Here’s a chart of all US recessions since 1900 and their length

TO BE NOTED: From Trader's Narrative:

"Published April 3rd, 2009 in Economy Tags: 1929 crash, depression, economy, federal reserve, NBER, recession, SEC, unemployment, US recessions.

While the stock market has perked up slightly, the economy continues to be mired in a deep recession. Unemployment, housing and other measures are still negative with no real sign of improvement.

Since 1900, there have been 22 recessions which works out to one about every 5 years. While recessions are labeled officially by the NBER, in January 2008 I pointed to a specific indicator which I believed meant that we were in a recession (by late 2007). A while later, this was confirmed by NBER.

Here’s a chart of all US recessions since 1900 and their length:

Source: Chart of the Day (using data from the National Bureau of Economic Research)

The outlier, of course, is 1929. The G-20 leaders huddled together in London to do everything to keep it an outlier and prevent an equally devastating world-wide depression..

At the start of the century there was a cluster of long recessions. These 5 recessions all happened before 1930 and were also the longest in length. The next 70+ years saw much shorter recessions.

Although you may think this was due to the institution of the Federal Reserve and its role in managing the economy, you’d be wrong. The Fed was created in December 23th, 1913. It was the SEC that came about as a result of the chaotic aftermath of the 1929 crash and ensuing depression.

Here’s a chart showing the relationship between the unemployment rate and the stock market during the past few recessions. Notice how the “bad news” of a rising unemployment rate accompanies a rising stock market. In other words, the market discounts the future and starts to rally well ahead of the turning point in the economy.

1929 crash, depression, economy, federal reserve, NBER, recession, SEC, unemployment, US recessions"

But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?

TO BE NOTED: From Barron's Online: Via Credit Writedowns:

"Recession? No, It's a D-process, and It Will Be Long

Ray Dalio, Chief Investment Officer, Bridgewater Associates

By SANDRA WARD
AN INTERVIEW WITH RAY DALIO: This pro sees a long and painful depression.

NOBODY WAS BETTER PREPARED FOR THE GLOBAL market crash than clients of Ray Dalio's Bridgewater Associates and subscribers to its Daily Observations. Dalio, the chief investment officer and all-around guiding light of the global money-management company he founded more than 30 years ago, began sounding alarms in Barron's in the spring of 2007 about the dangers of excessive financial leverage. He counts among his clients world governments and central banks, as well as pension funds and endowments.

Matthew Furman for Barron's

"The regulators have to decide how banks will operate. That means they are going to have to nationalize some in some form." -- Ray Dalio

No wonder. The Westport, Conn.-based firm, whose analyses of world markets focus on credit and currencies, has produced long-term annual returns, net of fees, averaging 15%. In the turmoil of 2008, Bridgewater's Pure Alpha 1 fund gained 8.7% net of fees and Pure Alpha 2 delivered 9.4%.

Here's what's on his mind now.

Barron's: I can't think of anyone who was earlier in describing the deleveraging and deflationary process that has been happening around the world.

Dalio: Let's call it a "D-process," which is different than a recession, and the only reason that people really don't understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process.

Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process?

Both of those words have connotations associated with them that can confuse the fact that it is a process that people should try to understand.

You can describe a recession as an economic retraction which occurs when the Federal Reserve tightens monetary policy normally to fight inflation. The cycle continues until the economy weakens enough to bring down the inflation rate, at which time the Federal Reserve eases monetary policy and produces an expansion. We can make it more complicated, but that is a basic simple description of what recessions are and what we have experienced through the post-World War II period. What you also need is a comparable understanding of what a D-process is and why it is different.

You have made the point that only by understanding the process can you combat the problem. Are you confident that we are doing what's essential to combat deflation and a depression?

The D-process is a disease of sorts that is going to run its course.

When I first started seeing the D-process and describing it, it was before it actually started to play out this way. But now you can ask yourself, OK, when was the last time bank stocks went down so much? When was the last time the balance sheet of the Federal Reserve, or any central bank, exploded like it has? When was the last time interest rates went to zero, essentially, making monetary policy as we know it ineffective? When was the last time we had deflation?

The answers to those questions all point to times other than the U.S. post-World War II experience. This was the dynamic that occurred in Japan in the '90s, that occurred in Latin America in the '80s, and that occurred in the Great Depression in the '30s.

Basically what happens is that after a period of time, economies go through a long-term debt cycle -- a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes. At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren't adequate to service the debt. The incomes aren't adequate to service the debt. Then begins the reversal process, and that becomes self-reinforcing, too. In the simplest sense, the country reaches the point when it needs a debt restructuring. General Motors is a metaphor for the United States.

As goes GM, so goes the nation?

The process of bankruptcy or restructuring is necessary to its viability. One way or another, General Motors has to be restructured so that it is a self-sustaining, economically viable entity that people want to lend to again.

