Is A Depression Coming? The Impending Second Economic Crisis Facing America

The near-collapse of the banking and financial industry in September and following months is only the first horrendous crisis threatening our nation. We are stalked by a second crisis, which will present itself next year. The next crisis is the failure of economic recovery. Economic recovery must come from somewhere; it cannot come from the economic stimulus measures. Putting more money into peoples' pockets for a few months and adding a few million construction jobs in infrastructure make-work projects will not generate a sustained recovery.

• Most of the Congressional stimulus money of 2008 was saved or used by households to paydown debt, e.g., credit cards. Most of it was not used to buy goods. The same will happen with Obama's and Congress's bigger stimulus payouts in 2009. 

Stimulus and infrastructure investment will have a meliorative effect for a few months or a year, then the descent into deeper recession, or depression, will resume. Why? Because only an increase in American economic productivity will generate lasting recovery. But what sectors exist in the American economy to become more productive?

The manufacturing sector has shrunk so much that it is not capable of leading a recovery of the economy as a whole. You can figure this out for yourself by going over the rebound capacity of the different industries. Here is a start.

• Would it be the American auto industry (as distinguished from non-American auto companies with assembly plants inside the US)?  Hardly; we'll be lucky if the American domestic auto industry (distinguished from its overseas production) is half its current size in two years. As the big automobile Assembly companies, like GM, decline, the parts suppliers, dealers, after-market manufacturers (paint and chrome detailing, moon-roofs, high-lift shocks, etc.), and repair services will also decline.

• Would it be the farm supply industry--tractors, combines, harvesters, etc.? Nope. Falling commodity prices will prevent farmers from expansion and from new investment.

• Would it be the civilian aircraft industry? Nope. Boeing is the only commercial passenger aircraft manufacturer left. Much of its 787 production is based overseas to begin with. It will be stringing out its domestic production schedule as its loses order or orders are delayed; it won't be increasing production.

• Would it be the military aircraft industry? Nope. Obama intends to reduce military expenditures. High-priced weapon acquisition programs, such as advanced aircraft, are on the chopping block.

• Would it be the housing industry? Hardly. Housing prices remain in free-fall. Soon the majority of mortgaged homes will be under water and their owners will not be trading up. New housing construction will continue to fall. The housing supply industries--lumber, concrete, plastic and metal pipe, dry wall, paint, toilets, kitchen sinks, nails, roofing materials, and so on--will continue to contract. In a year or two, the housing manufacturers and builders will be near depression level activity.

• The collapse of the housing market has also hit the home furnishing industry hard. Manufacturers of furniture and home decorating and furnishing items in the US and abroad have been closing down. I'm sure you've seen furniture stores in your community that have gone out of business in the past year. Their suppliers will follow. The contraction of these manufacturers will continue.

• Would it be the energy sector--petroleum, gas, coal, electricity, etc.? Nope. Falling energy prices have stopped private investment in new sources of petroleum, such as shale oil, and new sources of gasoline, such as coal to gas. They required $80/barrel floor price of petroleum to be competitive; we won't be back to that price for sweet crude for several years. Falling demand for gasoline along with the falling price, will slow construction of refineries. Exploration of new sources of oil, off-shore, for instance, are stopped by both political opposition and low prices. The loss of investment and jobs in this previously-booming sector will not be offset by Federal policy investment in alternative and green energy.

• Note that, as the manufacturers of end-products decline, the demand for products from manufacturers that produce goods for other manufacturers also declines. Companies like 3M, Cummins, Nucor, and IBM, for instance, manufacture goods to sell to other manufacturers to help those companies make the products they sell to consumers. They'll decline, too, contracting production, laying off workers, and reducing wages and salaries and benefits for the workers they retain.

Will it be the financial industry that leads the nation to recovery? Not hardly.

• Banks will be unable to lend freely, because the toxic mortgages they hold haven't been taken out of the finance system, because Paulson reneged on his plan of September 2008 to have the government do so. And the collapse of housing prices is creating more toxic mortgages. Banks are holding onto their bailout money, rather than lending it, because they are building cash reserves in case of further disaster.

• Consumer lending will decline, because fewer consumers are good credit risks. 

• Commercial lending to businesses will decline, because businesses are contracting, not expanding.

• Banks are laying off employees. Financial institutions are going bankrupt. Investment firms are going bankrupt, because the retirement planning boom that fueled their growth has collapsed and retirement wealth has been liquidated. Over 30,000 financial industry workers in lower Manhattan have been laid off in the last two months alone.

Will it be the government that leads us out of the economic collapse? Of course not.

• To fund its programs, state and federal governments will increase taxes, reducing consumers' purchasing power and businesses' capacity to invest. Governments will use some of the tax revenues to increase the number of government workers. Biden says that the government will take 25% of the jobs it creates in the infrastructure program. Governments are not productive, because they do not produce anything at all. They regulate and govern. Regulations reduce economic activity in the private sector.

• What about private jobs created by government-directed and -paid green and alternative energy sector? Not here, either. All green products and alternative energy products are several years away from being available to consumers and they will cost more than conventional products they are intended to replace. Green and alternative energy products will therefore reduce consumer purchasing power, further reducing demand for products for the truncated American manufacturing sector outside of the government green and alternative energy sector. Furthermore, investment and jobs in green alternative energy will be offset by losses in the alternative petroleum and old energy programs (see above). No net gain here.

