People often ask me why I think this recession will become a depression when we've had many recessions in the 70 years since the Great Depression i.e. what's different this time? The fact is that nothing's different. What's different for a guy who has been living an unhealthy lifestyle for 30 years and eventually has a heart attack? The answer is nothing. Complex systems are often able to absorb substantial "adverse stimuli", but eventually they reach a critical tipping point that ends in disaster. Contrary to human optimism, the passage of time does not lessen the likelihood of an adverse event, it only increases the probability of an adverse event. When the tipping point occurs, it's not because of a "Black Swan Event", it's because of a "Dumb Swan Event".
In the case of our economy, the negative factor that's been building up all of this time isn't cholesterol, it's credit. Not to say that all forms of credit are bad, but just as with cholesterol, there is good credit and bad credit. In the case of our economy, our figurative "arteries" are clogged with "bad credit" also known as non-self-liquidating credit. This "nsl" credit refers to money borrowed to pay for consumption as opposed to self-liquidating credit which is is debt used to invest in productive assets (factories etc.). Borrowing for consumption imposes a negative burden (debt service) on future consumption, whereas productive investment creates a future source of income that (usually) more than offsets the cost of the debt service.
Non Amortizing debt
There is an even worse form of credit that the Government uses, which is non-amortizing credit. As opposed to a mortgage or even revolving credit, the Government's favourite debt instrument, Treasury bonds, does not require periodic payments on principal. Government bonds only require interest payments, so for example, on a thirty year bond our Government can defer paying back principal for the entire time to maturity (30 years). And when these "long bonds" do eventually expire, what does Government do? They of course issue a new long bond to pay off the old one and hence extend the time for repayment by another 30 years. Needless to say, this is an extremely handy way of shifting the repayment burden from one generation to the next. So, not only does Government run up obscene amounts of debt, they've even found a great way of paying the least amount possible in the current period against the debt. This is equivalent to an interest-only mortgage where you basically never pay off a dime against your house.
Why Now?
So then people ask me why do I think we are reaching this critical point now? I first came to realize that we were facing the first depression in 70 years when I observed the response of the Government and Federal Reserve to get us out of the last recession (2001-2002). In the end, the Fed had to lower interest rates from the 6% range all the way down to 1% in order to revive the economy. In addition, we had the massive fiscal stimulus caused by the war in Afghanistan and the war in Iraq AND the Bush tax cut. That for me was the wake up call. What that told me right there, is that monetary policy is losing its effectiveness. Fast forward 6 years to today and we've been borrowing steadily throughout this expansion and now we face yet another recession, this time much more leveraged thanks to all of the additional debt that's been incurred in the meantime. Add to that the recent evidence that the long-awaited "deleveraging" process is already well underway, to wit, the extreme turmoil and massive writedowns we've seen across the credit markets to date. And, as I wrote recently, (Fed Funds) rates are all the way back down to 2% and yet Fed policy is now trapped between the Scylla of inflation and Charybdis of bank failure.
Debt Addiction
The real story is how the hell did we get here? As I've indicated before, coming out of the 1970s, the U.S. was incurring structural fiscal and balance of trade deficits, indicating that the economy was no longer competitive. That's when the "neo" Supply Side Economics movement came along and convinced us that we could have our cake and eat it too, we just had to get used to taking on a little bit of debt. Or as Cheney put it "Reagan proved that deficits don't matter" (which makes as much sense as eating a Big Mac and declaring cholesterol doesn't matter). The other insidious element of SSE is the relentless drive for growth, because growth hides a lot of underlying problems - in the short-term. Stated GDP is never adjusted for debt levels which means that recent years' GDP is massively overstated relative to historic GDP.
The End of Credit
Our economy represents a 30 year bubble in credit. As the bubble expanded, our sponsors (China, Japan, Saudi Arabia) were more than willing to lend to us, in the belief they would be paid back with interest. More importantly, our current level of economic activity is predicated upon continued and growing access to credit. Credit is extended based on confidence in the likelihood of repayment. Once lenders' confidence is lost, it will go away for a long time and it will take with it the biggest part of our economy.
In short, it's wake up time folks. There are signs everywhere that we are at or near the all important "tipping point", you just have to be willing to look for them. Paraphrasing from Robert Prechter (EWI), it's better to be a year early, than an hour late when it comes to preparing for financial calamity. For those reading this near the time of writing, you must take steps to protect yourself, your family and your assets before it's too late.