This has happened in Latin America regularly. Emerging countries default, and then restructure. It is an essential process to get them economically healthy.

We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes -- the cash flows that are being produced to service them -- or we are going to have to raise incomes by printing a lot of money.

It isn't complicated. It is the same as all bankruptcies, but when it happens pervasively to a country, and the country has a lot of foreign debt denominated in its own currency, it is preferable to print money and devalue.

Isn't the process of restructuring under way in households and at corporations?

They are cutting costs to service the debt. But they haven't yet done much restructuring. Last year, 2008, was the year of price declines; 2009 and 2010 will be the years of bankruptcies and restructurings. Loans will be written down and assets will be sold. It will be a very difficult time. It is going to surprise a lot of people because many people figure it is bad but still expect, as in all past post-World War II periods, we will come out of it OK. A lot of difficult questions will be asked of policy makers. The government decision-making mechanism is going to be tested, because different people will have different points of view about what should be done.

What are you suggesting?

An example is the Federal Reserve, which has always been an autonomous institution with the freedom to act as it sees fit. Rep. Barney Frank [a Massachusetts Democrat and chairman of the House Financial Services Committee] is talking about examining the authority of the Federal Reserve, and that raises the specter of the government and Congress trying to run the Federal Reserve. Everybody will be second-guessing everybody else.

So where do things stand in the process of restructuring?

What the Federal Reserve has done and what the Treasury has done, by and large, is to take an existing debt and say they will own it or lend against it. But they haven't said they are going to write down the debt and cut debt payments each month. There has been little in the way of debt relief yet. Very, very few actual mortgages have been restructured. Very little corporate debt has been restructured.

The Federal Reserve, in particular, has done a number of successful things. The Federal Reserve went out and bought or lent against a lot of the debt. That has had the effect of reducing the risk of that debt defaulting, so that is good in a sense. And because the risk of default has gone down, it has forced the interest rate on the debt to go down, and that is good, too.

However, the reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece -- banks and investment banks and whatever is left of the financial sector -- that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.

Is a restructuring of the banks a starting point?

If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -- the mortgage piece, the corporate piece, the real-estate piece -- you are wrong, because they need financially sound entities to lend to, and that won't happen until there are restructurings.

On the issue of the banks, ultimately we need banks because to produce credit we have to have banks. A lot of the banks aren't going to have money, and yet we can't just let them go to nothing; we have got to do something.

But the future of banking is going to be very, very different. The regulators have to decide how banks will operate. That means they will have to nationalize some in some form, but they are going to also have to decide who they protect: the bondholders or the depositors?

Nationalization is the most likely outcome?

There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?

Let's say we are going to end up with the good-bank/bad-bank concept. The government is going to put a lot of money in -- say $100 billion -- and going to get all the garbage at a leverage of, let's say, 10 to 1. They will have a trillion dollars, but a trillion dollars' worth of garbage. They still aren't marking it down. Does this give you comfort?

Then we have the remaining banks, many of which will be broke. The government will have to recapitalize them. The government will try to seek private money to go in with them, but I don't think they are going to come up with a lot of private money, not nearly the amount needed.

To the extent we are going to have nationalized banks, we will still have the question of how those banks behave. Does Congress say what they should do? Does Congress demand they lend to bad borrowers? There is a reason they aren't lending. So whose money is it, and who is protecting that money?

The biggest issue is that if you look at the borrowers, you don't want to lend to them. The basic problem is that the borrowers had too much debt when their incomes were higher and their asset values were higher. Now net worths have gone down.

Let me give you an example. Roughly speaking, most of commercial real estate and a good deal of private equity was bought on leverage of 3-to-1. Most of it is down by more than one-third, so therefore they have negative net worth. Most of them couldn't service their debt when the cash flows were up, and now the cash flows are a lot lower. If you shouldn't have lent to them before, how can you possibly lend to them now?

I guess I'm thinking of the examples of people and businesses with solid credit records who can't get banks to lend to them.

Those examples exist, but they aren't, by and large, the big picture. There are too many nonviable entities. Big pieces of the economy have to become somehow more viable. This isn't primarily about a lack of liquidity. There are certainly elements of that, but this is basically a structural issue. The '30s were very similar to this.

By the way, in the bear market from 1929 to the bottom, stocks declined 89%, with six rallies of returns of more than 20% -- and most of them produced renewed optimism. But what happened was that the economy continued to weaken with the debt problem. The Hoover administration had the equivalent of today's TARP [Troubled Asset Relief Program] in the Reconstruction Finance Corp. The stimulus program and tax cuts created more spending, and the budget deficit increased.

At the same time, countries around the world encountered a similar kind of thing. England went through then exactly what it is going through now. Just as now, countries couldn't get dollars because of the slowdown in exports, and there was a dollar shortage, as there is now. Efforts were directed at rekindling lending. But they did not rekindle lending. Eventually there were a lot of bankruptcies, which extinguished debt.

