Uh-oh

Depression talk is gaining steam again.

The blog-o-sphere is a tither today about the last hour of trading on the stock market in which the market suddenly reversed course in the final hour of trading.

Analysts attribute the tumble to a downgrade of Wells Fargo & Co.

Fargo, the largest U.S. home lender this year, slid 5.1% after Bove of Rochdale Securities cut the shares to “sell” and said earnings were boosted by mortgage-servicing fees rather than improving business trends. Wal-Mart Stores Inc., the world’s largest retailer, tumbled 2.1% after saying it expects a “tough” holiday shopping season. The Standard & Poor’s 500 Index reversed a 0.9% advance as nine of 10 industry groups retreated, led by financials.

“Wells Fargo’s downgrade spooked investors,” said Michael Nasto, the senior trader at U.S. Global Investors Inc., which manages about $2 billion in San Antonio. “Investors are concerned because that’s one of the biggest in the industry and most of the recent news has been positive so far. So that could be an indication of problems ahead for other big names.”

And those 'problems' are significant.

Jobs: The United States continues to lose jobs month over month. And, while the statistics being released are showing a slow down, many are coming to the conclusion that this is basically a fabrication. There are thousands of people falling off of unemployment compensation each week — none of them are reflected in the official numbers. Shadowstats.com estimates unemployment is above 20%. These numbers are rapidly approaching the unemployment rate during the 1930s.

Credit: As we noted yesterday, credit is contracting. The last decade in America has seen credit (or debt, however you want to look at it) essentially become used as a second income. No more. The banks may be getting billions in loans, but for the individual on the street, credit is frozen. Couple this with the loss of primary income streams and you have a lot of people with no money for even essential goods.

Real Estate Foreclosures: Foreclosures in the US continue to mount. In addition to the foreclosures of the last 2 years, millions more are in play right now, regardless of the mortgage programs the government institutes. Job Loss + Credit Contraction means there is no way millions of people will be able to make their monthly payments. Nowadays, once you lose your job, you aren’t going to have an easy time finding a new one that adequately services personal debt. In real terms housing prices are not done dropping. There are some conservative down-side estimates that say an additional 15% is likely. But, what if they are underestimating? What if it turns out to be 30%, or more?

Japanese real estate lost 80% (adjusted for inflation) in the 1990’s and so did their stock market. Fears that the United States is rapidly travelling down an identical road are starting to influence observers.

Defaults: Debt defaults keep rising. Bank of America just released their numbers and lost upwards of $2 billion dollars, due in part, to credit card defaults. This is not the sign of a healthy consumer. When a consumer defaults on a credit card, that is leading indicator that they will not get easy credit if they need it in the future. A default in 2009 is a big red flag for lenders. Empirically, this seems like it may be a leading indicator for continued credit contraction on the consumer side.

Small Business: Small businesses are getting hit hard. Small business is the engine that runs the entire US economy. Right now, they have no access to loans, and the consumer is drying up. To survive, they’ve had to cut costs significantly. The next step will be to cut jobs. Many have already resorted to letting people go. As much as owners may not want to let go of their people, they realize they have no choice at this point. Incidentally, many major corporations showing “better than expected” results employed these same strategies. But, the businesses themselves, not necessarily by choice, are perpetuating the negative feedback loop. As they lay off employees, more consumer income is destroyed, leading to fewer revenues across the board for a majority of businesses, big and small.

Middle Class: The Middle Class is holding on for dear life. If small business drives jobs and production, it is the middle class that drives consumption. And the middle class is getting hammered for all of the reasons mentioned above. Many middle class families are realizing, or will realize very soon, that their lifestyle choices are going to need changes. Cut out the gym and take a jog instead. Why pay $100 for cable when you can get similar, if not better, news and movies online for $30 a month? Is organic really necessary at the grocery store when one can save 30% buying the regular stuff we grew up on? Do I really need to get a new car when my 2005 Explorer is just fine? Why go out and spend $100 when dinner and a movie at home a couple of Fridays a month saves enough money to pay the electric bill? These and other questions are going through the collective mind of middle class America. They are desperately trying to avoid becoming a member of working or under class America. The initial step to maintain stability is the same as with small businesses - cut spending.

