Chances of a New Economic Depression Are 5%, But Severe Downturn at 15% to 30%

Brad DeLong, Department of Economics, U.C. Berkeley has written an interesting article estimating the chances of a new depression at 5%. He used to say that there was no chance of a repeat of the Great Depression, or anything close. However, he no longer thinks that way. The chances are no longer zero.

What is more troublesome is that in the current crises we are currently in a "1/3-of-a-Great-Depression". The chances of another big downward shock to the U.S. economy that would bring us to 2/3 of a great depression (or more) are about 5%.

And, he says, if such a shock hits there is nothing the U.S. government will be able to do about it.

"We could cushion the impact of another big downward shock by a lot more deficit spending--unemployment, after all, goes down whenever anybody spends more (even though sometimes falling unemployment comes at too-high a price in rising inflation), and the government's money is as good as anybody else's. But the centrist Democratic legislative caucus has now dug in its heels behind the position that we cannot undertake more deficit spending right now because we have a dire structural health-care financing proble afrer 2030. The Republican legislative causes has now dug in its heels behind the position that the fact that unemployment is 10% shows not that policy earlier this year was too cautious but rather that it was ineffective. And the Obama administration has not been able or has not tried to move either of those groups out of their current entrenchments".

"We could cushion the impact of another big downward shock by recapitalizing the banks again. But the failure of the Fed and the Treasury in the aftermath of Lehman to grab a share of the upside from its capital injection and purchase operations for the public in the form of warrants means that there is no coalition anywhere for a repeat or anything like a repeat of propping-up the banking system: the right thinks it is an unwarranted intervention in the free market, the left thinks that it is a giveaway to the undeserving and feckless superrich, and the center is bewildered because it is an enormous and poorly-structured intervention in the market, it is a giveaway to the undeserving and feckless superrich, and the optics are terrible".

You may read the full article on his site.

Mike Hedlock of Global Economic Analysis responds to this today as follows:

"The problem is debt. One does not cure a debt problem by going deeper in debt. We should have let failed banks actually fail instead of making zombies out of them. We are repeating the very same mistakes Japan made, and ironically Delong's wants to to make the same mistakes only much bigger. Sadly, that is how Keynesian economists think."

Mish goes on to mention how the Great Depression ended: with war. As I have posted before, that is my concern as well. Ultimately, war to cure the problems caused by the bankers. When people go hungry, the problem cannot be stopped, and wars happen.

"We have made all the wrong policy decisions just as Hoover and FDR did in the 1930's. Contrary to popular belief, it was not failure to keep up the stimulus that lead to a relapse in the late 1930's, but a rather a whole series of policy errors on top of the basic problem: Eventually stimulus will always run dry because by definition it must, and when it does the artificial boom ends but the debt overhang still remain. WWII ended the Great Depression at a huge expense to the rest of the world.The US was a shining beacon of growth after the war for the easily explainable reason that our productive capacity was not destroyed while productive capacity was destroyed everywhere else."

Mish mentions that we are repeating the same mistakes Japan made and says that Japan is ready to implode. We have also written about Japans's troubles, several occassions, see the latest The Land of the Setting Sun and Will Japan default?

"What the administration should have done is let failed banks fail. Instead we propped them up, just as Japan did."

This is all too depressing.

By the way, Mish has his own estimates for new downturns, in the range of 15% to 30%. I will have to add the WW and WWW to my potential shapes of recovery.

"I have the odds of a severe downturn at 15% (unemployment exceeds 13% perhaps by a lot) and a less severe fashion at 30% (unemployment exceeds 12% or higher). In both of these scenarios there is a double dip recession. This is the "L" or "WW" scenario. In the milder form we flirt in and out close to recession for a number of years and unemployment essentially flatlines for years before finally turning lower. "Muddle Through" means things do not get much worse nor do they get much better (Unemployment tops out under or near 12% and we do not double dip or if we do it is barely noticeable). Unemployment peaks, then very slowly starts to drop. Let's put the odds of "Muddle Through" at 35%. "Muddle Through" might be labeled a "U Shaped Recovery" but it would feel more like an "L". Realistically this is about the best we can hope for. Slightly better than muddle through has about a 15% chance (A genuine U-Shaped Recovery). Unemployment peaks, then drops at a modest pace. The vaunted V-Shaped recovery with strong growth in jobs has about a 5% chance in my estimation. Even in a V-Shaped recovery, the odds of unemployment dropping to 6% or less by 2015 are close to zero."