In the U.S., a Democratic administration replaced a Republican one and there was a major devaluation and reflation that marked the bottom of the Depression in March 1933.

Where is the U.S. and the rest of the world going to keep getting money to pay for these stimulus packages?

The Federal Reserve is going to have to print money. The deficits will be greater than the savings. So you will see the Federal Reserve buy long-term Treasury bonds, as it did in the Great Depression. We are in a position where that will eventually create a problem for currencies and drive assets to gold.

Are you a fan of gold?

Yes.

Have you always been?

No. Gold is horrible sometimes and great other times. But like any other asset class, everybody always should have a piece of it in their portfolio.

What about bonds? The conventional wisdom has it that bonds are the most overbought and most dangerous asset class right now.

Everything is timing. You print a lot of money, and then you have currency devaluation. The currency devaluation happens before bonds fall. Not much in the way of inflation is produced, because what you are doing actually is negating deflation. So, the first wave of currency depreciation will be very much like England in 1992, with its currency realignment, or the United States during the Great Depression, when they printed money and devalued the dollar a lot. Gold went up a whole lot and the bond market had a hiccup, and then long-term rates continued to decline because people still needed safety and liquidity. While the dollar is bad, it doesn't mean necessarily that the bond market is bad.

I can easily imagine at some point I'm going to hate bonds and want to be short bonds, but, for now, a portfolio that is a mixture of Treasury bonds and gold is going to be a very good portfolio, because I imagine gold could go up a whole lot and Treasury bonds won't go down a whole lot, at first.

Ideally, creditor countries that don't have dollar-debt problems are the place you want to be, like Japan. The Japanese economy will do horribly, too, but they don't have the problems that we have -- and they have surpluses. They can pull in their assets from abroad, which will support their currency, because they will want to become defensive. Other currencies will decline in relationship to the yen and in relationship to gold.

And China?

Now we have the delicate China question. That is a complicated, touchy question.

The reasons for China to hold dollar-denominated assets no longer exist, for the most part. However, the desire to have a weaker currency is everybody's desire in terms of stimulus. China recognizes that the exchange-rate peg is not as important as it was before, because the idea was to make its goods competitive in the world. Ultimately, they are going to have to go to a domestic-based economy. But they own too much in the way of dollar-denominated assets to get out, and it isn't clear exactly where they would go if they did get out. But they don't have to buy more. They are not going to continue to want to double down.

From the U.S. point of view, we want a devaluation. A devaluation gets your pricing in line. When there is a deflationary environment, you want your currency to go down. When you have a lot of foreign debt denominated in your currency, you want to create relief by having your currency go down. All major currency devaluations have triggered stock-market rallies throughout the world; one of the best ways to trigger a stock-market rally is to devalue your currency.

But there is a basic structural problem with China. Its per capita income is less than 10% of ours. We have to get our prices in line, and we are not going to do it by cutting our incomes to a level of Chinese incomes.

And they are not going to do it by having their per capita incomes coming in line with our per capita incomes. But they have to come closer together. The Chinese currency and assets are too cheap in dollar terms, so a devaluation of the dollar in relation to China's currency is likely, and will be an important step to our reflation and will make investments in China attractive.

You mentioned, too, that inflation is not as big a worry for you as it is for some. Could you elaborate?

A wave of currency devaluations and strong gold will serve to negate deflationary pressures, bringing inflation to a low, positive number rather than producing unacceptably high inflation -- and that will last for as far as I can see out, roughly about two years.

Given this outlook, what is your view on stocks?

Buying equities and taking on those risks in late 2009, or more likely 2010, will be a great move because equities will be much cheaper than now. It is going to be a buying opportunity of the century.

Thanks, Ray."

What does all this tell us?

From Free Exchange:

"Barro of bad news

Posted by:

Economist.com | WASHINGTON

Categories:

Business cycles

MACROECONOMIC historians to your data sets, the global downturn has seemed to call. Carmen Reinhart and Kenneth Rogoff have given us a detailed survey of the economic consequences of financial crises—work which revealed that crisis-driven recessions tend to be longer and deeper than other species. Today, in the Wall Street Journal, Robert Barro explains the findings of his examination of stock market behaviour and economic downturns. He also sounds a rather ominous warning:

In applying our results to the current environment, we should consider that the U.S. and most other countries are not involved in a major war (the Iraq and Afghanistan conflicts are not comparable to World War I or World War II). Thus, we get better information about today's prospects by consulting the history of nonwar events -- for which our sample contains 209 stock-market crashes and 59 depressions, with 41 matched by timing. In this context, the probability of a minor depression, contingent on seeing a stock-market crash, is 20%, and the corresponding chance of a major depression is only 2%. However, it is still the case that depressions are very likely to feature stock-market crashes -- 69% for minor depressions and 83% for major ones.

