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A Depression or Not a Depression

It seems that the D-word is now becoming prevalent. You won't hear it from the any of the financial authorities, or the politicians, or anybody in an official capacity. Well okay we overheard Stephan Harper, Prime Minister of Canada say "The world is entering an economic period unlike, and potentially as dangerous as, anything we have faced since 1929". Okay so maybe there is some recognition that we are in unchartered territory. But the thought of an economic depression is not something anyone really wants to discuss. We have stated that we don't believe we will see anything on the scale of the Great Depression. Trouble is, even economists can't agree on the definition of a recession or the rarer depression.

The rule of thumb is that a recession is two consecutive quarters where GDP declines. A depression is a severe recession, with GDP declining by more than 10 per cent. Thus far at least we have seen no one predict that will happen but it hasn't stopped a host of pundits declaring that we could be in a depression and that the stock market is probably only about half way through its decline. Certainly if the latter were the case then that would be equivalent to the long liquidation that took place 1929-32. In all of stock market history of North America there simply is no record of decline of that nature either before or after. Typical panics and sharp recessions or even prior to the 1929 crash and depression collapses usually shed no more than 50 per cent. By that definition for the stock market we are there.

Prior to the Great Depression, economic downturns were referred to routinely as depressions. In looking back, many of them are probably better described as recessions, even when prolonged. In 1929-33 GDP declined in the US by almost 33 per cent. Following a period of recovery a secondary depression hit, and GDP declined 18.2 per cent in 1937-38. Since then the largest decline was the recession of 1974-75, where GDP declined a modest 4.9 per cent.

Most depressions in modern times have occurred in emerging economies. The worst one recorded for more advanced economies was the Russian depression of 1990-95 where GDP declined by almost 50 per cent. By contrast, despite all the talk about the long Japanese nightmare of the 1990s, only 1993, 1998-99 and 2001-02 saw negative growth. The worst was a 2.1 per cent GDP decline in 2001. For sure GDP growth was way down from its go-go growth years of the late 1980s but Japan never tumbled into a huge depression like the 1930s or the Russian collapse of 1990-1995.

Today China has replaced Japan as the go-go economy. But given that its growth was always in the area of 10 per cent annually, even a decline to five per cent is a significant slowing. But that is not by any stretch a depression, irrespective of its impact on other economies. The real danger is that the US is very dependent on Chinese credit. If the Chinese maintain their emphasis on exports and on recycling those dollars into US debt then that will sustain the US economy. But if the Chinese shift their focus to building their own consumption society encouraging their own people to buy their own products then that would create a huge debt hole for the US to fill.

The start of the current collapse is traced back to June 2007 and the sub-prime mortgage crisis but the financial panic portion of the collapse can be traced to September 15, 2008 the day Lehman Brothers (LEHMQ-OTCPK) declared bankruptcy. On that day the Dow Jones Industrials closed at 10,917. Four days later the DJI reached a high close of 11,388. Then came the deluge and the financial panic of 2008 as the DJI fell 31 per cent in less than a month.

With unemployment now rising we are facing a further and potentially worse crisis with the North American automotive industry and hundreds of thousands of jobs in the balance. The unemployment rate in the US is already at 6.5 per cent (and that's the official rate, not the much higher rate reported at www.shadowstats.com) and with the spectre of more unemployment and companies going under, it explains why we are seeing the D-word being tossed around.

But negative growth is not a depression, unless of course we are truly slipping off towards a GDP decline of more than 10 per cent. But given the heights from which we have come, the signal is already there that we are facing a crisis of severe proportions. For the boomer generation that has known nothing but good times it is quite a shock.

So where are the signs that things could get worse? In any downturn, companies go under. The biggest has been Lehman Brothers. Washington Mutual (WAMUQ - OTCPK) became the most notable bank collapse. Many others were just absorbed by someone else, like Bear Stearns (taken by J P Morgan Chase (JPM-NYSE) and Merrill Lynch (MER-NYSE), which is to be merged with Bank of America (BAC-NYSE). Some, such as Goldman Sachs (GS-NYSE), are in the process of converting themselves into bank holding companies.

One of the problems as we see it right now is that all of the money being thrown at the problem is not really getting into the broad economy. Instead it is being used to try to bail out the financial powers (i.e. banks, investment dealers). There is no guarantee that this money will find its way into the broader economy. Numerous other banks have gone under and some big ones such as Citicorp (C-NYSE) are teetering, threatening to lay off thousands more workers. That is the real problem here in that the credit system has become paralyzed. In that kind of environment everyone suffers.

