Deep Downturn or Greater Depression - Which Is It?

Are we in a deep cyclical downturn, or the first few innings of The Greater Depression?

This is the question many investors are trying to answer, because this is what it all gets down to. If we are "merely" in a deep recession - likely the longest and deepest since the 1930s - then we should expect things will go from bad to less bad in the not so distant future.

This is key, because this is how you can make a lot of money investing - putting money in when things look really bad, but about to go to "not quite so bad." You can find some great values, and your downside is limited.

Problem is, this is the playbook everyone knows and is waiting for. This is why the stock market typically starts to turn up around the middle of a recession - the stock market, being a forward looking vehicle, is able to detect when things are bleakest and about to become less bleak, and the ascent begins. By the time sunny skies have reappeared, most of the easy money has been made.

So here we are - the end of March 2009. We've been in a recession since December 2007. The stock market began rallying a couple of weeks ago, despite economic news that still looks as bleak as ever. So is this time to start buying undervalued blue chip stocks, following the play book that has worked so well over the past 25 years of buying good, quality stocks on dips?

I don't think so - because, I believe (and this is just my personal belief) that we are in a depression, not a recession.

IF the government had done nothing since the start of this financial crisis in the summer of 2007, and IF bad banks and bad companies had been allowed to fail, then I think we would indeed be on our way out of this mess right now. Sure the last 18 months would have been very painful, but we would have taken our medicine, cleaned out the system and excesses, and have transferred assets from the incompetent people to the competent people.

Instead, the market has not been allowed to reset itself. The incompetent people have been bailed out time and time again, and the competent people have not been able to pick up market share due to one government intervention after another.

So we find ourselves digging deeper and deeper into this hole, with the Federal government determined to "do something" to help the situation. We are repeating the mistakes of the Great Depression, of Japan in the 1990's, and we are going to have financial hell to pay for it.

Despite the fact that no country has ever devalued its way to prosperity, the UK, Japan, Switzerland, and now the US are in a race to devalue their respective own currencies as fast as possible to juice their economies.

click to enlarge

US Adjusted Monetary Base is skyrocketing (Source: St Louis Fed)

Meanwhile, US government spending is balooning as well. (Hey, why not print it and spend it). Unfortunately there is no free lunch in life, and this is not really helpful for the economy, because the government does not actually produce anything of value.

There are only two ways the government can raise money:

1. Tax the productive private sector
2. Print it

Right now, we're seeing a liberal application of both options.

The problem I have with this whole situation is that there doesn't appear to be a free market anymore. It's more profitable for many businesses to angle for stimulus money than it is for them to build and sell something of value to the marketplace. That's a problem!

Now, recently I've attempted to step back and look at the situation with a level head. Morality and economic beliefs aside, the tax burden and the size of the US government has no doubt been trending up throughout the entire 20th century. And during that century, the US managed to do well economically. So are things really that different this time?

Things looked pretty bleak in the 1970's - how many would have predicted, at that time, the 80's and 90's would be so prosperous?

It's an open question, and one that I think we investors must continue to mull. Though things may look quite pessimistic now, there will eventually be another dawn, because we know one of the most dominant trends in the history of the world has been the ascent of humans.

But we also know that no trend goes straight up, trees do not grow to the sky, and right now the world is in the midst of a correction. It's important to remember that corrections can be quite long and nasty, and that markets can remain "irrational longer than you can remain solvent."

As long as we continue to follow the playbook of the 1930s, I think we must expect that we'll get similar results. As Mark Twain once said, history may not repeat, but it most certainly rhymes. The past 25 years were an anomaly, a Pax Romana of sorts, where the US and much of the world experienced relatively peaceful, uninterrupted economic growth and prosperity.

History shows, though, that the world is often in turmoil and upheaval, and it's prudent to at least stay mindful of the fact that good times may not return next month, next year, or even next decade necessarily.

There are glimmers of hope and positive signs to be found, and I'll leave you with a must see video of Daniel Hannan laying the smack down on UK Prime Minister Gordon Brown. It's encouraging to remember that as bad as things may look, not everyone is asleep at the wheel, and there will eventually be a day for us to dust off our investing playbooks from the 80's and 90's. Just not yet, though.

