Looks like we are heading for Depression

After reading this article,

http://market-ticker.denninger.net/archives/775-Its-A-D,-Not-An-R-Folks.html

it's clear that we are heading into a Depression. There isn't just a supply/demand issue, there are structural issues with today's economy, in the US and the world.

It's a very deep hole we are in and the current solution by the Federal Government is to dig faster. The stimulus package is not - it will be good for growing government but won't do much for the economy.

What's a definition of insanity? Keep doing the same thing over and over and expect a different result. That seems to be what the Federal Government is doing.

The government is not going to be able to print enough money to cover the destruction of fantasy wealth that has been created over the past 20 years. There will be many trillions worldwide (my guess is $50 trillion) that will need to be washed out of the global economy before the world can begin healing again. My guess is that it will take a decade to do so, and we will move farther to the Left and become much more socialistic as well.

When people choose security over freedom the government will easily centralize and expand their power. And this will happen with governments around the world.

Interesting times.

Depressions are a different animal. They come about because of structural problems in the economy, and are always credit-driven.

Credit began as a way for goods producers to get paid for things they needed to make the goods before the goods were made. That sounds circular, and it is. That is, the farmer who has land requires seed, fertilizer, water, sun and labor to produce wheat. Some of those things (labor) he can personally produce in limited quantities, but the rest are either things he must buy or are outside his control (the sun and of course weather - that is, rain.) It is the same for the builder of a television set - he requires plastic, electronic components, electricity to operate his machinery and people to assemble the sets, all of which he must pay for. The farmer with apples to sell must have a way to get them to the store, and he must pay the truck driver to get them there.

Trade credit evolved as a way to provide this short-term financing necessary to take raw materials and turn them into finished goods, or to get finished goods from one place to another. It is referred to as 'self-liquidating' because when the goods are made and sold forward the credit (debt) is retired as a consequence of the sale.

It didn't take long before people realized that credit could be used to finance consumption too. That is, your desire to own a car can be realized through the provision of credit. But this credit doesn't self-liquidate; the car is consumed as you drive it, and when you're done with the car its value is greatly diminished instead of remaining constant or being enhanced. This sort of credit effectively "pulls forward" demand - that is, it allows one to play "Wimpy" and have a hamburger today for which one will pay next Tuesday.

When this sort of financing becomes embedded in an economy there is a very real risk that it will expand almost without limit, based only on the optimism of the people involved. This in turn will create distortions in supply that are irrational and cannot be "worked off" with short layoffs and labor cutbacks.

Automobile demand is a good example. The last few years we've built 14 million cars a year. But our inherent demand to replace destroyed cars (rusted away, crashed, etc) is only 11 million or so. The other three million were "pulled forward" with creative financing - for a while.

We employed hundreds of thousands of people building cars that cannot be sold on a permanent basis. That's a problem.

These distortions cannot happen without active government involvement. Without allowing willfully false statements on 1003s (mortgage documents) you cannot grant $500,000 loans to people who make $8/hour. It simply can't happen, because the inherent risk of default on those loans is so high that absent fraud nobody in their right mind will fund those loans and honest regulators will step in and stop the stupidity before it can get out of hand.

But when these distortions become embedded in the economy as a consequence of government mismanagement, willful blindness and even active complicity in the frauds then you've got a major problem because now laying people off for a few weeks or months won't solve anything. The excess capacity that gets built into the economy is too great and creative destruction has to take place - that is, we must actively destroy that excess capacity to get out of the mess. Worse, since "pull forward" financing has taken place we've got an even bigger problem - the companies that overbuilt wind up bankrupt as they can't service their debt, and the bankers who wrote that credit go under as well.

Thus we need some sort of "systemic reset" to get out of it, lest the spiral become embedded - and the economy experience a Depression.