Emphasis mine. Mr Barro defines a minor depression as a fall in real GDP per capita of 10% or more, and a major depression as a fall in real GDP of 25% or more. His study seems to differ from that of Ms Reinhart and Mr Rogoff in that they examine financial crises as precipitators of recession, while Mr Barro examines stock market crashes as barometers of recession. That is, a recession brought on by a collapse in stock prices might or might not be severe, but a recession coincident with a broad and deep market crash suggests dangerous conditions indeed. Markets recovered much of their value following the crash of 1929, for example, but began a sustained decline in 1930 as the extent of the financial damage became clear.

What does all this tell us? Well, that there is a real risk of an economic calamity of historic proportions, such that policymakers must work diligently to avoid disastrous errors—sharply contractionary policy, for instance, or a modern day Smoot-Hawley. Or war. But also that things aren't yet that bad. As Mr Barro notes, a 20% chance of a minor depression implies an 80% chance of avoiding a 10% decline in real GDP per head. Given the situation—massive losses of housing and equity wealth, financial collapse, implosion of global demand, and so on—that's a pretty impressive statisic."

Me:

Don the libertarian Democrat wrote:

March 4, 2009 16:42

There's a huge upside to be seen as calling a market top or bottom, but is there any real downside? It seems that if you correctly call the top or bottom, you are seen as knowing what you're talking about. If you incorrectly call the top or bottom, you're seen as simply missing a few salient points, not that you're clueless. If this is correct, then you will always have people calling tops and bottoms, sometimes in the same paragraph.

Is there any way to weed out buffoons in economics or investment? We already know that it's impossible in banking and the overseeing of it. Here's my prediction:

There will be a bestseller entitled "How To Run A Ponzi Scheme And NOT Get Caught". The fact that it will work and go undetected for a long time will be assumed by the author.

"Nationalize them, let them fail, or shut up"

From Paul Kedrosky, a fine list indeed:

"Things I Don't Care About or Believe In

I find myself becoming increasingly irritated at so much of what is going on out there. Here is a quick list of the things I just don't care about:

• Where Bernie Madoff is in NYC on his way to/from hearings. Who cares? Really?( I AGREE )
  
• Apple statements on Steve Jobs' current employment status. Apple is marginally less trustworthy than the Kremlin.( I AGREE )
  
• Conversation about further capital injections in banks. Nationalize them, let them fail, or shut up. And pretending that PE firms can do the deed in the largest banks is tantamount to putting a dunce cap on your head.( I AGREE )
  
• Credit default swaps on the largest sovereigns. Sure, they're tradable, but in default who is on other side?( I AGREE )
  
• Decoupled anything. I have been arguing this point for a year, and I still run into idiots who think, say, China is going to bounce right back because it doesn't need trade. It not only won't bounce right back, it will likely go into outright recession.( I AGREE )
  
• Depression/recession chatter. We're doing that denial thing about a depression the same way we did about about a recession. A credit collapse, trade spiral, disappeared confidence, failing banks, fast-rising unemployment, and loss of confidence worldwide: We are in a depression of some to-be-determined eventual severity. Stop talking and move on.( I AGREE )
  

I find it helpful to keep track of things I don't care about. That way I can stop paying attention when they come. It's liberating, like emptying out the garage.

Feel free to add others."

I've heard enough about:
1) Complexity
2) Never Thought It Could Go Down
3) Incentives Caused It
4) Too Much Money Around
5) Interest Rates Too Low
6) Spenders Becoming Savers, And Savers Becoming Spenders
7) We Need To Replace This Exact Figure
8) Choose Your Theory Has Been Proven Or Shown To Be False
9) We Have A Capitalist System
10) Investors Are Believers In The Free Market
11) Silver Linings

"and that we can learn things about how to handle our present problems by looking at the experience of 1930s"

From A Fistful Of Euros:

"Well, one good turn deserves another. So if, like Paul Krugman (and me, I think, though I hadn’t gotten as far as thinking through all the implications of what was happening when I posted the original piece) you take the view the Ukraine industrial output chart I put up yesterday is the smoking gun (or starter’s pistol, or line judge flag, or whichever metaphor works for you) that tells us that the second great depression has now begun, then here are some more of those tell-tale charts to put in you pipe and smoke - or if , like Huck Finn that is your preference, to chew on.

