Saturday, February 7, 2009

Welcome to 2009 - The Depression has officially begun

This article puts it quite plainly and clearly. The recession began in 4Q 2007, but the Depression began in 4Q 2008. The facts are facts, and they do the best job speaking for themselves. Many are still in denial, or have not looked to see, but when we see 20+% unemployment by the end of 2009, it will be obvious to all. God help us.

For as bad as 2008 was, 2009 promises to be a whole lot worse. The problem isn’t just the banking system anymore. The problem is the banking system and everything else. This year, the financial crisis of yesteryear is morphing into an altogether different animal. It’s morphing into a financial crisis that has an economic crisis layered on top of it. In fact, to call the current environment an economic crisis is likely understating the situation. What we really have is a global economic catastrophe. One where weakness only begets more weakness, causing a vicious circle that is proving nigh impossible to reverse in spite of all the world’s financial, economic, and political brain trust throwing everything they have, including the kitchen sink, at the problem.

We mentioned how auto sales in the US were down almost 40%. How housing starts were down almost 50%. How industrial production is falling off a cliff, with each month worse than the last. How jobless claims are at multi-decade highs. How consumer confidence is at multi-decade lows. How the company surveys we follow are showing dramatic declines across the board in economic activity. We challenged the idea that this is a run-of-the-mill, minus-low-singledigit recession and we characterized this Depression (there is no other way to describe it) as “global, pervasive, and deep”.

In the month since we wrote that article, the data points have only gotten worse, and they will likely have gotten worse still by the time you read this article. US housing starts fell a further 15.5% in December to 550,000, the lowest on record. US industrial production fell a further 2.2% in December, to a 7.8% year-over-year decline. If you think that’s shocking try this on for size: European industrial orders (a leading indicator of industrial production) are down 26% year-over-year, the largest decline on record. Or how about Japanese exports plunging 35% in December – shocking, isn’t it? Global steel production was reported to be down 24% in December. All over the world, dramatic rates of decline in economic activity are being reported. The most disturbing developments have been in employment, which took a marked turn for the worse thus far this year. US jobless claims are now running almost 600,000 per week. You don’t want to annualize that number, but you may have to. It wouldn’t be too much of a stretch to say that nobody’s hiring, and everybody’s firing.

The world is experiencing a global economic catastrophe, where weakness becomes self-feeding, begetting even more weakness. As more and more people lose their jobs, their contributions to the economy will decline. There will be more and more home foreclosures and credit card defaults, and even more problems in the banking sector, leading to further wealth destruction. There will be even fewer people buying cars, or buying anything for that matter. As consumer spending declines, so will corporate sales, leading to further layoffs, resulting in fewer customers and even weaker sales, etc. It’s a vicious circle.

Why isn’t all this stimulus working? It doesn’t take a Masters degree in Mathematics to understand why none of this has made an iota of difference so far. All it takes is a back-of-the-envelope calculation of how much wealth has been destroyed over the past couple of years. Let’s begin with the stock markets. At their peak, global stock markets had a market capitalization of approximately $60 trillion. Since then they’ve dropped by half, resulting in $30 trillion of lost wealth. That’s just stocks! The other major source of wealth for people is houses. Taking the US as an example, the latest Case-Shiller readings show that housing prices are down almost 25% from their peak. There are over 100 million homes in the US, and they once had an average price of just over $300,000. Multiplying the three numbers together we get $7.5 trillion of lost wealth in the US from the fall in housing prices. Since the housing bubble was by no means confined to the US (where, it was in fact quite tame compared to other markets), let’s multiply that number by four (the inverse of the US share of global GDP) to get a conservative estimate for the global fall in home values. That, coincidentally, equates to another $30 trillion, for a total of $60 trillion in lost wealth, give or take, just from stocks and houses. This doesn’t even include the losses from other asset classes that have been decimated, such as corporate bonds, commodities, and commercial real estate. But let’s just stop there. This crude but simple analysis already shows the magnitude of the problem that needs to be overcome. The global wealth destruction that has taken place dwarfs anything that has been spent on stimulus and bailouts. This is why it has failed to stem the tide. A trillion or two or three (or even ten for that matter) just isn’t going to cut it. As desperate and as generous as government solutions may seem, they are but drops in the bucket compared to what’s already been lost.

The end result: too much debt and an economy that, at its foundation, became dependent on people spending beyond their means. Those days are likely gone, never to return. There’s been a paradigm shift – a permanent change. People will save rather than spend more than they make. The implications for the economy are enormous. Just envision a world where 25% of all shopping malls close down and try calling that a recession.

So here we are today with governments the world over taking an increasing role in the functioning of the economy and the financial markets. But are they trying to solve the main problem; namely, too much debt? Quite the contrary, every single solution they’ve adopted has been trying to get the good ol’ days back. Cutting interest rates to zero. Throwing money at the banking system so it can lend again. All these solutions have one goal: to bring back debt. They are ignoring, at least for the time being, the paradigm shift. But the markets aren’t buying it… literally. Debts continue to implode. Every bailout is being followed by an even more massive bailout down the road.

Instead of individuals living beyond their means, we now have governments living beyond their means. Substitute taxpayers for governments and you will quickly realize how the whole thing is a farce. Take no solace in the fact that the government is the buyer of last resort. It is really you who are the buyer of last resort. In the end, people will be even more indebted than they were before, setting the stage for the next crisis: a currency crisis. This is why governments aren’t, and cannot be, the solution.

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