Already because of job losses, home losses and portfolio losses, the consumer economy has stopped spending. The result is that the already weakened automotive industry led by the Big Three (General Motors (GM-NYSE), Ford (F-NYSE) and Chrysler (DAI-NYSE)) are on the verge of bankruptcy. After the September 11, 2001 crisis the President implored for everyone to go out and shop. Today that seems just rather quaint as if it were the solution to societal ills.

Numerous retail stores have either entered Chapter 11 bankruptcy, such as Circuit City (CCTYQ-OTCPK). Eddie Bauer (EBHI-NASDAQ) and Ann Taylor (ANN-NYSE)) are teetering, and have closed stores. Many other large chains have also announced store closings and are warning of problems, such as Best Buy (BBY-NYSE) and J C Penney (JCP-NYSE). Smaller stores just close their doors as numerous ones already have. All of these result in the loss of thousands of jobs. If the North American automotive industry is in a state of catharsis then the retail industry is having a nervous breakdown.

But it goes even deeper. To the above companies and industries we can add airlines (Continental (CAL-NYSE)), hotels (MGM Mirage (MGM-NYSE)), anything in Las Vegas these days, tourism (see Las Vegas), real estate and construction, manufacturing, telephony (Vodafone (VOD-NYSE)), the mining and the energy sector both of whom are having a seizure. This is just a bare bones indication of the companies' currently experiencing trouble. While the focus is primarily on the automobile companies, the potential for trouble in the consumer economy beyond the auto companies is huge. In this environment, does buying another iPhone or iPod make any economic sense? If it doesn't then one should be concerned about Apple (AAPL-NASDAQ) which hit new lows on Friday. Without infusions of cash into these sectors they could be badly impacted, leading to even more job losses.

They have defined the greatest threat to the markets as being the seizing-up of the credit markets. Even international letters of credit which impact international trade have had credit problems of late. But to pour funds into the banking system through the so-called Troubled Asset Relief Program (TARP) is not the answer. Paulson's about-face on the type of assets eligible for TARP caught everyone by surprise and was a major factor behind the most recent sharp selloff.

TARP is not a solution because all it does is pour public money into private hands, leading to a further concentration of wealth and power in the banking system. There is no obligation on the part of the banks to lend the funds out to a broader economy in dire need. Indeed the banking system is protecting its own position by not granting credit and also by calling in healthy loans, on the pretext of protecting its capital position. This just adds to the woes of the industrial and service sectors.

What is needed is a bailout of the consumer economy, not of creaky banks. This is one area which if not properly addressed in the coming months could make the situation worse than it might be. Of course that can only be accomplished by fiscal stimulus. The risk is that the authorities have "blown their wad" so to speak, bailing out the financial system.

So how much have they blown? One needs to look at the balance sheet of the Federal Reserve. It has jumped $1.3 trillion in the past year. Most of that occurred in the past several months as the financial collapse got underway.

Obvious ones that have leaped are as follows ($ billions):

Factors Affecting Reserve Balances November 20, 2008

Term Auction Credit


Commercial Paper Funding Facility


Primary Dealer Credits


Primary Credits (banks)


Other Credit


Other Fed Assets




A year ago most of these were either non-existent or minimal in amounts outstanding. The Fed has offset some of these amounts through the sale of US Treasuries from the portfolio that have fallen $303 billion over the past year.

But this is really only a part of the explosion in funding being provided either through the Fed or the US Treasury. A CNBC story (Financial Crisis Tab Already in the Trillions - CNBC.com Nov 18, 2008) noted funds spent or promised and assumed thus far that the actual or promised increase in funding approximates to $4.3 trillion. ($ billions):

Financial Crisis Balance Sheet

Government Entity Sum in Billions of Dollars
Federal Reserve  
(TAF) Term Auction Facility 900
Discount Window Lending
Commercial Banks 99.2
Investment Banks 56.7
Loans to buy ABCP 76.5
AIG 112.5
Bear Stearns 29.5
(TSLF) Term Securities Lending Facility 225
Swap Lines 613
(MMIFF) Money Market Investor Funding Facility 540
Commercial Paper Funding Facility 257
(TARP) Treasury Asset Relief Program 700
Automakers 25
(FHA) Federal Housing Administration 300
Fannie Mae/Freddie Mac 350
Total 4284.5
Note: Figures as of Nov. 13, 2008

*References include US National Archive, US Dept of Defense, US Bureau of Reclamation, Library of Congress, NASA, Panama Canal Authority, FDIC, Britannica, WSJ, Time, CNN.com, and a number of other websites.

The question that has to be asked is where the US Treasury is going to find the money to fund this. Who is going to buy this - China? Japan? Or will it just be recycled back to the same banks they are bailing out through TARP and other Fed facilities? And is that the end of it? Some estimates have said that the $700 billion TARP program could increase to $5 trillion. Some of this is clearly showing up in the explosion of the monetary base.

