Thursday, March 5, 2009

Depression

The following is part of a letter I sent to my siblings a few weeks ago. In it I am explaining my rational for asserting that we have a 50-50 chance of falling into an economic depression. Here's a slightly modified version of what I wrote:

You may be aware that a component of my job is economic development. Because of this I have spent a good deal of time over the last few weeks researching economic trends and history, and that is why I have arrived at the conclusion that a depression is possible, even likely.

Here are some ways that recent events are like those of 1929:
- Bank failures (banks in the 20's were much more localized than today, so our "big" bank failures may mean more than several small closures.)

- Rising unemployment (25% of people were unemployed during the worst of the Great Depression. The official number today is "only" 7.8%, but it is measured differently today. Using the methodology from that time, today's number would be closer to 12%.)

- Massive decrease in stock prices. (We still have a way to go before we see a similar percentage loss. We have lost about 40% of the Dow Jones Industrial's high of 14,000.)

- New technologies (Cars, radio, movies in the 20's, computers and the internet in the 90's) had caused a massive economic expansion and feeling that the economy was too good to fail.

- The federal government stepped in and made things worse while trying to make things better.

Now I don't think those things alone necessarily add up to a depression. What will drive this recession into a depression with be a chain of events that I see no way around. The U.S. has lost around 3,000,000 jobs in the last year and a half. That amounts to about 1% of the workforce. (Generally these have been decent paying jobs.) Those who are out of work are obviously spending less, but so are those who still have jobs. If this condition persists, retail stores will find they can't keep the doors open. (Note that Albertson's is closing its Cedar City and St. George stores already.)

As this happens, there will be a surplus of commercial real estate on the market, meaning construction jobs in this sector will follow construction jobs in the housing sector (Downwards, if you weren't aware.). Not only will this cause less spending, but we will see the commercial real estate bubble "pop" like the housing market did. This will likely cause another round of bank failures, and it will leave commercial districts vacant, giving communities that wonderful vacated, post-apocalyptic feel.

Now, that scenario is bad enough, but what really troubles me is how things could go after that. Here are some ways that today's situation differs from that of 1929:

- The population has shifted from rural to urban. People during the Great Depression and WWII planted gardens. A large chunk of our population isn't near enough to arable land to do so today. People get mean when they are hungry.

- There are more homeowners with mortgages today than there were in the 20's. That potentially means more foreclosures and homeless people than back then.

- Because of the real estate bubble, many Americans have "upside down" mortgages. That means they owe the bank more than the house is worth. Home equity loans don't exist when there is no home equity to speak of.

- The dollar is no longer tied to a gold standard. Many people don't realize that the dollar is only backed by the government's word, and more and more Americans are doubting the validity of that word. This also opens the door to so called "hyper-inflation."

- A higher percentage of our economy is tied to governments now than in the 20's. For example, colleges are big business today. As state endowments decrease (which they will as tax revenues decrease), colleges will lay off professors and staff and/or hike tuition to cover shortfalls. By way of example, USU just announced that all employees will take a one-week unpaid furlough next month. That will not quite cover the 10% budget cut the university has to deal with. (Compare that to the rumor that UNLV will be looking at a 50% endowment cut. It's just a rumor, but FIFTY percent?)

- Americans are in debt without assets to sell. Consumer debt is around 140% GDP right now. If you aren't into the numbers, that means that a great deal of debt won't get paid off, and banks (and their customers) will have to eat that cost. [edit: it turns out that consumer debt was equally high in 1929]

- The federal government is in serious debt and may run into the end of its borrowing capacity. The national debt started to get stupid in the 80's and has been on that track ever since. (It is currently about 60% of GDP.) Because the federal government has never defaulted on its debts, it gets great rates... until there just isn't enough capital worldwide left to borrow. Then the government has to agree to pay a higher interest rate to attract new capital.

- The large "baby boom" generation is just moving into retirement. We will eventually get to the point that there will be about 1.5 workers for every social security recipient. When social security first started the ratio was about 30 to 1. Moreover, the baby boomers aren't really a healthy generation. The cost of Medicare for them will exceed that, per person, than it did for prior generations.

- The U.S. wasn't fighting two wars in 1929.

So with that said,, let us recall what Yogi Berra said. "Making predictions is hard, especially about the future." You just can't ever tell how things will shake out, so here are some suggestions to consider for the coming year(s). Not all of these will apply to everyone, of course.

- Let's all liquidate our assets, buy a big boat, and sail the high seas (that's just a test to see if you are still with me).

- Look at your budgets and see where you are playing the worst "defense" with your money.

- If you are looking at a vehicle purchase, see if you can't make your current car last a couple of more years.

- Regarding large purchases in general, consider whether the thing you buy will go up or down in price. (Hint: there aren't many things that go up.)

- If you are carrying comp and collision on your cars, check out the blue book value (kbb.com) and compare that to your deductible. If they are close, drop down to liability coverage only.

- If your mortgage isn't a fixed rate, look at refinancing. If inflation kicks in like it might and you are paying a variable rate, you will be hurtin' for certain.

- As an experiment, you might try calculating the cost of meals and avoiding those that cost the most. (This isn't to say to go hungry or forego nutrition, just be aware.)

- If you have the space, try planting a small garden. I am no gardener, but I do plan on planting something this year. Fruits and vegetables have gone up in price more than most items over the last few years.

- Look at your energy consumption. If it is high, see if the cost of making your house more energy efficient will pay for itself in a year or two of reduced energy bills.

Yeah. Aside from those things, recognize that the Great Depression was a time where the country reinvented itself. New music and art styles came about during that time, Communities grew closer as people depended on one another, and the refiner's fire of that time produced what we call today "the Greatest Generation."

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