(Update: someone in comments has made the perfectly legitimate point that Paul Krugman may only be saying that a Great Depression has broken out in Ukraine, and obviously only he can say what he really thinks, but as far as I am concerned, since one of the hallmarks of the original Great Depression was a sudden sharp drop in output, sustained over a number of years, and in a large group of countries, accompanied in several cases by outright price deflation, then I do think that a depression rather than a recession( DON'T AGREE ) is what we now have on our hands, and what makes me more or less sure about that is looking not only at what is happening in Ukraine, but also at neighbouring Russia, and China, and so on and so on. Evidently, since history never exactly repeats itself, I am certainly not saying that this is going to last a decade, or end in a big war, or anything like that, but that it is already in the history books, and already in the class of large and unusual economic phenomena, and that we can learn things about how to handle our present problems by looking at the experience of 1930s, of all of this I am absolutely sure, and I have a pretty good idea that both Bernanke and Krugman are too, if you look at the constant references to those years in almost everything they say and do these days( THE 1930s ARE OF LIMITED USE. IT WAS A COMPLETELY DIFFERENT CONTEXT )

Now For Some Charts

Japan industrial output isn’t exactly falling at the same dramatic pace as Ukraine, but a 16.2% year on year fall isn’t to be sniffed at either, and this is what they informed us today happened in November. Worse still, according to Japan’s Economy Ministry output is expected to decrease by a further 8.0% between November and December, which, if accurate, will surely push the year on year decline in December over the 20% mark, not the great depression, but then again, not exactly enjoyable.

And exports, which drive the Japanese economy, were down by 26.7% in November. Even more to the point, deflation is baaack, or almost back, since “core” core prices hit zero (or 0.1% below current overnight BoJ interest rates) in November, and outright deflation surely isn’t far behind.

You can find more detail on all today’s Japan data over at the Japan Economy Watch Blog, and for those of you who want some more deflation background on Japan, well, Krugman has the goods here (extremely wonkish).

Moving nearer to home we have Germany. Here is the latest (flash) December manufacturing PMI for Germany, which is just about as point of the spear as you can get in terms of just in time data.

The slope of that line looks pretty telling doesn’t it, especially if you are into depression economics. Then we have the November new orders chart, another shocker, and indicator of much worse to come, I think.

Now going back to this point:

“There is a burgeoning economic crisis in the European periphery,” Krugman said on the ABC network Dec. 14. “The money has dried up. That’s the new center, the center of this crisis has moved from the U.S. housing market to the European periphery.”

I think this is largely true, if we mean by the periphery the UK, Ireland, Eastern and Southern Europe, but the periphery in a very literal sense always ends up biting the hand that feeds it, since German industry depends on exports to that periphery perhaps more than to anywhere else, so it is not surprising that once the periphery folds, the shock wave moves on in towards the centre. I don’t know if the blast which is about to hit Germany next year will count as a depression, but if it doesn’t, it is going to be a damn close call. And the hard part for Germany is when you get to ask yourself where exactly the new demand will come from to drive the exports( THE GOVERNMENT COULD SPEND, WHICH IS WHAT WILL HAPPEN )?

Moving off now towards the periphery, we have Spain to the south, where the money certainly has dried up, and with it internal demand for Spain’s manufactured products. The November PMI showed Spanish industry contracting at an all time series maximum for any country.

Central Europe

The whole of central European manufacturing is now contracting rapidly. First off, the Czech Republic

Then Poland

And finally (for this little illustration) Hungary

Then There Is Russia

Moving on now to Russia, industrial output was down by 8.9% year on year in November, so it hasn’t yet reached Ukraine levels, but at the rate of contraction they are experiencing I wouldn’t be too confident that that state of affairs will last too long.

And Finally China

Where the November PMI also showed quite a strong contraction:

So where does that leave us? Well basically I’m not sure. We still need to see more data. (Do I sound horribly like Jean Claude Trichet at this point?). If we look at the chart for US industrial output which Krugman presents, the first thing which is pretty obvious is that the 1928-1930 boom-bust was a pretty rapid affair.

After that output dropped very sharply, going in the space of twelve months from a 20% expansion to a near 30% contraction, and the contraction continued at those levels until mid 1932, when the position started to improve - although all this year on year % contraction data is a bit misleading for non specialists, since to have a 30% contraction in mid 1932, following near 30% contraction in mid 1930 and (what) a 15% contraction in mid 1931 (taking into account base effects) then the drop is really massive, and I doubt even Ukraine (barring very worst case scenarios where the country simply disintegrates) will get this. But where this current output slump (or call it what you will) in a number of key countries already does resemble the 1930s more than any other drop in activity since (remember, Japan’s November fall in output is greater than anything that has happened in the entire lost decade-and-a-half) is in the sharpness of the drop, and in the sequencing of events. By sequencing I mean the fact that we have had a pretty dramatic financial crisis, which has lead to a generalised loss of confidence in the banking sector( THIS IS TRUE. THE AVERSION AND FEAR OF RISK ), and this in turn has produced a credit crunch, which is now working its way right through the real system( TRUE, IT'S ALL THE FEAR AND AVERSION TO RISK ). And nothing, but nothing, at this point, seems to be barring its pass( IT WILL SUBSIDE NEXT YEAR ). That is the worrying bit, and that is why I don’t think we are going to see a generalised “turnaround” in activity in 2010, or even 2011, this show is going to run and run, at least in some of the worst affected countries. And we still don’t know just how many icebergs there are lying out there for our convoy to hit. Life, as we know, is always full of surprises, and we should ever be ready for them, for good or for ill."