Comments

[ACCOUNTANT]

Simply put, you're an ideological idiot. You are basically advocating exactly what the Hoover administration did that put the country into the first Great Depresssion - and that was to do nothing.

It is because we are doing some of the things we are doing that will prevent this from becoming the next Great Depression. Proof? Look at what happened Oct-Dec when Lehman was allowed to fail. Now ask what might have happened had Bear Stearns, Merrill Lynch, Countrywide, Wachovia, AIG, Washington Mutual, Freddie and Fannie, and due to their ripple effects, probably Bank of America, JP Morgan, and others all gone belly up? That would have been the next Great Depression. Get your ideologies under control so you can think rationally.

2009 Mar 30 08:45 AM

[One Eyed Guide]

Actually, most "conservative" economics agree that devaluation is one of the only ways for a country to fix a balance of payment problem like the USA has.

Also, the record of the 30's clearly shows that the first to devalue were the first to get out of the Depression.

Of course this does raise the possiblility of inflation so buy gold.

2009 Mar 30 08:49 AM

[Steve Pasq]

Well put. The transfer of resources to the less productive parts of society is contributing to the collapse. I'm not saying that the bankers and brokers are good examples of productivity...they are just more productive than the green squads and regulators coming on line with big bankrolls.

2009 Mar 30 09:04 AM

[ain't no fortunate son]

The author needs to google "CDS" if he wants government to do nothing but let every major bank on the planet fail.

And then google Armageddon.

2009 Mar 30 09:06 AM

[Oso Velo]

Guys- Back to the Hoover statement: "You are basically advocating exactly what the Hoover administration did that put the country into the first Great Depresssion - and that was to do nothing."
We'll never know the outcome of Hoover's approach, as it was cut short by Roosevelt. Roosevelt's approach, which is so obviously admired by Obama, was an horrific failure that ultimately prolonged the depression.
Letting a failed bank founder for a decade was the Japanese tactic. We'll do it for the banks, automotives, insurers, hospitals and ultimately municipalities. We have confounded the most fundamental aspect of money- that money will chase production, intelligence and vision. I agree with Mr. Owens- this can't be good.

2009 Mar 30 10:32 AM

[Brett Owens]

@ accountant - Thanks for the kind words. I'm of a different opinion about the Hoover Administration, as I don't think they did as little as is advertised.

From Wikipedia - so it must be true:
en.wikipedia.org/wiki/...

It is often inaccurately stated that Herbert Hoover did nothing while the world economy eroded. President Hoover made attempts to stop "the downward spiral" of the Great Depression. His policies, however, had little or no effect.

2009 Mar 30 10:41 AM

[Brett Owens]

@ One Eyed Guide - Wasn't Germany one of the first - or the first - to devalue in the 30's?

2009 Mar 30 10:42 AM

[Stockmajor]

You should read "The Great Crash of 1929" by Galbraith. You are incorrect is stating that we are repeating the mistakes of the 1930s. The steps being taken today are 180 degrees from those taken in the 30s. Will they work? I don't know, but we better hope so.

You state that we would have been better off if our government had done nothing so far. Well, that is what was done after the crash of 1929, nothing. Our government was more concerned with maintaining the good faith and credit of the USA (normally, a good idea). They eventually passed a balanced budget and raised taxes and cut services to make it happen. I'm sure that seemed like the thing to do at the time, but it didn't work.

The Secretary of the Treasurey back then is famously quoted as saying, "Liquidate the banks, liquidate the laborers, liquidate the farmers..., or words to that effect. It sounds like that is the path that you are advocating. It was bad medicine then, so I'm glad we are taking another path.

I choose to remain bullish on our recovery. Remember, our collective sentiment has a HUGE role to play in how this crisis resolves. Therefore, I'm willing to be optimistic that Obama, Geithner, Bernanke, et. al. might just make the right moves to get us out of this mess.

2009 Mar 30 12:17 PM

[Stockmajor]

Brett, did you read through the article on wikipedia that you are quoting as a source to say that Hoover did more than most believe? It states that he made "attempts" that had little or no effect.

