Depression may be here already

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By Colin Speakman (China Daily)
Updated: 2009-03-13 07:47

Recession is now the word that embellishes any article about Western economies, but it was not that long ago that the word was harder to find. Although some economists were brave enough to use it, many were not - taking refuge in the fact that the data did not show the required two successive quarters of negative growth of GDP. Perhaps others, especially in government, did not want to damage confidence by suggesting such a state.

I prefer the theory that if it looks like a duck, walks like a duck and quacks like a duck, then it probably is a duck. There was plenty of evidence from job cuts, house price stalls and company profitability that all was not well. When the Western recessions were officially recognized, the data showed that they had been around for sometime. It is not unusual that, in a period of downturn, the data being estimated lags reality and are subsequently revised to less favorable numbers. At a micro level, many players are not willing to reveal the entire depth of the problem - banking, insurance and auto industries spring to mind - and that's without some participants who simply "distorted" the figures for their own businesses.

Correctly identifying the economic situation as early as possible is very important as there are time lags from recognition through decision-making, to implementation to economic impact. Moreover, many recently unemployed might have wished that government stimulus measures had been introduced some six months earlier.

Today it is perhaps more salient to ask "Is the duck depressed?" It sure feels like more than a common garden-variety recession - and perhaps it has now become misleading to use that term. Recession has traditionally been associated with another stage of the economic cycle - recovery.

Western leaders have assured us that there will be recovery, but it is what comes in between that will determine affairs.

Some think of recession as part of a V-shaped cycle where what goes down must come up. Others recognize that it can be U-shaped and that recovery is not so rapid. But what of the L- shaped version, where after steep declines there is no sign of upturn for several years? Isn't that really a period of depression with all that it implies? It is to be hoped that there can be general agreement on the distinction between recession and depression beyond the notion that "we are in recession when your neighbor loses his job, and in a depression when you lose your own". Some economists will look to the data that accompanied the depression of the last two centuries to define our current state. But I would argue that each century has it's own Great Depression and if we are in the west's 21st Century Great Depression, it will have its own features.

Unemployment, bank and business failures and stock market collapses are the stuff of a Great Depression. Some will therefore say that the rise in unemployment to possible double digits, while alarming and a tragedy for those impacted, is not high enough to call a depression. However the economic world has changed - true unemployment is probably much higher in our world.

There are those who now are on reduced working weeks, who have taken paycuts, who used to need a second job to keep up with Western dreams, who supplemented their income with day trading, property flipping and internet dabbling who are all now feeling the pinch yet, along with discouraged jobless, are not part of the unemployment statistics. It is likely that the drop in effective demand associated with the current downturn is much higher than the unemployment figures suggest. As for banking and business failures, we have those on a wide scale.

Indeed many respected experts have said that "aspects" of today's downturn are arguably worse than the 20th century's Great Depression. The Fed's Bernanke has said "another concern is that the Fed and other Washington policymakers won't be able to break a vicious cycle where disappearing jobs, tanking home values and shrinking nest eggs are forcing consumers to cut back sharply, worsening the economy's tailspin. In turn, battered companies lay off more people and cut back in other ways."

Investment management guru Warren Buffett proclaims, "The US economy will be in a shambles throughout 2009 - and probably well beyond." He talks about a "paralyzing fear" that has engulfed the country. Renowned investor George Soros said recently that the world financial system has effectively disintegrated, and there's no near-term bottom to this financial crisis in sight. Speaking at a dinner at Columbia University, Soros said, "We witnessed the collapse of the financial system".

How many negative aspects by respected commentators are needed before we start to call it what it is? We would need to bring in the other two "d words" associated with a depression - disinflation and deflation. A period of disinflation could bring benefits - it is about removing inflation and expectations of inflation from the system. So prices remain flat and there is more encouragement to rebuild the savings ratio as households do not fear they are chasing ever -increasing prices and thus justify buying on credit today. Citizens stop over-stretching themselves with debt taken on with the rationale that future money wage increases and other inflationary aspects will help them manage or re-finance it, if they can struggle through the first year or two. Thus the "leverage" concept is dampened down.

However deflation is another matter. This is the process in which prices continually fall as do money wages. This has very worrying aspects as consumers postpone expenditure, expecting to get products cheaper in the future and the real cost of servicing debt rises, as a fixed monetary debt has to be managed out of a failing monetary income. Governments will wish to avoid this at all costs. Individuals need to know what they are facing - a recession or a depression - to make economic decisions.

Despite the terrible losses in asset values in property and stock markets, entering a depression will almost certainly mean that those lower values are as good as it is going to get in the foreseeable future, with property prices in Western economies down another 20 percent and the US stock market falling to 5000 or worse in the year or two ahead. Euro Pacific Capital President Peter Schiff proclaims that the Dow could drop from current levels of under 7000 down to 850.

This means that those who feel that they will need to cash in assets are going to get more today than in the near future, and hanging on only to suffer further losses does not make economic sense. Of course, in the long run there should still be a recovery, but economic decisions right now need to be informed on whether a depression exists in the medium term. Equally, government stimulus policy will need to be stronger and further initiatives enacted sooner rather than later. It may well be that by late 2009, more economists will be calling this a depression. It may also be that we will be told that it actually had us in its claws a bit earlier. Only time will tell.

The author is an economist and Director of China Programs at the American Institute for Foreign Study.

(China Daily 03/13/2009 page10)