflects expansion expansion or contraction.

    Here is where things can get misleading because nominal growth doesn’t always lead to actual growth. If the economy grows at 8%, nominal GDP, and inflation is 4%, than in REAL terms the economy has actual grown by 4%(Nominal 8% -4% = 4%). Living through this type of situation feels good because growth is exploding but the gains don’t reflect the perception of growth but they are good none the less.

    Now if Nominal GDP is 6% and inflation is 6% (GDP Deflator), (Nominal 6% – 6% – 0% growth) You will still perceive the growth, new building and jobs, but the result will be no net gain because of the loss in purchasing power from inflation. In aggregate the experience will be a wash out for all involved.

    If Nominal GDP is 2% and inflation is 6% (2% – 6% = -4%) than growth is slow and any gains are lost to rising costs and savings also lose purchasing power. A $1 saved at the beginning of the time period will only buy .94 cents of goods at the end. So the situation is not good for anyone, think 1970s stagflation.

    If Nominal GDP is -2% and inflation is – 6% (-2% – (-6%) = + 4% Real GDP growth). In this example the economy is shrinking, people are losing jobs, stores closing and salaries decreasing but GDP will be reported higher. Clearly things are worse and only savers and the employed are content with the situation but anyone who is leveraged is unhappy.

    This is why you can be misled and have an increasing GDP during economic downturns. GDP is not always reflective of the current economic environment but it is rather a tool for measurement, nothing more nothing less.
    The question we now must ask is, which situation are we now experiencing? I lean towards the last example but that is my opinion.

    • Larry Doyle

      Aaron….thanks for adding to the dialogue. Your analysis is succinct and impactful.

  • Larry Doyle

    Pip Daddy….welcome to Sense on Cents.

    I consider myself an optimist and pragmatist but also a realist. As such, my Jesuit education compels me to continually pursue the truth in whatever form that takes.

    Little doubt we collected far too many toys too often purchased with borrowed funds.

    I am serious in stating, there are lots of tag sales going on in my town.

  • Petricone456

    Thank you for providing the link to Sprott and Franklin’s paper! Do you think Sprott and Franklin fail in their analysis by not comparing the actual characteristics of the underlying economies of the 1920s/1930s and today? I don’t disagree with any of their data but overlaying datapoints from one period onto another and stating the outcome will be very similar seems dangerous or at the very least incomplete.

    • Larry Doyle

      You have hit upon why and how economics is the most inexact of sciences. Forecasting future human behaviors totally upon past models and data is completely imperfect …but we have no other choices with which to work.

  • fiscalliberal

    Could I suggest that the lower 75% of the population defines depression in terms of job availability. Things do not look good in that front. My son in law rims a plant of about 60 people. He is holding even after cutting 25%(now at 60) of staff and asking people to take a week of unpaid vacation including himself. He also eliminated pensions. So it will be a while before things turn around

    This part of the population drives consumer spending and they are starting to do the right thing in terms of saving for a more rainy day. However until consumer spending comes back, we will bump along the bottom for some time, just as LD has been predicting.

    While all the technical stuff regarding GDP, has merit, however untill employment starts coming back, inventories will remain stale and production in the world will stay stagnant.

  • divvytrader

    CNBC and various media pundits have the champagne out and talking about bidding wars for even crappy NYC apartments coming soon and that those who don’t believe the recession ended a week ago must be crazy or just partisan Republicans .

    • kbdabear

      I view Bubblevision as a day long infomercial to reel in the retail investors. I’d sooner believe the large busted babes who pitch the late night “make millions off the internet” than the likes of Cramer and Co.

      I view CNBC as the con artists who run a poker game where the sucker is given a run of winning hands to build up a false confidence before they start dealing him so many losing hands he’s hitchhiking home in his undershorts.

  • Larry Doyle

    Well, congratulations for them.

    If they want to explain how that works for the 16.5% who are underemployed that would be nice.

    CNBC and many other outlets are all about ‘day trading’.

    Having been an institutional trader for 15yrs, I am always respectful of the market. That said, I view the markets overall as being seriously disconnected with the economy.

    The challenge for me and everybody else is measuring the near term benefits of all of Uncle Sam’s liquidity injected into the economy versus the long term costs.

    In short, this market and economy is very quickly turning into the HAVES and HAVE NOTS.

    Very challenging overall.

    While those at CNBC may view this entire scenario as a series of one day sprints, I have always chosen to view things as a marathon, that is, over the long haul.

    Discipline….discipline…discipline…never too high, never too low…

    • kbdabear

      As your previous commentary on financial literacy covered, the majority of Americans, myself included, have a lot to learn. I come here to fill in some of the large gaps between what I think I know and what I don’t know.

      Anyone who followed the mystery of the Air France crash would see the vast difference between what is reported in the media in simplistic form by reporters and what is discussed on aviation boards by seasoned professionals in the field.

      Most who follow the markets look only at the closing numbers on the DOW and NASDAQ. This is analogous to flying a plane by looking only at the altimeter. Financial markets and investment banking are immensely complicated fields, which is why those who master them are highly paid. When I read some of these analysis I have to admit that it makes my head spin, so I know enough to say to myself “do not try this at home”.

      • Larry Doyle

        My pleasure…this back and forth has actually inspired a brief commentary which I am about to post.

        Thanks for the inspiration. Happy to help you learn to fly…although I will readily admit I am not an expert on all areas of this aviation.

        That said, thanks for flying Sense on Cents.

  • kbdabear


    Thanks for taking the time for analysis on this. Like any diagnosis, the old wisdom of “always get a second opinion” applies.

    In the illness analogy, I’ve learned from your analysis of banking that the medical teams have seen the MRI’s but are not disclosing what they see on the scans.

  • Larry Doyle

    kbdabear…my pleasure. Funny you should use that analogy. It plays right into the next commentary I wrote about accounting games.

  • TeakWoodKite

    Great read LD.

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