Few public figures have been willing to say the word. On Feb. 4, Gordon Brown, prime minister of Great Britain made a comment in which he spoke of pulling the world out of depression. His handlers scrambled and said it was a slip of the tongue, but the damage had been done. The quote ricocheted around the world. Richard Posner has publicly stated that he believes that we are indeed in a depression and in a few months he will be releasing his new book, “A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression.” Most other economists and commentators have been more circumspect and careful about using the term. And, while there are different definitions of a depression, I define it as a deep and persistent economic downturn that damages well-run companies and prudent individuals along with the rest, and which cannot be solved with traditional monetary and fiscal measures alone. A depression leaves lasting scars and a forever altered landscape. But I think a depression is exactly what we are experiencing and here’s why:
- The suddenness and ferocity of the downturn. Although the rumblings of stress in the financial markets had been with us since August of ’07, hell really didn’t break loose until Lehman was permitted to fail. The severe restriction of credit availability whacked the economy immediately with full force. Economists and policymakers were caught flatfooted and have consistently underestimated the depth and breath of the damage. The Fed and Treasury both missed it. Ben Bernanke admitted that he underestimated the scope of the subprime problem And consider this quote from Treasury Secretary Henry Paulson in April of ’07, "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained." Today, Paulson’s quote, along with the “Mission Accomplished” banner at the conclusion of the initial phase of the Iraq war will certainly make the top 10 misjudgments of the decade. Almost all sectors have been pounded—manufacturing, services, retail, tech—you name it. We have had the worst 3 months of job losses in 45 years and even the most optimistic forecasters are talking about ’09 as a lost year. The speed and scale of the downturn are almost unprecedented.
- Systemic triggers. Most recessions, by accident or design, are Fed created. In the usual scenario, momentum in the economy builds, slack comes out of the system, labor demands higher wages, producers demand higher prices. Inflation begins to set in and the Fed raises rates to cool things down. Because of the time lag (6 months to a year) before interest rates take effect in the economy, the Fed cannot calibrate perfectly and often overshoots, squeezing too hard and pushing us into recession. The Fed will then lower rates to spur credit creation, and lowering interest rates along with tax cuts typically work. And then the cycle begins all over again. That’s not what happened here. Our current downturn was triggered by asset deflation and a credit crunch, and so is fundamentally different than the past several recessions.
- Deflation signs. The inflation numbers came in at the lowest level in 53 years last week. Economists aren’t seeing serious deflation in the economy---yet. But I am seeing little indications of deflation beginning to pop up. Law firms have frozen billing rates, and sometimes lowered them. Retailers have slashed prices. Even the local delis are offering “recession fighting new lower prices”. ACCO recently announced steep pay cuts for its workers. In short, very few players in the economy have any pricing power at all. If significant deflation takes hold, look out.
- Worldwide reach. This contagion is truly global. When Northern Rock failed, it made the papers, but few saw it as a harbinger of what was to come. Asia and Europe are contracting, with Japan in particular showing a sharp decline. Eastern Europe is close to defaulting on its debt and Western European banks are holding lots of Eastern European paper. Iceland is insolvent. Ireland is nearing default on its debt despite the fact that just a short time ago Ireland was a darling performer in the world economy. Because the rest of the world followed us right down quickly, exports aren’t going to be much help in getting us out of this. This is truly a global phenomenon.
- No consumer help. The consumer is severely wounded and is not likely to lead the way back. No one is spending. We all have holes in our balance sheets. Most ordinary Americans have wealth in 2 principal assets—their home and retirement account and both have taken heavy hits. Because of this and because of the generalized fear, consumers aren’t spending. Indeed, consumers saved rather than spent 87% of the tax rebates that the Bush Administration authorized to help jumpstart the economy. Since the American consumer represents roughly 60% of our economy (and therefore a significant factor in the world economy), the consumer will be unable to spark a comeback anytime soon.
- Fear. If you don’t have at least some fear in this environment, you are either so wealthy that it really doesn’t matter or you have a mild mental illness. This is an area in which the new administration has been woefully inadequate. Instead of reassuring us, Obama’s message of hope has been inverted. By using the politics of fear to get the stimulus package through, he is has stoked anxiety and panic. Instead of saying, “We will get through this together,” he has chosen the language of fear. He warned of a “catastrophe” if the stimulus bill didn’t pass immediately and without debate and warned that we may go into an irreversible tailspin. Maureen Dowd, Bill Clinton, Robert Schiller, and the Wall Street Journal have all commented on Obama’s fear mongering. He needs to project hope and calm reassurance. We don’t need to be reminded of the potential for dire consequences.
- Vibes from the front. Last December, I attended a large function sponsored by the Turnaround Management Association, a trade group comprised primarily of consultants and other professionals that assist companies in crisis. Ordinarily, a downturn is met with some glee at these events for it translates into more billable work for its members. But this time, I noted a very different tone in my conversations. “This time, it’s different,” was most common reaction. There was a somberness in the room that I had not seen before. You know it’s bad when the workout guys look shell-shocked.
Taken together, I believe that we are in a depression—a multiyear swoon that will be very painful for us and will leave permanent changes in our society. A few like Richard Posner have had the courage to say it and Gordon Brown said it by accident. But it is clear that this is an episode that will inflict a great deal more pain before it’s over. I, for one, am willing to call it by its proper name.
Now that you know where we are, if you are interested in very readable books on the Great Depression era, I highly recommend The Worst Hard Times by Timothy Egan (focused on the Dust Bowl) and The Forgotten Man by Amity Schlaes. Both are quite good and will give you an appreciation for our ultimate fortitude and ability to persevere in a pretty harsh environment.
All is not lost, however. Stay tuned. We will get through this and next week, I will give you my list of things to be happy about despite the fact that we are in a depression. Remember that after 9/11, we all feared that massive terrorist attacks would be regular occurrences. 9/11 hurt a lot of people and caused some permanent changes in our society, but none of the worst things that we feared ever happened. That is what I predict the ultimate endgame of this depression will be like.