We have never seen anything like this before. We noted a few weeks ago that this is very inflationary down the road and makes it essential that one own bullion (gold, silver, platinum). Add to that the hints that China keeps dropping that they would like to add 4,000 tonnes of gold to their reserves. We suppose this can only be accomplished by selling some of their US Treasury holdings. (China has now surpassed Japan as the largest foreign holder of US Treasuries.)

Speaking of China, things are so bad there that they had to roll out a $586 billion stimulus plan. They are concerned that all the laid-off factory workers no longer building toys for America will riot. So this drop is not just in the USA; it is global. And everyone is being impacted as even the Dubai the capital of fun and luxury for the obscenely rich is facing bankruptcy, closings and the capping of towers. We even noted that the Yellowstone Club of Montana has gone bankrupt. The Yellowstone Club is private ski and golf resort for billionaires.

While there may be duplication with lists that others have compiled the areas of vulnerability that need to be pointed out are:

  • US consumer debt totalling $2.5 trillion is extremely vulnerable to further meltdowns. Efforts to combat the growing delinquency and defaults in the credit card sector may actually make things worse as the credit card issuers clamp down.

  • While the automobile companies are bleeding money and in danger of bankruptcy, many car dealerships which are independently owned are closing their doors or are themselves threatened with bankruptcy. As dealerships go out of business there is no one for the automobile companies to sell their cars to. The car dealerships are the face to the public.

  • US States and municipalities are bleeding, not only with portfolio losses but with a collapsing tax base. US States and municipalities are not allowed to run a deficit but many of them if not already in deficit are headed there. The same story is being played out in Canada although the situation is not as bad - yet. Most of the provinces are predicting deficits in the coming year as is the Federal Government. Municipalities who cannot run deficits will be severely squeezed and residents of towns and cities will be undoubtedly be facing potentially large service cutbacks.

  • Pension plans have been devastated, particularly corporate and private pension plans. But even large government pension funds have taken a huge hit. The Canada Pension Plan and the Caisse de Depot the huge financial institution that runs Quebecers pensions have both reported large losses. Most corporate and private pension plans were in deficit even before the onset of this crisis. Either the corporations will have to ante up a lot more (not likely) or retirees are headed for sharply reduced pensions (most likely). Some pension plans that invested heavily in their own stock like AIG or Freddie Mac and Fannie Mae have been almost wiped out.

  • Freddie Mac (FRE-NYSE) and Fannie Mae (FNM-NYSE) the two mortgage giants are still in catharsis and may need more funding. How they maintain their NYSE listing as penny stocks is beyond me.

  • Bond spreads for corporate debt and especially junk bonds are still very wide, making it difficult for them to raise cash through bond issues. If they can raise cash, it is expensive because of high yields. Given the huge new demands of the Federal government the risk is of crowding out so that the corporations cannot access the markets at all.

  • Social security, Medicare and Medicaid in the US are unfunded to the tune of over $40 trillion. Here in Canada Medicare and Social Security (Old Age Pension and CPP) are both secure but will come under stress.

  • As unemployment rises the workers losing their jobs lose their medical benefits, adding to the 46 million and growing who do not have medical and drug coverage in the USA.

  • The cost of two wars is now approaching $900 billion. It will go a lot higher because the US is ensconced in Iraq and Afghanistan until at least 2011.

  • There is a risk of more wars. One should not take this possibility lightly. History has clearly demonstrated that periods of economic stress often result in wars. Anyone of these could widen in a wider war. The global flashpoints are many.

    • The US's illegal incursions into Syria and Pakistan could risk retaliation and a widening of the Iraq war.

    • While the Iraq parliament is to debate a bill that allows US troops to stay in Iraq for another 3 years its passage is not guaranteed as the Iraqi street is opposed to it.

    • The passage of the bill may restart or escalate the crisis in Iraq. The US will not leave Iraq lightly because of the huge investment they have already made in the invasion and occupation of the country.

    • The US under Obama has promised to up the ante in Afghanistan leading to a possible widening of that conflict.

    • The Iranian situation has not gone away. Israel in particular has threatened strikes against Iran in retaliation to its possible building of nuclear weapons.

    • Russia has reasserted its presence in its sphere of influence and this comes into direct conflict with US interests in the Caucasus region (Georgia and the former Russian states around the Caspian Sea, where huge reserves of oil and gas lie).

    • The Israeli/Palestinian question remains unresolved and continues to fester as it has since 1948.