Combine all these factors and more and more analysts are drawing parallels to 1930/1931.

Trends Forecast founder Gerald Celente, a noted business consultant and author who makes predictions about the global financial markets, is gaining followers for his conviction that these are the opening states of 'the Greatest Depression'.

And with the way the market dropped in the last hour of trading today...

...many in the blog-o-sphere are sounding the alarm that investors should be on high alert for the rest of the week.

Investor emptor!

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Or is it the Looming Era of Deflation?

There has been an interesting trend developing lately in the bond market.

Some of the world's biggest bond funds have been buying longer maturity US Treasuries in recent weeks. With significant flattening on the long end of the yield curve, analysts believe this reflects the re- emergence of deflationary fears. Basically the treasury market is increasingly skeptical of the reflation effort taking hold in the North American economy.

If they are correct the United States will be at the center of an ongoing deflationary de-levering as opposed to an accelerating, inflationary growth period.

Those that hold to this opinion believe that deflation is being fuelled by continuing overcapacity, shrinking credit, reduced corporate spending and falling consumer demand.

Backing this up is data showing consumer prices falling at their fastest clip ever last month in Japan (no mean feat considering Japan has been fighting a losing war against deflation for much of the past two decades). Meanwhile Germany, Europe's biggest economy, has now suffered through four consecutive months of sliding prices, and the rest of the region that uses the euro is not faring much better.

Should deflation take hold, the result would inevitably be years of dismal economic performance, staggering unemployment, deeply pessimistic consumers and businesses that cease spending and focus on surviving.

“We are certainly in a deflationary state,” said David Rosenberg, chief economist and strategist with Gluskin Sheff and Associates in Toronto. “Of that, there's no doubt.”

“I think people still have no clue as to just how weak the economy is,” Mr. Rosenberg said.

The ultimate fear is that if you remove the massive stimulus being administered by governments, most economies are at a virtual standstill.

The end result? A decade of stagnation for the North American economy.

Perhaps that's why Bank of Canada Governor Mark Carney, in a speech to the Greater Victoria Chamber of Commerce on Monday, called on the private sector to step up and get the economic recovery going.

"The global recovery is in its earliest stages, and is almost entirely driven by public policy," Carney said. He then warned that governments and central banks have done all they can after putting in place "war-time spending on a peaceful calamity".

"It's now up to the private sector to start spending," Carney said. "Otherwise, the fragile recovery will weaken as government stimulus ends. Consumer and business spending will need to drive economic growth in Canada."

Oh my... it's back to scolding the 'bad consumer' again.

So are we set to trigger inflationary times as the end of the recession moves trillions of stimulus dollars into circulation and combines with the pressures of servicing massive amounts of government debt?

Or will the economy sputter with faltering demand, dropping prices, rising unemployment and plateauing interest rates because financially-stressed consumers are unable (or unwilling) to go back to their hyper-consumer ways?

It's hard to say. But one thing is for certain: deflation is far more destructive than inflation.

Just this past Monday, the City of Vancouver confirmed it will eliminate 60 full-time jobs in order to deal with a $61 million budget shortfall this year. The revenue woes are being blamed on the weak economy and federal and provincial budget cuts.

And that's only the tip of the iceberg.

If deflation takes hold, the stock market will suffer a massive correction, tons more businesses will fail and unemployment will skyrocket beyond what are already substantial highs.

And what will that mean for real estate?

Hundreds of thousands of newly unemployed will be unable to pay mortgages. Wave after wave of boomers will be retiring each year and desperately trying to sell their homes because that's where their retirement funds are stored. And the younger generation is unable to step up and fill the void because they lack both the numbers and the income from a floundering economy.