I don't see things this way. For one thing, the steep decline tells you that it can't be fundamentals, which don't fall off a cliff like that. Rather, like a Bank Run, this is a generalized Fear and Aversion to Risk and the Accompanying Flight to Safety. Because it began in the US, it has rippled around the world. When the US turns around, that will ripple around the world as well. The movement of information is also a main cause of the speed of this tsunami of fear.

I'm saying that the resemblance of the charts, similar in both Spender and Saver Countries, should be a clue that this is not fundamentals driven. It is more like mass panic.

Should I Start A Helicopter Club?

Greg Mankiw also agrees that the Fed should work to produce inflation:

"With the Fed having cut interest rates today to a target range of zero to 1/4 percent, many people will be asking whether the central bank has run out of ammunition. A good question. Obviously, the next step is not going to be further cuts in the federal funds rate. But there is still more the Fed can do.

Notice this passage in the Fed's press release (emphasis added):

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The phrase "for some time" is aimed at managing expectations in order to keep long-term interest rates down.

The next step for the Fed is to drop the "price stability" rhetoric. The Fed has never been truly committed to stable prices. After all, inflation during the Volcker-Greenspan era averaged about 2 to 3 percent. The Fed could have lowered it to zero if it had wanted. Now that zero, or even below zero, is a possibility, the Fed needs to convince people that we are going back to the normal inflation rate of 2 to 3 percent.

Let me suggest this wording for the Fed's next press release:

The Committee recognizes that moderate inflation would be desirable under the present circumstances. In particular, the overall level of prices a decade hence should be about 30 percent higher than the price level today. The committee anticipates keeping the stance of monetary policy sufficiently accomodative to achieve that degree of inflation over the coming decade.

That is, even if the Fed cannot reduce nominal interest rates, it can reduce real interest rates by committing to a modest amount of inflation.

Some would view this as a radical change in monetary policy. In some ways it would be. Given how weak the economy is, however, a bit of radicalism may be called for. I am more comfortable having the Fed commit itself to modest inflation than having the federal government commit itself to a trillion dollars of new spending. ( I AGREE )

The abandonment of "price stability" would be the modern equivalent of Roosevelt's abandonment of the gold standard. Of all the things that Roosevelt did to get the economy out of the Depression, jettisoning the gold standard was the most successful. Today, monetary policy is fettered not by gold but by fear of inflation. Perhaps it is time is get over that fear, at least for a while. As Jim Tobin said in an earlier era, there are worse things than inflation, and we have them. ( I AGREE )

Maybe I should have started the Helicopter Club.

"As it has become evident that the financial crisis is comparable, in important ways, to the early stages of the Great Depression,"

I'm not much interested in these lessons from the 30s discussions, but here's John Quiggin's take:

"As it has become evident that the financial crisis is comparable, in important ways, to the early stages of the Great Depression, there has been a lot of debate about the lessons to be learned from the responses to the Depression in the US, most notably the various policies that made up the New Deal. There’s a lot to be learned there, but it’s also important to remember that the Depression, in the US and elsewhere, continued throughout the 1930s before being brought to an abrupt end by the outbreak of World War II.[1]

Not only did the slump end when the war began, it did not return when the war ended - a huge difference from previous major wars.[2] Instead the three decades beginning in 1940 were a period of unparalleled prosperity for developed countries, with economic growth higher and unemployment lower than at any time before or since.

What lessons can we learn from this experience?

In the immediate aftermath of the war, the lesson seemed obvious. Planning had succeeded where capitalism had failed, and more planning was needed to maintain that success. As the White Paper on Full Employment (Commonwealth of Australia 1945) put it

Despite the need for more houses, food, equipment and every other type of product, before the war not all those available for work were able to find employment or to feel a sense of security in their future. On the average during the twenty years between 1919 and 1939 more than one-tenth of the men and women desiring work were unemployed. In the worst period of the depression well over 25 per cent were left in unproductive idleness. By contrast, during the war no financial or other obstacles have been allowed to prevent the need for extra production being satisfied to the limit of our resources.

Over time, as the difficulties of planning became apparent, emphasis shifted to the idea that the war had provided a Keynesian stimulus to aggregate demand, and that, with careful management, unemployment (or inflation) due to inadequate (excessive) aggregate demand could be avoided. Thirty years of success seemed to confirm that view.

After the failure of Keynesian economic management in the 1970s, this explanation appeared less adequate, but no adequate alternative was proposed. Given the apparent success of monetary policy in stabilising output and inflation, and reducing unemployment, from 1990 onwards, the issue seemed largely academic, and given the focus of US economists on the New Deal, even academic attention to the question has been limited.