  • Despite lower oil prices the US trade deficit is still around $650 billion annually. This could actually improve if imports fall due to falling demand in the malls of America.

  • Planned expenditures on infrastructure, while badly needed, will only add to the US debt.

You add all these up and see why some are now using the D-word. The planned move on the infrastructure is very positive. Recall that huge infrastructure spending in the 1930s on the New Deal. Much of that infrastructure still exists today and is what needs replacement or rebuilding today.

Despite all of these gloomy prognications we still do not believe that we are headed for another Great Depression. It may well be a steep recession with unemployment (the official one) rising to 10-12 per cent but that would be in line with unemployment seen in 1974-1975 and 1980-1982. GDP may contract as much as two per cent in the coming year and could be worse. But as we have noted in the past, the economy today is very different from that of the 1930s. (Note: In the last Scoop November 17, 2008 - "Buy when there is blood on the streets" we noted that from 1929-1932 the Fed hiked interest rates. We were incorrect .The Fed actually lowered rates during that period and attempted to flood the system with funds but the impact of the strategy was very ineffective).

The recent CPI numbers showed the largest drop ever of one per cent, driven primarily by the sharp fall in energy prices. Year-over-year the CPI is still up 3.7 per cent. The core rate, which they love to tout, fell only 0.1 per cent, emphasizing the fall in energy prices. This has set everyone into a panic that deflation is setting in not only in the US but globally. The monetary and political authorities fear deflation. They will do what they need to do to prevent deflation.

They will do what have to do to re-inflate their economies. Price declines such as we are seeing in energy prices is temporary and oil undoubtedly will overshoot on the downside just as it overshot on the upside. We are seeing so many negative forecasts on oil prices that the odds of it reaching these levels ($20, $30 etc.) is probably diminishing quickly. The reality is that global demand remains high and production is declining from many major fields. With low prices, exploration will slow or stop altogether, ensuring that the next sharp price movement will be set in motion as soon as demand perks up again. Any outbreak of war or upping the ante in current wars in the Mid-East or the Caucasus will send prices up as quickly as they fell.

Given the huge infusion of liquidity into the system, the risk of a deflationary depression is extremely low. The real risk lies in an inflationary depression or inflationary recession. The focus then should be on the next bubble. We continue to firmly believe that the next bubble will be in Gold and by extension silver and platinum. While the risks of a depression are certainly there, the odds that we will actually have one are probably low.

Our monthly Gold chart shows the huge up move from the double bottom of 1999 and 2001. We appear to have completed three major waves to the upside. Once this steep correction, a correction of the entire move from 2003, is out of the way we will embark on another wave to the upside. This is the one where we suspect that Gold will go to $2000 and quite possible higher (some are calling for a move to $10,000). Of course what we are not sure of is the current correction over as witnessed by the huge ABC drop since March 2008 or is this merely the A wave of a larger degree with at least two more waves to come. The nature of the coming up move will determine better where we are.

As well there remain arguments on where the Dow Jones Industrials is headed. Many are saying that this is a bad as it gets. Typically speaking any one collapse never or at least rarely exceeds 50 per cent (other markets clearly can experience far more). But given the risks for a depression as noted above others believe that the fate of the DJI is actually much lower eventually. While we may be on the cusp of a rebound (which we firmly believe) that should last a few months the nature of that rebound will determine whether we will go through a period of wide swings such as we saw from 1966 to 1982 or will we actually have a much larger decline.

Of course in an inflationary depression one could actually see the DJI rise even if as it fails to keep up with inflation. We are showing a chart we found at Cycle Pro Analysis showing the US stock market from 1800 to today. It is an inflation adjusted chart of the DJI based on yearly prices. The chart shows a clear channel rising from those long ago dates. On an inflation adjusted basis the decline will last until 2016-18 and fall to the 3000-4000 zone. Now remember this is on an inflation adjusted basis so the actual may be considerably higher depending on the rate of inflation. Note the 1982 low was below the 1974 low.

We are also showing our chart of the DJI from 1920 also adjusted for inflation. The story seems to be largely the same. On an inflation adjusted basis the DJI has a lot further fall.

Whether it is "To be a Depression, or not to be a Depression" we clearly have a lot more adjustments to make in our lifestyles. For years we have been living in a world of illusion built on a sea of debt. The piper has now arrived and the payment will be steep. But as been shown so many times in the past Gold and bullion will once again be a panacea for global economic stress. It has been demonstrated so many times in the past that when upheaval occurs as Europe has experienced in the past century or even as parts of Asia has experienced many times as well the one thing you take with you when you are uprooted is the Gold. Gold has been a currency for 3 thousand years. We expect it to be around once again through this crisis.

Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.


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