Is US Economy Flirting With 'Modern-Day Depression'?

While economists have made no secret of their fears that another recession is about to strike, the real danger could be worse.

People wait in line at a government employment office in the center of Madrid.
Dominique Faget | AFP | Getty Images
People wait in line at a government employment office in the center of Madrid.

Instead, the country could be headed for a 21st century version of a depression, an economic term that, unlike a recession, defies a standard definition but instead conjures images of soup lines, 25 percent unemployment and a devastated economy.

A drastic view? Perhaps. But with the US economy facing growth well below expectations two years after a recession, and an increasingly ominous European debt crisis, the superlatives being used to describe conditions are gaining in intensity.

“Here we are today, with a severe recession (2007-09) followed by the weakest recovery on record and now on the precipice of another economic downturn,” David Rosenberg, senior economist and strategist at Gluskin Sheff in Toronto wrote in a special analysis. “This is a modern-day depression, not entirely dissimilar to Japan’s post-bubble experience of the past two decades.”

Rosenberg takes issue with the standard issue of a recession being two consecutive quarters of negative growth, and rather says it measures peaks in sales activity, jobs, industrial production and income growth.

The US already has had something of a lost decade, Rosenberg reasons, citing stock values still around 1998 levels and little net job growth.

This is occurring even despite unprecedented policy measures including a massive monetary easing campaign from the Federal Reserve and about $800 billion in government stimulus.

”Simply put, an economic depression occurs only once it becomes painfully obvious that the markets and the economy are failing to respond to repeated bouts of policy stimulus,” Rosenberg said.

While Rosenberg is certainly out of the consensus in discussing a depression, he is not alone.

Harvard professor and economist Niall Ferguson recently projected a “mild depression” (if there can be such a thing) as have other economists including the noted “Dr. Doom” Nouriel Roubini and HSBC’s Stephen King. The latter two, though, have raised risks of a depression and have not stated, like Rosenberg, that one is actually under way.

Most economists, rather, have confined their predictions to recessions and mild ones at that.

Jan Hatzius at Goldman Sachs recently said there’s a 40 percent chance of recession, but even at that sees “the main downside scenario as a shallow recession followed by a slow recovery.” Similarly, Deutsche Bank economists recently noted that if leaders fail to find satisfactory solutions to the European debt crisis, “the prospects for a moderate dip in GDP will grow.”

Some economists, though, have been doing their utmost to find silver linings that defy recession probabilities. Jeffrey Greenberg at Nomura Securities, for instance, cited a rise in construction spending in August to reason that second-quarter gross domestic product growth would come in at a decidedly nonrecessionary 2.5 percent.

Recession-themed newsprint cuttings
Recession-themed newsprint cuttings

Representing many of the economic voices out there, Citigroup’s Robert V. DiClemente pondered whether the current period should redefine the way recoveries are considered.

“Perhaps we should label this period a convalescence instead of a recovery in recognition of the ongoing attention to saving, deleveraging and balance sheet rebuilding,” DiClemente said in a note. “Flat is the new up and subpar growth has redefined optimism.”

Yet it is some of those very conditions—the slashing of consumer debt (or deleveraging), reticence to spend and general risk aversion—that helps drive Rosenberg’s depression case.

“It will take time and shared burden by lenders, households and future generations of taxpayers before we hit bottom in this credit contraction,” he wrote. “Time is certainly going to be a big part of the solution, and history tells us that the deleveraging cycles last years.”

Indeed, ominous signs abound.

Strategists at Bank of America Merrill Lynch earlier this week published a note with the sub-heading of, “The chart that keeps us up at night.” The particular chart in question tracks the bond yield differences, or spreads, in the European financial credit default swaps market .

The instruments are insurance against debt defaults and the spreads, BofAML says, have gone 0.70 percentage points or so beyond their levels at the 2008 financial crisis apex. The same spread for US financials is only about 0.40 percentage points away from late 2008, while high yield spreads are right at the point they were the day before Lehman Brothers went bankrupt.

Scary stuff, even for a firm saying that the chance of a recession remains below 50 percent.

“The experience of 2008 has taught us that once the level of distress in the financial system reaches a certain level, it can become an uncontrollable force, with the potential to push market participants into deleveraging as counterparty exposures are being cut,” the firm said.

“We may not be at that point yet, but we believe we might not be too far away from it, and with the markets behaving the way they have over the past few weeks, we could get there quickly.”


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