How Long Will It Last v.2.0

In January I published How Long Will It Last, v.1.0 and discussed some new research on the results of studies of past depressions. You may wish to review that article. Professors Rogoff and Reinhart show that the historical average of banking crises have the following characteristics:

Housing prices declined an average of 35% over six years;

Equity prices declined an average of 55% over 3.5 years;

Unemployment rises to an average of 7% over four years;

GDP declines an average of 9% for over two years;

Government debt increases an average of 86%.

Here is an update on that information. Robert Barro, another Harvard professor and an associate introduced a new study that showed depressions don’t occur without a stock market crash.

In the end, we learned two things. Periods without stock-market crashes are very safe, in the sense that depressions are extremely unlikely. However, periods experiencing stock-market crashes, such as 2008-09 in the U.S., represent a serious threat. The odds are roughly one-in-five that the current recession will snowball into the macroeconomic decline of 10% or more that is the hallmark of a depression.

If you are seeking comfort, he said that the economy will likely recover despite the policies of the Obama Administration. But he said, “On the other hand, the 59 nonwar depressions in our sample have an average duration of nearly four years, which, if we have one here, means that it is likely recovery would not be substantial until 2012.”

What can we take from all this?

First, we’ve had a stock market crash. Here’s a chart (from Calculated Risk) that will put things in perspective:

It seems we’ve succeeded fabulously here.

Housing? We’ve only declined about 29% on a national scale, so we have a way to go to reach 35%.

Unemployment? We’ve already exceeded 7%. Tomorrow the jobs report comes out. The rumor is that it will be in the 7.9% to 8% range. Forecasts exist that show unemployment rising 9% to 10%.

GDP is shrinking. It fell 6.2% in the fourth quarter for 2008. Here’s the data:

Need a bit more guidance? Option traders see another two years of a bear market according to a Bloomberg report. The so-called implied volatility (VIX) of two-year contracts on the S&P 500 jumped to a record 43.58 in November and stayed above 30 since then, a level it never previously exceeded.

If you want more, how about Nouriel Roubini (Dr. Doom) and Nassim Taleb (Black Swan). They gave CNBC an interview from Davos where the likes of Bill Gates and Michael Dell lined up for hours to get in to hear them speak.

Roubini sees a recession/depression that is three times longer and deeper than past recessions – a U-shaped recovery, not a V-shaped recovery. He fears Japanese-type stagnation. He recommends nationalization in order to clean up the banks. He said you can’t build a recovery based on debt; you need “real investment” which is economist-speak for saving and rebuilding our capital to spur real business—not debt-based consumption.

Taleb was equally negative because he feels we’ve let the same people who got us into this mess continue to run the show. He recommends firing Bernanke Immediately. He feels it will take about four years to deleverage the economy and rebuild the capital base. He said he’s in cash. And he’s short.

I agree with Roubini and Taleb. This is the largest credit cycle bubble in history. We’ve looted our future by borrowing against our capital and spending it. Now we’ve got to get out of debt. We’ve got to save—and that’s what people are doing right now. We can’t repair the economy by continuing to borrow and spend, which is what our government proposes as a solution.

I don’t agree with Professor Barro that the economy will recover despite what our Keynesian leaders do to the economy. History has shown that government can seriously negatively impact the economy with their policies. So, in large part it depends what the Obama Administration does. Based on their philosophy I have no faith in their ability to cause the economy to recover. I fear we’ll catch the Japanese disease—economic stagnation and continued high unemployment. But, like everyone else making prognostications, including our two Cassandras, it’s just a guess.