Another quote from the article states, "As the economy quickly deteriorated in the early years of the Great Depression, Hoover declined to pursue legislative relief, believing that it would make people dependent on the federal government. Instead, he organized a number of voluntary measures with businesses, encouraged state and local government responses, and accelerated federal building projects. Only toward the end of his term did he support a series of legislative solutions."

In other words, early on, he did very little. He went with the hands-off approach.

Your source to back your claim that Hoover did more than most believe is hardly convincing. In fact, it rather seems to back up Galbraith's opinion in his book "The Great Crash of 1929".

2009 Mar 30 12:28 PM

[Mad Hedge Fund Trader]

Call me an optimist, but I am starting to see crocuses of economic recovery busting out all over. Long side traders now have a spring in their step after a 23% rise in the Dow in three weeks, the best move since 1938. If it is true that the stock market anticipates moves in the real economy by six months, then a lot of managers are going to come back from their summer vacations in September to find a surprising batch of new orders. Commodities have been on an absolute tear this year, especially oil and copper, classic harbingers of future business activity. Just look at my favorite, Freeport McMoran (FCX), which soared 170% from the November lows. The downward momentum of a whole range of economic indicators is slowing. The durable goods number was actually up last week! The mother of all inventory adjustments is almost over. Retailers are still offering the deals of the century, but there is very little left in the back room. The Baltic Dry Shipping Index has tripled off of its November low, hinting that international trade may come out of its comatose condition. And they are no longer looking for organ recipients for the major airlines. Now I hear that semiconductor makers are expected to make their Q1 targets. Maybe it’s because spring has arrived, and the girls on the Embarcadero have shed their overcoats for low cut tank tops. Or maybe the $4 trillion in global stimulus is starting to have its desired effect.

2009 Mar 30 12:34 PM

[Gedankonomist]

That's one "hockey stick" chart you won't see on the evening news.

2009 Mar 30 02:00 PM

[David Roskoph]

Mad hedge Fund Trader,

Bully, quite. The crowd must be frightenened out of their senses, just as they were intoxicated out of them 10 years ago. This is a financial soap opera for a public that demands entertainment in every venue.

2009 Mar 30 02:08 PM

[Ragnarok]

The federal government is not only injecting stimulus but is structurally bankrupting us with long term obligations and debt. Adding salt to the wound, he has all but nationalized the insurance, banking, and now automotive industries.

If stimulus was the real objective, Obama would have simply implemented an across the board tax cut of personal, payroll, capital gains and corporate taxes.

Instant stimulus and no "gaming" of the tax code. No checks to write and no delay for capital injection.

Nope, he is using the crisis to reshape America into Venezuela.

2009 Mar 30 06:18 PM

[realold]

Unfortunately, I tend to agree with Ragnorak. Being old, I can say that this reminds me alot of the 1970's, but with deflation up front - probably alot worse. In the 70;s President Johnson tried to have "guns and butter" ,spending huge sums and lives in Viet Nam while creating the new welfare state - sound familiar?

The mid-term result was fantastic inflation. I remember buying a CD at the local savings and loan that paid 19%. To me, inflation is the obvious conclusion in the mid-term. Inflation is an easy way for government to do what it wants and then "pay" for it by making the debt seem small.

So, what to do? In the 70's it was buy real estate, but then the polticians doubled the property tax each year......

Good luck to us all.

2009 Mar 30 10:55 PM

[Teutonic Knight]

To Brett and everyone who commented,

Great debate. I enjoyed it. Can't help chipping in my little two cents even it is getting pretty late at night here.

My short comment is going to be disappointingly dull and non-inspiring. Everyone may be right or wrong. At the rate things are going, we and the world are just going to muddle along.

But I have a sinking feeling the road to final recovery is going to long and full of surprises.