Back in February and March we made a number of posts about the possibility of a depressionary slide.

And while we lean towards the inflationary outlook (75% vs 25%), the reality is either scenario is still possible.

There is only one thing for certain. Neither inflation or deflation bodes well for real estate.

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Inflation: The Case Against It

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Bank Failure Friday Update: 3 Bank Failures and 2 Credit Union Failures (see bottom of post)

As faithful readers already know, Garth Turner is the author of After the Crash, web blogger at Greater Fool and one of the early Canadian soothsayers who acurately predicted the downturn in Canadian Real Estate.

He steadfastly stood up against critics and warned Canadians about the real estate crash and how it would spread to Canada.

So I asked Garth. What does he think about my concerns of inpending inflation worries?

"Not a credible position", he told me matter-of-factly.

"We are trying to escape the jaws of deflation. There will be no threatening inflation and no rate increses in 2010."

Garth elaborated yesterday on his blog. He thinks the market reaction to Bernanke's decision to dump another $1 Trillion dollars is the manic over-reaction of bullionist's who don't understand the process.

While we may teeter on the cusp of Depression, Garth says that Governments will spend whatever it takes to stave it off, borrowing massive wealth from the future disregarding how the Boomers and their kids in the process. Interest rates will continue to race to zero and stay there.

"GDP will likely be rising marginally a year from now, but that does not mean ugly days will be passing. Far from it. Recession in the real economy – where we work, buy houses and shop – will last for several years. Real estate prices will be lower at Christmas than they are now, will stabilize in 2010, and then flatline for years after that. Jobs will start to reappear by next Spring, but they will come back in dozens after being lost in hundreds and thousands."

"Most significantly, however, is the certainty that what governments are doing to stave off depression will only cause another problem of equal size in the future. And, no, I am not talking about hyper-inflation in a year or two because of the new American trillions. Instead, we are guaranteeing a future of higher taxes, debt-shackled governments, a far less competitive North America and the end of the US empire."

Turner summarizes the bullionist's position as opportunists who are betting that the US Federal Reserve (and other central banks, like the Bank of Canada and the European Central Bank) will buy up government securities and create a honking big pot of money to scare off the deflation demons. The bullionist's, Garth says, are convinced we are just months away from the collapse of paper money as crazed central banks overdose on creating cash.

"Under their scenario, hard assets inflate wildly as paper money deflates. The US dollar collapses, causing the likely demise of major banks. In this world, smart wealth rushes into the only global currency alternative – bullion – sending it skyward, as the rest of us use hundred-dollar bills to buy bread and watch as our life savings are destroyed in a matter of months. Others see real estate, oil, two-by-fours and chickens soaring in value. As that happens, debt fixed in dollars fades as fast as your RRSP, which means mortgages slip away into nothingness, at the same time as interest rates hit 20% or 40% or higher."

And then Garth Turner dismisses the argument. He says, "this is exactly why it ain’t gonna happen. No depression. No hyper-inflation. Both are toxic to human society and would inflict irreparable damage. There is not a sane government in the world (sorry. Zimbabwe) which will allow either to take place. If we tip either way, it will be totally by accident."

Impressive argument. But it begs the question... would any sane goverment have allowed the current crisis situation we find ourselves in, to have taken place to begin with?

Yet it happened and all government can do is react.

As we wait on the FDIC to give us our Bank Failure Friday fix, I invite you to check another oracle who predicted not only the 2006 subprime mortgage disaster in the United States, but also predicted the 2008 stock market crash.

His name is Peter Schiff and he started making the real estate predictions in 2002. Check out this compilation of his interviews on the major American business networks. Co-panelists openly laugh at him, audibly scoffing and gasping at his claims about pending real estate and stock market crashes.

He holds a viewpoint on inflation that is diametrically opposed to that of Garth Turner.

