US in depression

by Vivek Kaul

The cure for a depression is a depression. The situation won't return to 'normal' until this crisis has been able to do its work.
-- Bill Bonner

"It's all in your mind, V. They can take away your job, but they can't take away that brain you have inside your head," she told me, trying to pacify my fears of being fired.

"I guess, you are right," I replied.

"But to tell you frankly, it is not looking good. The US has come up with another rescue plan. This time, the big round number is $787 billion. So if we add the earlier two rescue efforts, the bigger round number is more than $2 trillion. One of the biggest items in this new plan is a $400 payroll tax cut for individuals and $800 for couples.
Some others like retirees, war veterans etc who do not pay payroll taxes will get a $250 payment from the government. The idea is that the beneficiaries will spend all this money, which will help revive a contracting economy and, in turn, save jobs. But I don't think all this is going to make much of a difference," she said, puncturing all the pacification she had just indulged in.

"Why do you say that?" I asked.

"I don't think all the efforts being put in by the US government to get its citizens to start spending will bear much fruit. Private debt is usually around 80% of the gross domestic product (GDP), but right now in the US it is 140% of the GDP. In money terms, private debt in the US is now around $6 trillion and this is after nearly $1 trillion was written off in the last two years. Now, I need not tell you, that is a hell of a lot of money.

People realise that unless they save, they won't be able to pay off all the debt that they have accumulated. People have also lost nearly $30 trillion in value from their homes and investments over the last few years. This has led to a huge change in psychological attitude when it comes to spending. With real estate prices falling and incomes either stagnant or falling, it is natural that people want to hold on to all their cash. Savings as a percentage of income currently stands at around 2%. Now, that rate has to increase if people are to pay off all the debt that has been accumulated. So, basically, people want to save even though the government wants them to spend in order to revive the economy. Get that?"

"Yup, I do. You seem to be getting better and better," I commented.

"You know, David Rosenberg, an economist at Merrill Lynch, has opined that the US economy is not in a recession, but in a depression," she said.

"Depression! But what is the difference between a recession and a depression?" I asked.

"Good question. I Googled and found that there is no precise difference between depression and recession. But a depression is essentially an extremely severe recession. And that is why all these attempts by the government to print and spend money -- and to get its citizens to spend -- to revive the economy just won't work."
"Hmmm! But why won't it work? There have been cases in the past when increased government spending has helped revive many economies?" I questioned.

"You know this is an exception that proves the rule. The prescribed remedy for a government to get out of any recession is increased government spending that leads to its citizens spending more and hence revival of the economy. But this time it's different. People just have way too much debt to pay off and, even if they are given tax cuts like they have been offered in this new plan or lower interest rates to borrow and spend, they just won't spend. All the plans presented till now seek to get people to spend and hence revive consumption. But the economy is in trouble primarily because people borrowed way beyond their capacity and spent too much. As economics and financial writer Mike Shedlock recently put it,
'Consumers and banks have both been burnt, and attitudes have changed'," she replied with great confidence.

"You explained the consumer part of it. But what about the banks...
Why are they not lending? The US government has been helping banks. The increase in lending to American banks as of November 2008 was a staggering $700 billion. Where is all that money going? Even after a lot of government money has been pumped into banks,"

"Hmmm! Just imagine if all that money were to hit the economy. What do you feel will happen?" she asked.

"Well at a very basic level, such an increase in money supply will lead to a humungous increase in inflation. "Inflation is always a monetary phenomenon," this is one of the few things that various schools of economics seem to agree on," I answered.

"Right! The fact is that inflation is well under control even with all this increase in money supply. What does that tell you?" she asked.

"It means that all that money given to the banks is not coming into the economy... But if it's not coming into the economy, where is it going?" I asked.

"Banks are depositing the money lent to them by the US Fed, back at the US central bank. On this, the US Fed pays them an interest of 0.1%. Other than this, the money that banks raise through depositors is also being deposited with the US Fed. Now why would a bank which pays an interest of around 2% on its fixed deposit, go back and deposit that money to the US Fed at almost zero percent?" she questioned.

"It would do that only if it expects to lose more money by lending to people," I replied, finally getting what she was trying to explain.

"But is there a way out of this?" I asked.
"There is a way," she answered. "Economist and investment letter writer Bill Bonner wrote in a recent column, 'There is about $6 trillion worth of debt that needs to be eliminated before the economy can begin to grow again. Liquidation would do it - quickly and painfully'. He seems to be suggesting that the simplest way to get around all this is to write off the humongous amount of private debt that remains and start afresh."

"So why is it not being done?" I asked nonchalantly.
"You know, you can be really stupid at times. If that happens, the US dollar would simply collapse and that of course is not acceptable to the present establishment or for that matter the previous establishment.

But I guess the US dollar would collapse anyway. All those dollars that are being printed to rescue the economy will hit the economy sometime, and, when that happens, inflation is going to go through the roof. When inflation goes through the roof, the world at large won't want to hold on to the humongous amount of securities issued by the US government. They will get out of those securities leading to a crash there. Once they have got the dollars by selling those securities, they will also want to sell off those US dollars and get into other currencies and that my dear, as you have explained in the past, will lead to the US dollar crashing," came as a long wielding response from her.

"So what is the moral of the story?"
"Buy gold. With the expected collapse of the US dollar, all the money is going into gold."

The example is hypothetical

References:
Ben Bernanke's Wild Ride (and Ours)
by Gary North, January 28, 2009,
www.lewrockwell.com

What We Face Now Is a Depression,
by Bill Bonner, February 6, 2009,
www.lewrockwell.com

Ghost Malls - Coming to Your Town
by James Quinn, February 04, 2009,
www.dollarcollapse.com

via DNA