What if the economy got much worse?
That single question has been the driving force behind the evaporation of trillions of dollars from the stock market and the loss of millions of jobs. Worries that the 16-month recession could transform into a depression have led cash-strapped consumers to stop spending and regulators to press for more government action.
Despite those fears, most economists say a depression seems unlikely given a slew of unprecedented actions already taken over the past year by Washington.
Since the recession began in December 2007, the Federal Reserve has vastly expanded its balance sheet and cut rates to the lowest levels on record while lawmakers have signed off on trillions of dollars in spending.
“If the government had not done what they’ve done so far, we would be in a depression now,” said Gary Clyde Hufbauer, an economist at the Peterson Institute for International Economics and a former Treasury official.
Of greater concern, economists say, is that the U.S. will be mired in a Japanese-style “lost decade” where there is little to no growth.
“If we had a decade where we had very little growth we’d have millions [more] homeless. It would be a dire situation,” said Dean Baker, co-director of the Center for Economic and Policy Research, who thinks the chances of a lost decade are significantly greater than a depression.
Varying Views on Doomsday
Economics is an inexact science so it’s not surprising opinions differ greatly the chances of an economic catastrophe. While Hufbauer and Baker said they see the likelihood of a depression at no more than 15%, Douglas Elliott of the liberal-leaning Brookings Institution said it’s even more remote.
“We would have to have extremely bad luck and make a lot of mistakes,” said Elliott, who put the odds at less than 1%.
And given that the Dow Jones Industrial Average has surged 21% in 13 days -- its fastest such rise since 1938 -- it’s clear Wall Street isn’t betting a depression is likely. New economic reports on new home sales and manufacturing have also led some to wonder if the recession may soon stop getting worse.
Others are far more pessimistic.
“My analysis indicates that something like a depression is more likely than not,” said James Rickards, senior managing director for market intelligence at Omnis Inc.
Rickards based his assessment on his belief that the painful deleveraging process is only 25% complete and worries about unintended consequences stemming from monetary and fiscal policy.
Warning Signs
While opinions vary, there is a general consensus that the chances of a depression are greater now than they have been in decades. And experts agree there are clear warning signs that would precede a depression. Hufbauer said to watch the emerging markets, in particular China, which some hope will lead the world out of a recession.
If China’s gross domestic product grew just 2% “that would be quite depressing worldwide,” he said.
Others worry the financial crisis could worsen significantly if the populist furor erupting in Washington inhibits future emergency spending.
At the same time, consumer spending could plunge even further if the stock market suffered another meltdown.
“Consumers are panicked. Let’s face it. They are increasing their savings but they could do a lot more belt tightening,” said Hufbauer.
Rickards, by far the most bearish of the group, said he is watching for a rapid rise in gold, which is often used as a fear gauge and a hedge against inflation.
A depression could also be caused by another leg down in the nation’s already-weak housing market, which would put more pressure on the teetering financial sector.
Japanese Experience Looms
While many see a depression as unlikely, a so-called “lost decade” could very well be in the cards.
The model for a lost decade is the 1990s in Japan, where a financial crisis caused by an asset bubble lingered and infected the rest of the economy, leading to very little or no growth.
“It could haunt the whole Obama administration,” said Hufbauer, who sees at least a one in three chance of a lost decade.
President Barack Obama seems acutely aware of this danger. Defending government spending, Obama told a joint session of Congress that inaction “could result in an economy that sputters along for not months or years, but perhaps a decade…I refuse to let that happen.”
More Stimulus?
“A lost decade is probably the best outcome we can expect,” said Rickards, who called for eliminating the capital gains tax and corporate income tax.
Elliott was significantly more optimistic, saying he sees only a 10% chance for a lost decade.
One way to prevent a lost decade would be with another dose of stimulus in the $300 billion to $400 billion range, said Baker, who said the measure passed earlier this year was designed for a more modest recession.
Baker isn’t alone, as 43% of economists recently surveyed by The Wall Street Journal predicted another $500 billion stimulus will be needed.
While the specter of a lost decade has spooked policymakers, many Americans may already be expecting weak growth in the future.
“I think the common expectation is tough times ahead for quite a long horizon,” said Hufbauer, adding that such thinking can often be “self-fulfilling.”
I was being sarcastic. "Certain" posters seem unwilling to acknowledge that Russia (along with other export driven economies) is in a particularly dire situation. They claim that, because it has so much natural resources (oil, gas, etc) that it is immune, or at least less susceptible, to the economic downturn. But, in fact, because it has so much natural resources, it is acutely susceptible to the economic downturn in the West.
