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Tuesday, January 10, 2012


is this a depression?

the answer is yes -- but the claim is heavily reliant on definition.

so what is a depression? i would argue that the condition of depression -- separate from recession -- has little to do with GDP, employment rates, and the bevy of macroeconomic data that is commonplace in analyzing the national economy. standards such as a 10% unemployment rate or four or more consecutive quarters of contraction are arbitrary markers that seek to delineate recessions from bad recessions without marking a difference of type.

that there is a difference of type should now be clear. richard koo was among the first to my knowledge to articulate that difference, but with the spread of his ideas anyone paying much attention to macroeconomics should now realize that his concept of a "balance sheet recession" is not at all like a standard recession. (his latest paper on the faltering fiscal policy response is at real-world economics review.)

we might then define a depression as an episode of prolonged private sector deleveraging. and there can be no question that that is exactly the current condition, not only in the united states but virtually the entire first world.

within that episode there may well be periods of expansion as well as recession -- much like the roaring but forgotten expansion of 1933-36 or the rather more tepid US expansion of 2009 through today. indeed there is no reason that the economy of a country might not grow on a real per capita basis during a depression with the help of productivity gains.

but throughout a depression episode it must be realized that, in order to satisfy the balance of payments, the public sector must run a fiscal deficit which inversely corresponds to the private sector's newfound preponderance toward surplus (that is, savings and debt repayment in excess of investment and net exports) in order to prevent a deflationary collapse of income. if the government fails to do so -- through tax cuts or spending initiatives -- a sudden lapse back into recession is the sure and immediate consequence.

i am provoked to restate all this, much of it familiar, as i listen to the litany of 2011 retropsectives and 2012 prospectives that have accompanied the turn of the year. i've heard any number of forecasts for better and worse, but i've yet to hear one that clearly outlines the reality of the american economic situation, which is this:

if the federal government continues to run a deficit in the area of 9% of GDP, we will continue to lumber along a slow growth trend with vacillations over and under the trend as private sector deleveraging either decelerates or accelerates. this will continue until the private sector has reduced its vast debt hoard to something far more sustainable on a discounted cash flow basis -- a process likely to take many years.

if instead the federal government undertakes to reduce its deficit -- either by raising taxes or allowing tax breaks to lapse or reducing spending -- we will see private sector incomes drop, delinquencies and defaults rise, deleveraging accelerate to compound the public contraction, and recession thereby powerfully return as the deflationary circuit broken by 2009's ARRA spending reasserts itself.

in other words, the economic forecast for the united states in 2012 (and 2013 and some years beyond) hinges entirely on the political calculus of washington. any and all such forecasts are entirely reliant on that one factor.

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