Schiff is adament that rapid inflation will happen and it won't be by accident, leaving govement nothing to do but react.

His views tomorrow.

Bank Failure Friday

Bank Failure #18: FirstCity Bank, Stockbridge, Georgia

From the FDIC: The Federal Deposit Insurance Corporation (FDIC) approved the payout of the insured deposits of FirstCity Bank, Stockbridge, Georgia. The bank was closed today by the Georgia Department of Banking and Finance, which appointed the FDIC as receiver.

The FDIC estimates the cost of the failure to its Deposit Insurance Fund to be approximately $100 million. FirstCity Bank is the eighteenth FDIC-insured institution to fail this year. The last bank to fail in Georgia was Freedom Bank of Georgia, Commerce, on March 6, 2009.

Bank Failure #19: Teambank, National Association, Paola, Kansas

From the FDIC:Teambank, National Association, Paola, Kansas, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Great Southern Bank, Springfield, Missouri, to assume all of the deposits of Teambank.

The FDIC estimates that the cost to the Deposit Insurance Fund will be $98 million. Great Southern Bank's acquisition of all the deposits was the "least costly" resolution for the FDIC's Deposit Insurance Fund compared to alternatives. Teambank is the twentieth FDIC-insured institution to fail in the nation this year and the first in the state. The last FDIC-insured institution closed in Kansas was The Columbian Bank and Trust Company, Topeka, on August 22, 2008.

Bank Failure #20: Colorado National Bank, Colorado Springs, Colorado

From the FDIC: Colorado National Bank, Colorado Springs, Colorado, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Herring Bank, Amarillo, Texas, to assume all of the deposits of Colorado National.

The FDIC estimates that the cost to the Deposit Insurance Fund will be $9 million. Herring Bank's acquisition of all the deposits was the "least costly" resolution for the FDIC's Deposit Insurance Fund compared to alternatives. Colorado National is the nineteenth FDIC-insured institution to fail in the nation this year and the first in the state. The last FDIC-insured institution closed in Colorado was BestBank, Boulder, on July 23, 1998.

Credit Unions

In addition to the three bank failures, two large Corporate Credit Unions were seized today by the National Credit Union Administration (NCUA): U.S. Central and WesCorp. These two credit unions had a combined $57 billion in assets. The affected institutions don't serve the general public. They provide critical financing, check clearing and other tasks for the retail institutions. These wholesale credit unions, known in industry parlance as corporate credit unions, are owned by their retail credit-union members.

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Almost 40% chance of a Depression?

Laurel Magri: lying, deceptive, manipulative whore.
When my grandmother used to tell stories of the Second Great Depression of the 1930's, one comment always stood out. "At the time no one realized it was a Depression".

'Depression' was a term given to the period after the fact by historians who viewed events in panorama. Living events one day at a time, most people didn't realize the significance of the era that was unfolding around them.

Are we pedestrian witnesses to a similar situation?

Stats Can will not be releasing February 2009 job losses until Friday March 13th - a appropriate date because the numbers will be a horror show.

In January the Canadian economy lost a startling 129,000 jobs. That was a record single-month total. Unemployment stood at 7.2% and things have only gotten worse since then.

On March 3rd, Canada’s central bank cut its key lending rate to its lowest level ever. Lower than during the 1930s Depression. And Bank of Canada Governor Mark Carney stated it will probably be cut again to 0.25%.

It won't do any good.

In the United States, February's figures are out and the U.S. unemployment rate jumped in February to 8.1%, the highest level in more than a quarter century. It is a surge likely to send more Americans into bankruptcy and force further cutbacks in consumer spending.

The US jobless rate has now already reached the level the Obama administration projected as an average for the whole year and the magnitude of what is happening is overwhelming what steps the administration has already taken.

Many think that more big job losses are likely, with grim implications for the housing and banking crises.

It is clear we have definately entered the worst recession in the postwar era, but some experts are starting to suggest something far worse.