Teutonic

2009 Mar 30 11:21 PM

[Ned S]

Teutonic Knight - I agree that there are no obvious quick easy turn arounds here. Everyone in any position to know and/or with a smart mind is telling us PRECISELY that: Obama, Bernanke, Geithner, Volcker, Buffet and Soros come immediately to mind. (Although the political types are trying to put the happiest possible face on it.)
So why would an inherently ill informed dumby like me want to argue? But the broad markets want to. JUST ONE MORE BUBBLE PLEASE! (Beg, Whimper.) And they could get it. But heaven help them if they do - Because then the crash of 2014 will then be really nasty.

2009 Mar 31 05:34 AM

[Teutonic Knight]

To Nad, thanks, noted.

Well said. One more last (hopefully the) word.

The U.S. is perhaps the most unique and most powerful nation ever existed in human history (my conjecture only).

The world economy(ies) could not be "Fixed" magically with a snap of the finger like Mary Popin's, or like changing out a muffler in a car, or removing a turmor in the human body, or replacing a bad chip in a computer, or reloading the Operating System of a PC, etc.

It is the like a boiler in a gigantic reactor of billions of humans whose action and reaction could not be predicted or foretold. And past happenings could be adequately be extrapolated to forecast the future as well, as each situation is unique and different.

Let's pick on the Chinese again, that is handy. Therre is a philosophy called the Yin-Yang. Our nation's future is akin to some form of Yin-Yang behaviour. If, on the one hand, our entrepreneurial, innovative, and pioneering spirits and enerigies prevail, we will come out stronger.

If on the other hand, we continue to let our weaknesses as shown by the present fiasco prevail, we would spiral down and become relegated as a second-tier nation in 25-50 years.

Personally, I am not hopeful. This is because our next generation, the younger folks in their 20's, who are really going to be the masters of this nation after we (older folks) are gone, might follow the examples of the culprits of the present malaise. It is said that kids follow their parents. They do what their parents would do. If their parents divorce, they are more likely to divorce in their marriages. The present young generation as I see it are risk averse, too ready to take the easy way, have too high expection of life styles. IMHO.

I hope we (USA) would come out okay.

Teutonic


On Mar 31 05:34 AM Ned S wrote:

> Teutonic Knight - I agree that there are no obvious quick easy turn
> arounds here. Everyone in any position to know and/or with a smart
> mind is telling us PRECISELY that: Obama, Bernanke, Geithner, Volcker,
> Buffet and Soros come immediately to mind. (Although the political
> types are trying to put the happiest possible face on it.)
> So why would an inherently ill informed dumby like me want to argue?
> But the broad markets want to. JUST ONE MORE BUBBLE PLEASE! (Beg,
> Whimper.) And they could get it. But heaven help them if they do
> - Because then the crash of 2014 will then be really nasty.

2009 Mar 31 03:56 PM

[Brett Owens]

Teutonic, well said, and I hope you're right about the muddle through scenario.

Absolutely agree - fun to debate, in the end, nobody has a clue how things will unfold.

Even the most ardent bears failed to predict the breadth and depth of this recent crash!

2009 Mar 31 11:10 PM

[dcb]

I do have trouble understanding how if we are in the greatest crisis since the great depression asset prices don't fall to valuations in line with 82 and 70's. This is what makes it a bit hard for me to understand current market action. although if we assume the 2002 was a low that was actually prevented from reaching the bottom, this could just be another lull lasting 5 years then a further move down. I don't know. from my readings on a price to earnings ratio current market pricing is very high. can anyone help me to reconcile what is going on. In truth I expect sideways move movement for a long while. but who the hell knows. I suspect we are at near top of sideways movement, and the prior lows were near the bottom.

2009 Apr 02 03:51 PM

[dcb]

you have to explain that to me. Green squads and regulators never caused a financial crisis and you have to add the crisis to the efficiency factor. we have asain, lat amer, japan bubble, tech bubble ?, hosuing, LTCM, savings and loan. that isn't really very efficient to me. Got to include clean up costs. I include inflation and debasing the us dollar in those costs too.
On Mar 30 09:04 AM Steve Pasq wrote:

> Well put. The transfer of resources to the less productive parts
> of society is contributing to the collapse. I'm not saying that
> the bankers and brokers are good examples of productivity...they
> are just more productive than the green squads and regulators coming
> on line with big bankrolls.

2009 Apr 02 03:58 PM