Not Recession, But a Depression

Buy Gold while it's still cheap, advises one long-time gold bull...

THE COMPANY that Thomas Edison started cut its dividend for the first time in 71 years, notes Bill Bonner in his Daily Reckoning.

Some analysts think GE, too, could default – thanks to the company's move into the financial sector.

Hotels are going into foreclosure too, says USA Today. Dow Chemical is trading at a 24-year low. And the "Great Red Hope" – the idea that China will pull the entire world economy out of a depression – is "pure fantasy" writes William Pesek.

China relies on exports. And the export business sucks. It will be lucky to get through this downturn without a revolution.

Yet an Economist headline asks: "Are Investors Still too Optimistic?"

Our guess: Yes. Most of the action on the stock markets is professional buying and selling. The amateurs seem to be largely sitting on the sidelines, waiting for a rebound to get back in.

They still haven't gotten the message. This isn't a recession. There won't be a quick recovery. And the bailout/stimulus plans won't work.

This is depression. It will take years to restructure the economy. And bailout/stimulus plans just slow down the process.

Looking back at the Dow...if you take the market peak of January 2000 as the long-term cyclical top...you might expect an eventual bottom 10- 20 years later...and then a new bull market that would return prices to their peak highs 10-20 after that. Between the high of '29 and the next major high in '66 was 37 years. Between the '66 high and the '00 high was 34 years.

So sit back. Relax. Most likely, we'll see stock prices much lower...for much longer. Look for a return to '00 highs in 2035. Learn to make a correction your friend. Remember, this is a positive collapse, not negative growth. It is correcting the stupid 'growth' of the bubble years.

What really grew during that period was consumer spending in the United States and Britain. And it grew far beyond the ability of Anglo-Americans to pay for it. Because they were spending too much, the whole world economy bent to sell them too much. The Chinese built too many factories. The shippers built too many vessels. The truckers bought too many trucks. The homebuilders put up too many hovels. The retailers expanded too much...the malls were overbuilt...etc. etc. etc.

Now, in this period of positive collapse, all that surplus capacity is being marked down to what it is really worth...liquidated...and restructured.

Give it time, dear reader. Let Mr. Market do his work. Remember, this is a depression, not a recession. Both Anglo-America and the Chinese economies have lived in a grand, symbiotic delusion for the last 10 years. America believed it could let the Chinese do all the sweating and saving. China believed it could make money by selling to people who couldn't afford to buy. Now, both economies need perestroika. Both need to be refocused.

China will turn its economy towards domestic consumption...and military spending, no doubt. America will have to accept a lower standard of living with fewer imports.

These adjustments take time. The last time the world went through a depression was in the '30s. Every major economy – except Britain, which was already on the ropes – fell backwards...all of them losing more than 20% of GDP. It took three years before they hit the bottom. Then, some bounced back quickly – Germany and Japan – thanks to military spending. Others – the United States and France – barely bounced at all.

Now more bubbles ready to burst. In the United States, public pension systems are under-funded by about $1 trillion. Firemen, teachers, policemen, municipal workers...state bureaucrats. Every one of them is looking to the feds for a bailout. Oh...and AIG is getting its FOURTH go-round of rescue money. The fifth one will come around soon enough. And there's Detroit...California...student loans...commercial loans...the banks...the homeowners...the unemployed...the sick...the halt...the lame...the blind...the plain stupid.

Where will the feds get the money? They'll continue to borrow it. Then, when lenders get tired of lending, they'll print it. That's when gold will really fly...but that might not be for another few years.

Gold, meanwhile, continues its correction. It fell below $900 yesterday. Goldbugs, don't despair. Have faith. The commies aren't going to pull the world economy out of its tailspin. The bailouts and boondoggles in the West aren't going to do it either. Buying gold is still the smartest long-term decision that you can make for your portfolio...and we suggest you take advantage of this correction. Buy some while the price is low.

For the moment, lenders like buying US government I.O.U.s. It's the only thing they feel they can trust. One way or another, they're sure Uncle Sam will make his payments.

But, as we've been saying, we live in an upside down world. If and when the fear subsides, investors are going to look elsewhere for yield. The price of things will begin to rise again. So will yields. So, the US government will have to pay more to borrow. Thus, as things get better for the economy...they will get worse for the US Treasury. It will find itself with higher and higher interest costs...and no way to pay them.

What will they do? Throw up their hands and admit they can't make their payments? Or print money? We've already made our guess; they will do the wrong thing.

What is the right thing to do? "Leave it to time to affect a permanent cure by the slow process of adapting the structure of production..." said Friedrich Hayek.

"Depressions are not simply evils, which we might attempt to suppress," added Schumpeter, "but forms of something which has to be done, namely, adjustment to change."

The economy needs to be restructured. The dead wood needs to be burnt off. But the feds are trying to stop the fire.

Alas, said Schumpeter, "most of what would be effective in remedying a depression would be equally effective in preventing this adjustment."

Bradford Delong explains:

"Certain investments should not have been made. The best that can be done in such circumstances is to shut down those production processes that turned out to have been based on assumptions about future demands that did not come to pass. The liquidation of such investments and businesses releases factors of production from unprofitable uses; they can then be redeployed in other sectors of the technologically dynamic economy. Without the initial liquidation the redeployment cannot take place. And, said Hayek, depressions are this process of liquidation and preparation for the redeployment of resources.

"As Schumpeter put it, policy does not allow a choice between depression and no depression, but between depression now and a worse depression later: 'inflation pushed far enough [would] undoubtedly turn depression into the sham prosperity so familiar from European postwar experience, [and]... would, in the end, lead to a collapse worse than the one it was called in to remedy.'

"For 'recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead'..."