Perhaps stimulatory fiscal policy will produce a rapid and complete recovery from the current crisis, and a restoration of the postwar Keynesian orthodoxy. But given the damage that has already been done to the global financial system, and the prospect of much more to come, this is far from certain. The experience of Japan in the 1990s is not encouraging, and this crisis is far worse in important respects. Perhaps when the collapse of financial intermediation is as near-complete as it was in the Depression, a large element of central direction is needed to restore trade and ensure necessary flows of credit. In the absence of a rapid recovery, questions like this will assume increased urgency over the next year or two."

I don't agree with him on various points, but here was my main response:

1. Don the libertarian Democrat Says:
   December 8th, 2008 at 3:17 am

   I’m on record favoring a very grand stimulus, tax cuts, and even printing money. I also love Keynes, but more for his writing style, which means a lot to me.

   Anyway, I feel differently about the knowledge we can gain from the 30s. Abstracting out the economic data can be of some slight use, but not much. The reason I believe this is that the decisions people made in the 30s were made in the context of the 30s, and that was a very different context than ours.

   I’ll give you one example. I once read a bunch of books by Wyndham Lewis. I don’t remember much about them, except that he seemed to truly believe that the only choice available was between Communism or Fascism. In other words, some form of Totalitarianism. This shocked me, but, after reading his books, I was surprised to find that many people writing in the 30s made that same assumption.

   Fortunately, there were wiser and better people around, millions and millions of them it turned out,including Keynes and Hayek, who understood the world better, and so we weren’t left with only those choices. But I continue to believe that the existential situation of the times people live in are more important than other people do. So that, the choices and decisions made in the 30s really can’t help us much.

   Instead, what’s happening is that we’re lurching and veering in a pragmatic way towards a path that leads us out of this mess. It turns out that we’re doing so in a way more reminiscent of Keynes, so, in order to feel like we really know what we’re doing, and since Keynes helped get us out of the 30s, we’re calling upon his spirit for solace and guidance.

   That’s fine with me because, as I’ve said, I love Keynes. But we’re going to get out of this mess in our own way and in our own time, and part of the process will be reading great books that help us get through these kind's of times. But there’s one thing that makes me more hopeful about this crisis, and, maybe I’m different than everybody else, but I really wouldn’t want to have been in the existential crisis of the 30s. I’ll take this one any day.

"“We are already in a recession. The next economic phase will not be recession, but depression.”

Earlier, I posted about defaults and junk bonds. Now, how about insurance on the default of junk bonds. It should cost more if defaults are more likely right? From Bloomberg:

"The cost of protecting corporate debt from default jumped to a record in Europe and neared a high in the U.S. amid concern that the global recession will sink into a depression.

Credit-default swaps on a benchmark index tied to below- investment grade companies in Europe reached levels considered distressed for the first time. The cost to protect U.S. leveraged loans from default neared a record, and a benchmark gauge of credit risk tied to investment-grade companies including retailer J.C. Penney Co. and Alcoa Inc., the largest U.S. aluminum producer, also jumped as a private report showed the nation’s companies last month cut the most jobs in seven years.

“Markets are pricing somewhere between a recession and a depression, and that is what we are faced with,” said Philip Gisdakis, a Munich-based credit strategist at UniCredit SpA, Italy’s biggest bank. “We are already in a recession. The next economic phase will not be recession, but depression.”

Now, I find this hard to believe, but I'm not betting money on it like these people.

"Credit-default swaps on the Markit CDX North America Investment Grade Index of 125 companies in the U.S. and Canada climbed 8 basis points to 267 basis points as of 10:10 a.m. in New York, according to Barclays Capital. The index is at the highest since Nov. 20, when it traded at a record 284 basis points, prices from broker Phoenix Partners Group show.

Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly sub-investment grade credit ratings increased 65 basis points to 1,005 and earlier reached a record 1,010, JPMorgan Chase & Co. prices show. The index traded above 1,000 basis points for the first time, a level investors consider distressed."

You get the point. Read the whole post.

"MANY people are looking back to the Great Depression and the New Deal for answers to our problems. "

Tyler Cowen has a post in the NY Times about the New Deal:

"MANY people are looking back to the Great Depression and the New Deal for answers to our problems. But while we can learn important lessons from this period, they’re not always the ones taught in school."

Truthfully, I'm not one of them, because I believe that there is more agreement than is being portrayed in many posts:

"The traditional story is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. It’s worth sorting through this grab bag now, to evaluate whether any of these policies might be helpful."

I think that just about everyone agrees that some things from the bag worked, others didn't. Roosevelt gets credit since we survived, and, in the real world, it isn't at all clear that anyone else at the time could have done a better job. If it makes you feel better, you can view Roosevelt as many of the Rabbis viewed Noah. Namely, that he was the most righteous man in his time, not of all time.

