Welcome to the New Depression

| April 21, 2009 | 1 Comment
Recession optimism is misplaced

Recession over? April Fool!

We’re seeing the message this week that the worst of the recession could be over.

It seems a familiar April Fool’s message - we saw the same last year when stock markets enjoyed a brief rally after claims the credit crunch was effectively over.

You might be easily led into thinking that the worst is indeed over after a string of major US banks reported “record profits” over the past month.

What much of the reporting glossed over was the fact that these banks were reported a a few billion in “profits” on the back of tens of billions of government aid initiatives.

Bankrupt banks report profits from life support

In other words, if a bank received $50 billion in TARP money yet then reported a $1 billion profit, wouldn’t that mean the bank actually made a $49 billion loss?

In the real world inhabited by ordinary people, yes it would - in the murky world of corporate accounting, spin is being played out to try and hide the fact the US financial system is on life support, with emergency state aid propping it up.

In fact, it’s a world becoming murkier still after the banks were recently given freedom from mark to market accounting. Which means banks can now value toxic assets as healthy assets, and further give the appearance of profitability.

No wonder there’s been a surge in optimism when people listen to banks, who at present are trying to hide the fact that the US financial sector is effectively bankrupt.

Economic depression continues

In the meantime, every economic outlook for the past two years has been rewritten to account for increasingly pessimistic realities.

The IMF has already declared the current economic crisis to be the biggest financial shock since the Great Depression of the 1930′s. That means we should be looking at conditions under those times as a template.

And indeed, they do provide some interesting insights - not least the fact that there was periodic instances of misplaced optimism that led to three of the biggest stock market rallies in the history of the Dow Jones index, all occurring within the time span of the Great Depression itself.

Looking back at the 25% rise for the Dow over the March-April rally we can see this very much in action.

If you really want to see the full potential horror, take a look at this comparison chart covering the major stock market crises: The Four Bad Bears.

If the Great Depression really does server as our template, then the current Bear Market is only two-thirds finished, with the potential to drop far further.

In an environment where many companies are reporting either massive losses or minimal profits, credit remains limited if available at all, and work forces are slashed by massive figures, we’re certainly looking at no ordinary recession.

The next stage of the crisis

Meanwhile, underneath the glamorous claims of profitability by US banks, in the small print lies the devilish detail - financial conditions are becoming far more averse, with a major crisis in credit card lending ready to follow the subprime mortgage crisis.

This is exactly the scenario Nouriel Roubini sounded out back in 2007, when FM was one of the few financial news sites to air the claims of the real extent of the credit crisis from someone then claimed to be a rogue economist - a doomsayer to ignore.

Now he’s the darling of the press - the same press that dismissed him before the first salvoes of the credit crisis hit us.

Yet his message is consistent - we’ve still a long way to go before this crisis is played out, and the credit card crash is coming up soon on the agenda.

Here’s something to make everyone more sober - back in 2008 the IMF predicted that losses from the economic crisis via toxic debt could reach $1 trillion. Now Nouriel Roubini touts $3 trillion.

And if that makes your eyes water, Marketwatch recently pointed out the £700 TRILLION elephant in the room:

Derivative contracts total about three-quarters of a quadrillion dollars in “notional” amounts, according to the Bank for International Settlements. These contracts are tallied in notional values because no one really can say how much they are worth.

In other words, while the industry itself constantly revises upwards the actual cost of the crisis, the potential ceiling on those losses constantly out paces it, to reveal the frightening realities they are dealing with.

Economic support is all maxed out

The governments of the UK and US have tried throwing money at the problem - namely the banks - and now trying out uncharted methods to aid recovery. Not least breaking normal rules by pulling out the printing presses under “quantitive easing”.

The ultimate irony is that the massive changes in the financial system now results in optimum revenue opportunities for the banks - while ordinary people suffer most.

The Bank of England’s interest rates are held at 0.5%, yet almost all mortgage and loan products are in excess of 4%. Meanwhile savings rates are mostly under 1%. Overall, this makes the spread of profitability for banks much bigger than the boom years to 2007.

In the US, they are even screwing consumers even more with debt charges - something that has been stopped in the UK.

Yet it is taxpayer money that will be used for much of the reclaimed bank charges due to the part-nationalisation of the financial sector itself.

And as the rescue continues, the UK government is even risking a downgrade of the UK’s own sovereign credit rating.

Cries of “Capitalism for the Poor, Socialism for the Rich” aside, it’s plain that things are currently bad.

But also that they are likely to get worst.

A terrifying crash

The US and UK economies are both consumer driven economies. That’s why economists fret when high street sales figures fall - they in effect demonstrate the health, or not, of the country’s economy.

Yet these are consumer societies that already hold an inordinate amount of debt, and it was revealed at the end of 2007 that the UK held a third of all unsecured debt in Europe.

These same debt-ridden Britons, who are increasingly less likely to be able to afford to pay off their debt, thus bring the economy further into decline, thus further undermining the financial sector - and with no more options for the government, other than nationalisation of failed institutions.

So far we’ve seen the credit crunch become an economic crisis whose only relation is the Great Depression, even by admission from conservative bodies such as the IMF.

In making such a comparison, they are effectively stating that we are in a new depression.

And if that’s our lens on what to expect, any optimism now is horrifically misplaced.

Comments (1)

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  1. mark harrison says:

    I’m afraid that I believe the worst is yet to come in the UK. We are now seeing the destruction of our manufacturing industry and this has always been the bedrock of our nation in terms of a barometer of our financial health. Banking maybe levelling out but manufacturing is going to get a hell of a lot uglier…

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