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.
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.
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.
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