Harvard University professor Robert Barro has calculated a 30% chance the U.S. will slide into a depression, which he characterized as at least a 10 percent drop in gross domestic product.

The Intrade betting market pegs those chances at 38%.

Scary stuff.

Presumably that's why Bank of Canada deputy governor Pierre Duguay warned Canadians not to be spooked by "irrational fear" over the economy (this while telling the House of Commons finance committee that "there will be more bad economic news coming").

No worries Duggy... there's enough rational fear to suffice.

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Beware The Light At The End Of The Tunnel.

Recession or Depression, it will end at some point and the economy will turn around.

And whether or not you agree that Vancouver is in a housing bubble that is in the process of bursting (with condos declining 50% from peak and houses 40% from peak), there is one worrisome element that haunts every realtor and homeowner heavily vested in the book value of their property.

Inflation.

Yesterday Warren Buffett, known as the Sage of Omaha for his ability to make millionaires of ordinary investors in his company, released his keenly anticipated annual letter to shareholders.

Within that letter came the dark assessment which could ultimately deal the crushing blow to Vancouver Real Estate.

"The multibillion-dollar bailouts handed out by the US Government will bring on an 'onslaught of inflation'... Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel,” Mr Buffett said. “These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation.”

Every economist worth his salt has been sounding alarm bells recently about the amount of money being thrown into the financial crisis. It may be seen as a short term solution, but in the long term there will be a ton of liquidity around after all the deleveraging.

The worst of all possible worlds is declining purchasing power combined with high unemployment and rising prices.

This is 1970s-style stagflation.

But because inflation numbers have been understated for years, and money supply is set to increase at unprecedented rates, this time it could intensify into a hyperinflationary depression.

Does anyone remember that in the early 1980s, the actual interest rates for Lower Mainland families was 22% (prime was 19.5%)?

A return to 1970/80s style inflation will result in a return to sky high mortgage interest rates.

Even if interest rates ONLY soared to 15%, the result will devestate housing prices.

Consider... in order to have the same monthly payment on a $650,000 dollar mortgage today, the mortgage amount would have to drop to $250,000 at 15%.

When interest rates spike to combat inflation, no one will be able to afford a $650,000 mortgage.

If you want to sell your house, that $650,000 price tag will HAVE to fall to at least $250,000 to find someone who can afford to buy it.

And those poor souls who have to renew their large mortgages under these conditions? Well the monthly payments on that $650,000 will be over $7,000 per month when renewed at 15% (can you say default and foreclosure?).

If you knew that the $650,000 house you were thinking of buying today would only be able to fetch you $250,000 3-5 years from now, would you buy it?

There's a light at the end of the tunnel for potential homebuyers in the current Vancouver Real Estate market.

But beware... it's a steam train called 'Inflation', and it's barrelling towards us at a speed which will crush Real Estate values, destroy anyone holding a large outstanding mortgage and should scare off any prudent, potential buyers contemplating purchasing real estate this year.

Let's face it, only a fool would assume such a large mortgage with these economic storm clouds on the horizon.

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The 2nd Great Depression... Don't You Mean the 3rd Great Depression?

As mentioned on Saturday and Sunday, a great many commentators are raising fears that we may be entering a 2nd Great Depression.

Pundits recall a time when the stock market crashed and Wall Street panicked.

This set off a chain reaction of bank failures and temporarily closed the New York stock market for 10 days. Factories began to lay off workers as the United States slipped into desperate economic times.

18,000 businesses failed over the next two years and unemployment soared to record levels. Construction work lagged, wages were cut, real estate values fell, corporate profits vanished and people began stashing silver and gold under mattresses as bank failures reached epidemic proportions. Even 89 of the United States’ 364 railroads went bankrupt.

Am I referring to the Stock Market Crash and Depression of 1929?

Nope.

These events are a summary of the Panic of 1873, which lead to the Great Depression of 1873.