• The Obama stimulus and jobs program looks backward and measures itself in terms of adult laborers out of work; but doesn't look to the future labor force. In the next several years, millions of school age young men and women will graduate from high school and college and attempt to enter the labor force. They won't be able to take construction jobs or engineering and design jobs in green and alternative energies that Obama hopes to create. And existing conventional industries won't be able to hire them. Without new private enterprises and without existing businesses expanding, as would happen in a vigorous private market economy, these new applicants to the labor force will not be served and so will dampen the forces for recovery.

Will it be the service sector? Oh my gosh, nope. Consider two leading service "industries".

• Education. Funding of schools will decrease. The number of teachers will decline. Does this mean that instructional productivity will increase? Hardly. Educational productivity is not the number of student outputs per instructional input. Education "produces" knowledge and skills. The knowledge and skills of students will not increased in the recession-deprived classroom. They will decline, which will further degrade the labor force.

• Medicine. The government is going to increase greatly the number of patients the current medical system sees by welfare programs (however called). What medicine "produces" is not patient through-put, but health. Does anyone think that the health of the nation will be increased by overloading the current medical care system? Of course not, at least not in the near future. The kind of industrial medicine that Medicare style programs will produce will not produce the dramatic changes in, e.g., obesity and diabetes, that are required to have a healthier labor force able to be more productive. Maybe in a decade or a generation, but not in the next ten years. So neither education or medicine are going to increase "productivity" (assuming that the concept of productivity is meaningful in these services to begin with).

The consumer sector? Here the news is worst of all.

• What about consumer wealth, that is, assets? The decline of the investment markets and the decline of housing prices have already destroyed $7 trillions of household wealth (more than the total, annual, economic activity of the nation!). Their decline and the general economic decline will lead to further reduction of the pension and retirement system. The result will be, by the end of next year, the near liquidation of all household wealth. Regarding household assets, we will be in a great depression.

• What about consumer income? Alas, the news is bad here. The national unemployment rate is certainly going to hit 10% and probably more. Lawrence Summers is already talking about a mini-depression . The economists can't project more, because their models are so poor; but the likelihood is more than 10% of the civilian, nongovernmental labor force will be unemployed or under-employed (reduced to part-time). Those workers remaining employed will see their wages and salaries and benefits reduced significantly. They won't have the cash or credit-worthiness to "spend" our way out of the recessions.

• Suppose consumers would have income to spend on products, their spending would not power a recovery. They would buy goods, but nearly all of those goods are produced by manufacturers in other countries. Our consumer purchases would help them, but not us. The US stateside management offices that handle ordering, design, and distribution of the goods manufactured overseas would not expand to take care of the orders generated by consumer purchases. No net gain for us.

• The decline in consumption will contract the consumer-oriented retail, service (e.g., travel services), entertainment, and office management sectors. Expect many stores to close and retailers to go bankrupt in 2009. Expect theaters to close and museums to reduce their hours. The retail decline will result in millions of layoffs and further contraction of household income, as many retail workers are part-time and are second or third wage earners in households.

  • The office building developers and rental industry are already on the verge of collapse, with office and store vacancy rates of 20% in some markets. Some office building developers and owners have already asked to receive bailout funds next year. Expect to see store after store, malls, and office buildings close and be boarded up next year.

How are we going to get out of this second disaster? How are we going to avoid a depression?

Not by the new 'New Deal' that Obama is fashioning. (Critiques show the New Deal itself kept the nation in the Great Depression: 1 [1a], 2, 3.) Not by increasing and expanding 'New Deal' kinds of programs. Not by moving us toward more government run and paid social welfare and social justice programs. Moving in that direction simply puts the nation closer to the economic disaster of all the socialist economies. The more socialist they are, whether the former Soviet Union or the present day socialist economies like Cuba, the bigger the disaster their economies suffered. Haven't we learned anything from the economic disasters of the 20th century?

We can only get out of this disaster by one route. We must significantly increase the manufacturing industries in the private sector (my suggestions how: 1, 2), increasing productivity in their manufacture of tangible goods that we use and can sell to others, while commensurately decreasing the relative shares of the economy occupied by the service and government sectors.

Revised. December 28, 29, 30, 31, 2008; January 8, 2009.

Update. January 7, 2009. The Federal Reserve agrees that a deep economic downturn will occur through all of 2009.

Update. March 4, 2009. The Federal Reserve's regional report and analysis of economic conditions is dreary. In January and February, the economy continued to spiral down. Nonfinancial services are now declining, just like manufacturing and financial services. Health care is contracting, as fewer consumers choose elective procedures (e.g., such as cosmetic surgeries). I think that commercial construction should contract severely in the next few months. We will also begin to see public sector layoffs, such as in education.  The contraction for the first quarter of this year is expected to be worse than the contraction for the last quarter of last year, which was dreadful. The economy is not expected to bottom out and begin an upward turn until late this year or early 2010.

Update. March 2, 2009. Economists are trying to define, and agree on a definition of, a "depression". This effort is a clear sign that one is coming. Economists are trying to get a grip on how to talk about a depression, in preparation for revising their clearly inadequate macroeconomic models to account for the one into which we are sliding.

Update. March 4, 2009. Based on analysis of historical data concerning national economic contractions and stock market crashes in 34 countries, one analyst puts the odds of the US having a depression at 20%.

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A Primer on America's Economic Crisis

• Wealth and Income In the Current Economic Crisis

• The Real Problem With The Obama-Dems Stimulus Is That It Won't

• Is A Depression Coming?

• The Issue of Credit In 'Living Beyond Your Means'

• Government Regulation, Mandates, and Protectionism Have Destroyed US Productivity