Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Gold’s Major Reversal to Create the “Handle” - 5th July 20
Gold Market Manipulation And The Federal Reserve - 5th July 20
Overclockers UK Custom Build PC Review - 1. Ordering / Stock Issues - 5th July 20
How to Bond With Your Budgie / Parakeet With Morning Song and Dance - 5th July 20
Silver Price Trend Forecast Summer 2020 - 3rd Jul 20
Silver Market Is at a Critical Juncture - 3rd Jul 20
Gold Stocks Breakout Not Confirmed Yet - 3rd Jul 20
Coronavirus Strikes Back. But Force Is Strong With Gold - 3rd Jul 20
Stock Market Russell 2000 Gaps Present Real Targets - 3rd Jul 20
Johnson & Johnson (JNJ) Big Pharma Stock for Machine Learning Life Extension Investing - 2nd Jul 20
All Eyes on Markets to Get a Refreshed Outlook - 2nd Jul 20
The Darkening Clouds on the Stock Market S&P 500 Horizon - 2nd Jul 20
US Fourth Turning Reaches Boiling Point as America Bends its Knee - 2nd Jul 20
After 2nd Quarter Economic Carnage, the Quest for Philippine Recovery - 2nd Jul 20
Gold Completes Another Washout Rotation – Here We Go - 2nd Jul 20
Roosevelt 2.0 and ‘here, hold my beer' - 2nd Jul 20
U.S. Dollar: When Almost Everyone Is Bearish... - 1st Jul 20
Politicians Prepare New Money Drops as US Dollar Weakens - 1st Jul 20
Gold Stocks Still Undervalued - 1st Jul 20
High Premiums in Physical Gold Market: Scam or Supply Crisis? - 1st Jul 20
US Stock Markets Enter Parabolic Price Move - 1st Jul 20
In The Year 2025 If Fiat Currency Can Survive - 30th Jun 20
Gold Likes the IMF Predicting a Deeper Recession - 30th Jun 20
Silver Is Still Cheap For Now - 30th Jun 20
More Stock Market Selling Ahead - 30th Jun 20
Trending Ecommerce Sites in 2020 - 30th Jun 20
Stock Market S&P 500 Approaching the Precipice - 29th Jun 20
APPLE Tech Stock for Investing to Profit from the Machine Learning Mega trend - 29th Jun 20
Student / Gamer Custom System Build June 2020 Proving Impossible - Overclockers UK - 29th Jun 20
US Dollar with Ney and Gann Angles - 29th Jun 20
Europe's Banking Sector: When (and Why) the Rout Really Began - 29th Jun 20
Will People Accept Rampant Inflation? Hell, No! - 29th Jun 20
Gold & Silver Begin The Move To New All-Time Highs - 29th Jun 20
US Stock Market Enters Parabolic Price Move – Be Prepared - 29th Jun 20
Meet BlackRock, the New Great Vampire Squid - 28th Jun 20
Stock Market S&P 500 Approaching a Defining Moment - 28th Jun 20
U.S. Long Bond: Let's Review the "Upward Point of Exhaustion" - 27th Jun 20
Gold, Copper and Silver are Must-own Metals - 27th Jun 20
Why People Have Always Held Gold - 27th Jun 20
Crude Oil Price Meets Key Resistance - 27th Jun 20
INTEL x86 Chip Giant Stock Targets Artificial Intelligence and Quantum Computing for 2020's Growth - 25th Jun 20
Gold’s Long-term Turning Point is Here - 25th Jun 20
Hainan’s ASEAN Future and Dark Clouds Over Hong Kong - 25th Jun 20
Silver Price Trend Analysis - 24th Jun 20
A Stealth Stocks Double Dip or Bear Market Has Started - 24th Jun 20
Trillion-dollar US infrastructure plan will draw in plenty of metal - 24th Jun 20
WARNING: The U.S. Banking System ISN’T as Strong as Advertised - 24th Jun 20
All That Glitters When the World Jitters is Probably Gold - 24th Jun 20
Making Sense of Crude Oil Price Narrow Trading Range - 23rd Jun 20
Elon Musk Mocks Nikola Motors as “Dumb.” Is He Right? - 23rd Jun 20
MICROSOFT Transforming from PC Software to Cloud Services AI, Deep Learning Giant - 23rd Jun 20
Stock Market Decline Resumes - 22nd Jun 20
Excellent Silver Seasonal Buying Opportunity Lies Directly Ahead - 22nd Jun 20
Where is the US Dollar trend headed ? - 22nd Jun 20
Most Shoppers have Stopped Following Supermarket Arrows, is Coughing the New Racism? - 22nd Jun 20