Today the 'Great Depression of 1873' has been re-named 'The Long Depression' and is all but ignored in modern economic study. It was a period of deep economic recession that affected much of the world and was contemporary with the Second Industrial Revolution.

This depression started in the United States following the Panic of 1873. The National Bureau of Economic Research (NBER) dates the contraction following the panic as lasting from October 1873 to March 1879. At 65 months, it is the longest recession identified by the NBER. The Depression itself, however, ranged from 1873 until as late as 1897, some 26 years.

Until 1929, when people used the words 'Great Depression', they referred to 1873.

The 1873 Depression was a worldwide international phenomenon that started with the banks, just like the current 2008/2009 panic. In fact the collapse that has followed the Great Panic of 2008 looks a lot more like the 1873 crisis than 1929 one.

Historians familiar with the Panic of 1873 say that economic 'experts' are mistaken to compare the current crisis to 1929 because the federal government was far more passive in the 1920s. The U.S. let 15,000 out of 30,000 banks fail then. Government efforts to jump-start the economy were slow and relatively weak until President Franklin Roosevelt came along with the New Deal.

Today we reap the benefits of policies created during that era. Roosevelt helped create New Deal legislation to insure bank deposits and enacted other modern relief efforts like unemployment compensation to help those in distress. When a bank failed back then, regular people were completely wiped out... and half of all the banks in the United States failed in the years following 1929.

Historian's who have studied the panic of 1873 say the swirling events happening today more closely parallel what is properly termed 'The First Great Depression of 1873'.

And those same historians are very concerned at what they see happening saying today's economy might even be worse than the American economy in 1873.

Scott Reynolds Nelson, a professor of history at the College of William and Mary in Williamsburg, Virginia, says, "This is a perfect storm: banks failing, stock markets declining and commodity prices dropping," all conditions eerily reminiscent of 1873.

Nelson says it took America four years to recover from the 1873 panic. Tens of thousands of workers -- many Civil War veterans -- became homeless. Thousands lined up for food and shelter in major cities. The Gilded Age, where wealth was concentrated in the hands of a few "robber barons like John D. Rockefeller," followed the panic.

It is said that those who ignore history are bound to repeat it.

And when Paul Volcker, chairman of the newly formed Economic Recovery Advisory Board advising President Barack Obama, says "I don't remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world… you know, even the experts don't quite know what is going on", it rightly raises alarm.

Could it be that our so-called ‘experts’ are studying the wrong depression as they struggle to apply 1929 solutions to 2009?

If so it could prove to be a fatal oversight, ensuring that we slip inexorably into what will become known as The Third Great Depression.

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"This Isn't Any Ordinary Crisis" - Volcker. "Even the Experts Don't Know What is Going On!"

Paul Volcker is an American economist and was the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan (from August 1979 to August 1987).

He is currently chairman of the newly formed Economic Recovery Advisory Board under President Barack Obama.

On Friday he said that the global economy may be deteriorating even faster than it did during the Great Depression and made the frank admission that, "you know, even the experts don't quite know what is going on".

Volcker noted that industrial production around the world was declining even more rapidly than in the United States, which is itself under severe strain.

"I don't remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world," Volcker told a luncheon of economists and investors at Columbia University.

Volcker, a former chairman of the Federal Reserve famed for breaking the back of inflation in the early 1980s, mocked the argument that "financial innovation" , a code word for risky securities, brought any great benefits to society. For most people, he said, the advent of the ATM machine was more crucial than any asset-backed bond.

"There is little correlation between sophistication of a banking system and productivity growth," he said.

The current crisis had its beginning in global imbalances like a lack of savings in the United States, but policy-makers around the world were too reticent to take action until it was too late, Volcker said.

Now that the crisis had erupted, it was important to take decisive actions, including a more effective regulatory structure and some movement toward uniform accounting systems, Volcker said.

