Jun 012010
 

#660000;">I have to say that I am very worried about this happening. I am to the point of considering stockpiling non-perishable food items and such. I worry about the economy without knowing too much about it. In my mind though, it’s the same concept as my checkbook…just on a much grander scale.

#660000;">And why do we continue to send money to other countries when we have none to send? Why are we not taking care of our own people, communities, and institutions? These things make no sense to me. Where is all the money? Who has it hoarded up in the baseboards and vaults across America? I’m rambling about things I know little of, but I’m trying to make some sense of it all for myself….

Are we headed into a depression? – Investment News

#3333ff;">Despite massive funds from the government, the economy is getting worse instead of better

March 15, 2009 6:01 am ET

Are we headed for a depression? It seems possible. A depression lasts longer and cuts deeper than a recession, and it occurs when the economy fails to respond to aggressive monetary stimuli. That’s happening now.

The Fed has unleashed its entire arsenal, including pushing short-term interest rates to nearly zero. In addition, it has pumped almost $3 trillion into the financial system (some of that includes loan guarantees). Yet the economy is getting worse.

Here are some signs of an economy in depression:

Debt liquidation.

A credit contraction is a key ingredient of a deflationary depression.

Due to the monumental debt burden and speculative excesses that were part of the manic phase of the recent economic cycle, we believe that the debt liquidation and credit contraction now under way will continue for some time.

To be sure, debt liquidation is a key ingredient of a depression. For example, a bank refuses to renew a loan, which forces the sale of an encumbered asset. This lowers the value of assets held by others, which forces other banks to call in their loans. This creates a vicious downward cycle that depresses the economy.

Another deflation-depression component is a free fall of prices. Today, the storefronts of many retailers are covered with signs proclaiming huge sales. Home prices are falling, and most commodity prices have dropped.

On the bright side, price declines seem to be bottoming out. Nevertheless, collapsing prices are evidence of sinking demand and excess inventory. The slumping prices of collateral that supports most debt bring forth margin calls, which can further depress prices.

Falling prices also have a powerful psychological affect by delaying purchases. Even consumers who can afford to buy hold off because they come to believe that the same goods and services will be available tomorrow at lower prices.

Falling money velocity. Another ingredient of deflation or depression is a sharp decline in the velocity of money.

A decline in velocity, or the frequency with which dollars are spent, results from a decline in consumer spending and bank lending.

Declining loan volume translates into less business and personal spending.

While the Federal Reserve may continue to increase the money supply, a decline in velocity means the additional money doesn’t do its intended job of reviving economic activity. It’s like gunning an engine while keeping the transmission in neutral.

Banks refuse to lend. Currently, the Fed has been lending massive funds to banks, which have simply deposited most of that money back at the Fed. The funds are not helping the economy grow. The Fed can boost reserves in the system, but it cannot force banks to lend.

The problem is that banks lent too much and too aggressively in the prior years, and they are now saddled with toxic loans. Therefore, they are more concerned with rebuilding their balance sheet strength, not boosting asset holdings with more bad loans.

Moreover, money contraction is taking place around the globe. Central banks are creating money, but velocity is lower, causing economies worldwide to slump.

A sharp decline in consumer spending. Another factor in deflation and depression is a significant reduction in consumer spending, which in the United States accounts for nearly 70% of gross domestic product.

In late 2006, we forecasted the implosion of consumer spending when shares of J.C. Penney Co. Inc. of Plano, Texas — our proxy for retail stocks — took a tumble. It was a sign that consumer spending and the economy were going to slow down.

The downturn in consumer spending, which began in August, is falling at a dramatic, and almost unprecedented, annual rate. It is occurring across the board, with the more affluent, who ac-count for approximately 40% of consumer spending, in full retreat.

Instead of spending, Americans boosted their savings rate in the last quarter to 2.9% of after-tax income, up from 1.2% in the third quarter.

The irony is that “spending less, saving more” is good for the individual but horrible for the economy, especially when everyone is doing it.

Taken as a whole, these signs point to continued recession at best and maybe worse.

Ronald Sadoff is the founder and an investment adviser at Sadoff Investment Management LLC in Milwaukee.

  •  June 1, 2010
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