Market Oracle FREE Newsletter

AI Stocks 2020-2035 15 Year Trend Forecast

Looming Recession Could have been a Lot Worse

Economics / Recession 2008 - 2010 Oct 22, 2008 - 09:38 AM GMT

By: Money_Morning

Economics

Best Financial Markets Analysis ArticleMartin Hutchinson writes: The U.S. economy is entering a recession. With each day that passes and each indicator we see, that eventuality becomes more and more clear.

Even so, we can take some real comfort in knowing that we're likely going to avoid the “bottomless pit” of a Great Depression II. A substantial recession with accompanying inflation – roughly along the lines of the downturns of 1974 and 1980-82 – seems the most likely scenario we face.


The last two U.S. recessions – the 1990-91 downturn touched off by Saddam Hussein's invasion of Kuwait and the subsequent recession in 2001 – were both short and shallow, and perhaps even unnaturally so. Gross domestic product (GDP) declined by about 1.5%, peak-to-trough, in the first case, and a mere 0.5% in the second.

In 1990-91, the tax cuts and other structural changes made by President Ronald W. Reagan had increased the trend growth rate of the U.S. economy, so only the artificial drag of the savings-and-loan crisis brought a modest recession. In 2001, the U.S. Federal Reserve was expanding the money supply so rapidly, and dropping interest rates so far below the level of inflation, that what might have been a substantial downturn after the 1996-2000 stock market bubble was turned into renewed recovery led by the housing sector.

The Portrait of a Downturn

Thus, our experience of the last two decades, when recessions have been both shallow and short-lived, is not necessarily what we should expect going forward.

This time around, it is fairly clear the recession will be deeper than in 2001, and perhaps even worse than its 1990-91 counterpart. Retail sales were down 1.2% in nominal terms in September and industrial production was down 2.6%, while unemployment has already risen from 5% to 6%, with payrolls dropping more than 600,000 since the start of the year.  That suggests that an overall decline in output of considerably more than 1.0% to 1.5% is highly likely.

At the other extreme, and very thankfully indeed, we are highly unlikely to see The Great Depression – The Sequel. Creating the first Great Depression required a horrific stock-market crash, followed by several major policy miscues. Key among them:

  • A huge increase in tariffs ( The Smoot-Hawley Tariff Act of 1930 ) at a time when world trade was already in a fragile state, and trade barriers were much higher than they had been before 1914.
  • A 30% decrease in the money supply caused by bank failures, which made prices drop 20%, made real interest rates correspondingly high and was a major cause of real GDP dropping 25%.
  • A major tax increase at the bottom of a deep recession, taking the top marginal rate of income tax from 25% to 63%.

This time around, we have already bailed out the banking system, are increasing the money supply at a rapid rate, and are fairly unlikely to enact a major tax increase in the trough of a recession. And even if protectionism revives, we are unlikely to see a re-run of Smoot-Hawley (in any case, world trade remains very robust, indeed).

All these differences are protections against Great Depression II, and they should be sufficient. That's not to say we aren't still looking at a nasty inflation problem , which is a separate question.

It's High, It's Deep – and It's Gone

To figure out how deep the recession might be, look at a few factors in the U.S. economy that have changed or need to change. The housing decline has wiped out about $5 trillion of the nation's wealth, and the stock market fall has eradicated an additional $8 trillion; taking a reasonably pessimistic view of both would suggest a total eventual wealth wipeout of about $20 trillion .