He said all financial institutions that are deemed too large to fail should be subject to increased scrutiny, echoing the findings of the Group of 30, a panel of policy-makers and influential economists, which he leads.

Click Here to see Volcker's speech.

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Is this the start of a 2nd Great Depression?

How bad are things going to be over the next couple of years?

That's the question on everyone's lips these days as some politicians and commentators routinely invoke the Great Depression to describe today's economic crisis.

A recession is generally defined as a decline in the Gross Domestic Product for two or more consecutive quarters and North America has experienced two "rough" recessions: one in the mid-1970s and the other in the early 1980s. Our most recent recession was the dot-com bust, which hit around March of 2001.

But everyone concedes that this time, things are different. It is now clear that the Great Crash and Panic of 2008 is triggering something much worse.

In the past year, the market's fall has at times rivaled that of 1929. But the Great Crash of 1929 and the Great Depression were two separate events.

The Crash was a financial panic, the Depression an economic downturn. The Crash began in October 1929, and the worst of it was over in three weeks; the Depression did not fasten itself on the nation for another year. To this day, the connection between them remains unclear, which makes it difficult to draw lessons or analogies from them.

The Dow plunged 39 percent between October 23 and November 13, 1929, but it regained 74 percent of that loss by March 1930. Only when the economy failed to gain momentum in the spring did the market slip back.

By fall the country had slipped into a depression, and the market resumed a downward course that did not touch bottom until July 1932. It did not again return to the levels of 1929 until 1954. The Depression did not end until increased military spending revived the economy in the spring of 1940.

Is that what is happening again?

One positive sign is that today's unemployment rate is not as bad as in previous eras. The unemployment rate reached 10.8 percent during the early 1980s and 25 percent during the Great Depression and, so far at least, we are no where near that 25 percent level.

But there is an ominous feature to the current situation: The Federal Reserve has already lowered interest rates as far as they can go, to around zero percent, but the recession marches on.

From a definition standpoint a recession is a contraction in real GDP, brought on by a tight central bank policy (usually to fight inflation), that ends when the central bank eases it's policy.

It is relatively well managed via interest rate changes. Lowering interest rates stimulates the economy in three ways:

1) it reduces debt service burdens,
2) it stimulates demand for items bought with credit by lowering the monthly payments (e.g., cutting interest rates in half has nearly the same effect in cutting the cost of buying a home as cutting the purchase price in half) and
3) it raises the present value of income-producing assets thus producing a wealth effect.

So, lowering interest rates ends recessions and produces cyclical expansions.

But the US has already dropped rates to near zero with no effect.

So what, exactly, is a 'Depression'?

A Depression is a deleveraging process in which asset price declines cause already over-leveraged entities to become more leveraged and cash-strapped, leading them to be squeezed for cash and creating credit-tightening conditions which cause an economic contraction in which monetary policy ceases to work, generally because interest rates have fallen close to 0%, making meaningful interest rate cuts impossible.

Because interest rates can’t be cut, the three previously mentioned stimulations that cause the economy to grow do not occur.

As a result, the “cost cuts” that occur take place via deflation leading to real interest rates increases. Rising real interest rates raise debt service burdens and lower income-producing asset values and a self-reinforcing downward spiral occurs – i.e., as asset values and incomes fall, so do credit worthiness, lending activity and economic activity.

A depression is, most fundamentally, a shortage of liquidity relative to the need for it to service debts that has to be resolved by some mix of writing down debts and producing more liquidity without lowering interest rates.

The sharpness of the current global showdown has alarmed economists who see no obvious engine for recovery. Most Western developed economies are going to see the deepest downturn they have seen in a number of decades, in some cases, possibly, since the Second World War.

Most political commentators have called it 'scary stuff'.

As Frederick Lewis Allen observed, "Prosperity is more than an economic condition; it is a state of mind." The trick is always to find out what exactly is needed to restore it.

We are still fishing for the answer to that riddle.

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