"If I were preparing a “New Deal crib sheet,” I would start with the following lessons:

MONETARY POLICY IS KEY As Milton Friedman and Anna Jacobson Schwartz argued in a classic book, “A Monetary History of the United States,” the single biggest cause of the Great Depression was that the Federal Reserve let the money supply fall by one-third, causing deflation. Furthermore, banks were allowed to fail, causing a credit crisis. Roosevelt’s best policies were those designed to increase the money supply, get the banking system back on its feet and restore trust in financial institutions.

A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley (“What Ended the Great Depression?,” Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.

Today, expansionary monetary policy isn’t so easy to put into effect, as we are seeing a shrinkage of credit and a contraction of the “shadow banking sector,” as represented by forms of derivatives trading, hedge funds and other investments. So don’t expect the benefits of monetary expansion to kick in right now, or even six months from now.

Still, the Fed needs to stand ready to prevent a downward spiral and to stimulate the economy once it’s possible."

I agree with this, that a main cause was:

1) The money supply fell ( This won't happen again )

2) Banks were allowed to fail ( I think that it's better to say that accounts had no guarantee )

3) There was deflation ( I don't see that happening now )

I also agree that the Fed should try and work against the current downturn as best it can.

"GET THE SMALL THINGS RIGHT It’s not just monetary and fiscal policies that are important. Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry, backed by force of law. Neither policy helped the economy recover.

He also took steps to strengthen unions and to keep real wages high. This helped workers who had jobs, but made it much harder for the unemployed to get back to work. One result was unemployment rates that remained high throughout the New Deal period.

Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans."

Here, I just disagree. Although I'm against agricultural subsidies, except in certain dire circumstances, we can't blame Roosevelt for what has happened since. If it's on our watch, it's our fault. Cartels are bad, although is appears they're okay in Credit Ratings Agencies and Oil.

The union criticism is weird. Unions can serve a very useful function in a capitalist society, and, in any case, they're negotiated contracts. If you don't like them, don't enter into them. What criticism of this kind usually means is that unions are an interest group, but so are businesses. It seems to come down to cheerleading for one side or another, while I see both as important. In politics, this comes down to the give and take between these two interest groups. If you don't like that, then you have to lobby for a particular reform or give government less to do.

"DON’T RAISE TAXES IN A SLUMP The New Deal’s legacy of public works programs has given many people the impression that it was a time of expansionary fiscal policy, but that isn’t quite right. Government spending went up considerably, but taxes rose, too. Under President Herbert Hoover and continuing with Roosevelt, the federal government increased income taxes, excise taxes, inheritance taxes, corporate income taxes, holding company taxes and “excess profits” taxes.

When all of these tax increases are taken into account, New Deal fiscal policy didn’t do much to promote recovery. Today, a tax cut for the middle class is a good idea — and the case for repealing the Bush tax cuts for higher-income earners is weaker than it may have seemed a year or two ago."

I say lower taxes for the middle class and businesses, and review the Bush cuts when they come up.

"WAR ISN’T THE WEAPON World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. The economic historian Robert Higgs, a senior fellow at the Independent Institute, has shown in his 2006 book, “Depression, War, and Cold War,” just how much the war brought shortages and rationing of consumer goods.

While overall economic output was rising, and the military draft lowered unemployment, the war years were generally not prosperous ones. As for today, we shouldn’t think that fighting a war is the way to restore economic health."

This was why I was posting that I hoped people weren't going to make the argument that WW II got us out of the depression. Also, government does gain power during wars and crises, which is why they are to be avoided at all cost, although the human toll is the main reason to avoid them. In the current crisis and current wars, government is going to grow. The only real political solution is to pick your battles and try and institute policies that can be easily assessed and potentially dismantled. Of course, that's easier said than done.

"YOU CAN’T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well. The bad policies made things worse. Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to “do something” for its own sake."

This is very good. I'm going to make it Cowen's Creed.

"In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression. Our current downturn will end as well someday, and, as in the ’30s, the recovery will probably come for reasons that have little to do with most policy initiatives."

Who knows?

"Fortunately, our Fed chief is one of the pre-eminent scholars of the Great Depression. "

Greg Mankiw with a pretty funny post, and my heading can be a two-edged sword:

"The Best Book Promo of All Time

I am pretty good at promoting my books. (You're reading this blog, aren't you?) But I can't hold a candle to my old friend Ben Bernanke. This email from his publisher, received yesterday, sheds light on his secret plan:

Dear Professor Mankiw,

I wanted to alert you to our paperback edition of Ben Bernanke's ESSAYS ON THE GREAT DEPRESSION."

Read the whole post.

Too bad the book didn't tell him how to avoid meltdowns. Let's hope it did tell him how to get us out of one and actually avoid a depression.

I don't agree with everything he's done, but, unlike a number of people in this mess, I still think that he's a pretty level-headed and smart guy.