Past studies have suggested that there is a “ negative wealth effect ” in a market crash, with an annual consumption decline equal to about 3% to 4% of the wealth wiped out: In other words, for each $100 a consumer loses, they will reduce their outlays by $3 to $4. That translates into a consumption drop of about $600 billion to $800 billion, which equates to about 4% to 5% of our current GDP.

To look at this another way, the U.S. payments deficit is now around $750 billion per annum, or 5% of GDP, and will need to be eliminated – or nearly so – since foreigners won't want to go on pouring that amount of money into the U.S. market. That also suggests a re-balancing of U.S. trade by about 5% of GDP. This rebalancing will probably come partly from decreased consumption, which itself will reduce imports, and partly from a decline in the value of the dollar, which will increase exports.

Finally, the abysmal U.S. savings rate is currently around zero, or maybe 1% of GDP, and has historically been around 5% to 6% of GDP. This also suggests a switch from consumption into saving of about 5% of GDP, although that's realistically probably a very long-term change.

Those factors all tend to suggest a GDP decline of around 4% to 5%, top to bottom. That would be a little more than the recession of 1974, or the “double-dip” recession of 1980-82 – each of which equated to about 3.5% of GDP. However, as occurred in 1980-82, the anticipated decline is unlikely to happen in one leg, but will probably take a “double-dip” form. That's because interest rates are currently very low, far below the rate of inflation. Hence, inflation will probably accelerate, alleviating the housing problem (because incomes will rise approximately in line with prices, making housing more affordable).

Once home prices have bottomed out, and the housing market has stabilized, banks will resume lending more aggressively and the economy will move into a full-fledged recovery mode.

Where Are You Paul Volcker?

At that point, since interest rates will have been far below inflation for several years, inflation will have accelerated, and will be accelerating harder. Hence, a change in U.S. Federal Reserve policy will be needed – probably one that pushes short-term interest rates far above the rate of inflation, as then-Fed Chairman Paul A. Volcker did from 1979 to 1982, a painful-but-effective assault on inflation, that sent pricing pressures packing for two decades.

That will inevitably cause a second “dip” in the economy, but by this stage the housing and financial sectors will have stabilized, and the second “dip” will be focused on corporate profits and the “real” economy. Profits' share of GDP, which has been at an all-time high recently, will decline to more normal levels.

That is an unpleasant picture. It is bad news for stock prices and it may take five years to work through, albeit with a likely mild “bounce” in the middle.

But it could have been much worse. It's nowhere near as bad as the nightmarish Great Depression, or the long, drawn-out and relentless rolling Japanese recession of 1990 to 2003, which led to that country's “ Lost Decade .”

And for that we must be grateful.

[Editor's Note : When it comes to investment banking and the international financial markets, Money Morning Contributing Editor Martin Hutchinson brings readers a unique brand of expertise . In February 2000, for instance, when he was working as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians who had been stripped of nearly $1 billion by the breakup of Yugoslavia and the Kosovo.  And readers have benefited: Back in April, long before the collapse of American International Group Inc. ( AIG ) made “credit default swaps” a household word, Hutchinson penned a column warning Money Morning readers about the dangers of credit-default swaps , and his recent analysis of how the U.S. stock market would respond to the credit crisis proved to be incredibly accurate. Hutchinson is also a regular contributor to our monthly investment newsletter, The Money Map Report . And right now, new Money Map Report subscribers will receive a free copy of The New York Times best-seller, " Crash Proof: How to Profit from the Coming Economic Collapse ” – which, ironically, details the moves investors have to make to generate large-scale profits in a volatile, or even upside-down, stock market . The strategy is one of the best ones we've seen for navigating the current financial crisis . ]

By Martin Hutchinson
Contributing Editor

Money Morning/The Money Map Report

©2008 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules