• Text smaller
  • Text bigger

The Economic Cycle Research Institute’s Weekly Leading Indicators has now fallen eight consecutive weeks and has been below -10 for two consecutive weeks. … [T]here has never been a Weekly Leading Indicators plunge in history of this depth and duration, nor any dip at all below -10 that has not been associated with a recession.

– Mike Shedlock, Economic Cycle Research Institute Weekly Leading Indicators in Negative Territory, July 31, 2010

The percent change from the preceding year in real GDP was revised down for all 3 years: from 2.1 percent to 1.9 percent for 2007, from an increase of 0.4 percent to 0.0 percent for 2008, and from a decrease of 2.4 percent to a decrease of 2.6 percent for 2009.

– Bureau of Economic Analysis, Revised Estimates: 2007 through First Quarter 2010, July 30, 2010

As the government statisticians revise their statistics downward and the leading indicators suggest that the so-called recovery is nothing more than an artifact of massive federal borrowing and spending, I thought it would be useful to revisit the scenario that I considered to be the most likely when I wrote “The Return of the Great Depression” one year ago. Given the advantage of one year of hindsight, I see absolutely no reason to change my conclusion regarding the ongoing global economic contraction. “It is not over. It has only begun.”

Excerpted from Chapter 10: “Great Depression 2.0″:

As should surprise no one at this point, the return of the Great Depression is the scenario which I have seen developing since 2002. Others saw this even earlier. Robert Prechter saw 2000 as the peak of the Grand Supercycle wave and went on record accordingly in his book “Conquer the Crash.” Immanuel Wallerstein, the venerable historian who has a far wider perspective than most, sees the present depression as part of a much larger systemic collapse caused by a chronic debt crisis that began in Poland in 1980. Others who view the future through a lens darkly include Paul Volcker, Mike Shedlock, John J. Xenakis of Generational Dynamics, Steve Keen, John Williams of Shadowstats, and Barry Eichengreen, who, in partnership with Kevin O’Rourke, has created a series of illuminating charts that graphically demonstrate the way in which the present contraction exceeds the Great Depression on a global basis.

The parallels between the Great Depression of the 1930s and our current Great Recession have been widely remarked upon. … This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the U.S., it was transmitted internationally by trade flows, capital flows and commodity prices. … To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the U.S. causes one to minimize this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

– Barry Eichengreen and Kevin H. O’Rourke, “A Tale of Two Depressions,” April 6, 2009

In the previous chapter, I delineated 10 major reasons why the Great Depression 2.0 would be worse than its predecessor. And while Eichengreen’s graphs are an excellent illustration of the greater magnitude of the current situation, the fact that the world stock markets have fallen faster, that the volume of world trade has contracted faster, and that the decline in world industrial output is roughly tracking the historical decline are all merely symptoms of the causal factor, which is the fact that most of the perceived economic growth that has taken place in recent decades was nothing more than debt-based consumption, it did not reflect an actual increase in global wealth. The ability to spend tomorrow’s money today does not create any wealth, and to the extent that tomorrow’s money is spent in a manner that serves to divert resources away from what otherwise would have been wealth-creating activities, it will reduce tomorrow’s wealth despite the increase in consumption. And once tomorrow’s money is spent, it becomes harder to find those who will accept payment in the day after tomorrow’s money, and even harder to find those who will accept next week’s money. Eventually, the system becomes unsustainable.

This increasing inability to spend next week’s money today is exactly what is now beginning to be observed in the Treasury auctions around the world, as more and more national governments are finding it difficult to sell the debt that underlies their currencies. Even the market for U.S. debt is beginning to show signs of reaching the limits of its demand for it, and at a rather inopportune time considering that the federal government has announced its need to borrow significantly more money over the next decade by running 10 years of deficits conservatively estimated to amount to $11.1 trillion. There is, of course, little chance that the actual deficits will not be even larger; the previous federal budget anticipated a $407 billion deficit in 2009, not the $1,845 billion one currently projected.

But the global debt problem is far from being solely a matter of national government debt. For example, the U.S. national debt of $11 trillion is less than a quarter of the $53 trillion in debt currently owed by U.S. households, corporations and the various levels of government. These figures mark a significant change from the post–World War II period. While nonfinancial corporations and governments have long been debtors, the household sector has devolved from a 21-percent creditor position to one that is 69-percent debtor. The financial sector remains a net creditor, naturally, but its ratio of credit market debt held to credit market debt owed has fallen from 31.4 to 2.3. Furthermore, the financial sector’s credit-market-debt-held figure assumes that the various mortgages and credit-card balances owned are actually worth their book value; due to the rising rate of foreclosures and bankruptcies we already know this cannot possibly be the case. So, it is possible that the entire financial sector is, like every other major sector of the U.S. economy, also facing net debtor status, and that total U.S. credit market debt is not 375 percent of GDP, but is actually approaching 400 percent.

There is more to the severe economic threat posed by these excessive debt levels than is suggested by mere historical pattern recognition. This has to do with the distinction between the inflationists and the deflationists. While much of the Great Depression scenario is clearly recognized by the Whisky Zulu adherents as being relevant to it, the major distinction between the hyperinflation scenario and Great Depression 2.0 is the inflationist belief in the ability of the central banks to create sufficient money to repay the outstanding debt. However, since modern “paper” money is actually debt, this creates a tautological dilemma. Debt can be devalued by paper, but debt cannot be devalued by debt. It must be deleveraged; Australian economist Steven Keen has noted that the initial deleveraging process in Australia has already begun at a faster pace than it did in the 1930s; it has not even started yet in the United States where debt to GDP is still rising. But it will. And though it’s true that a printing press can print unlimited quantities of dollar bills, not even Ben Bernanke’s magical printing press is capable of printing buyers of U.S. Treasuries.

Conclusion: The Great Depression 2.0 is what is presently developing, although due to a reactive wave of positive social mood, statistical obfuscation and understandable denial, it will take about a year for the consensus opinion to cycle through the various scenarios in descending order of optimism before the grim reality finally becomes apparent to even the casual observer.

  • Text smaller
  • Text bigger
Note: Read our discussion guidelines before commenting.