Tuesday, September 29, 2009

What Causes a Depression?

…how does it all work? We’re doing some serious thinking this week. What is it that actually causes a depression? A stock market collapse? Or too much debt? How come government can appear to cure the problem sometimes – 2001-2007 – but not other times? How come the Japanese were not able to increase consumer prices? Even now…Japan’s inflation rate is negative. And why is it, despite the most massive effort at monetary inflation ever undertaken, the US bond market still forecasts an inflation rate of less than 2%?...

A friend made the mistake of asking us what to expect from the economy. We said it would go do down.

“You mean, you expect a W-shaped recovery,” he said… “A double-dip recession?”

“No…we expect no recovery at all. It’s a ‘W’ without the last stroke…”

Of course, we were exaggerating. But not much. We do not think that the economy of the Bubble Era can ever be revived. It will never recover…because it is dead....

“But when will it come to an end?” you ask.

“When it is over.”

A depression ends when it has done its work. It must correct mistakes. It must punish errors. It must destroy the bubble economy…and the mindset of the Bubble Era. Only then can new real, sustainable growth begin again...

Here’s how it works. The Fed lends the bankers money. Then, the bankers turn around and lend it back to the feds. The banks are happy; they’re making money on a risk-free trade. The regulators are happy; what could be safer in a bank’s vault than US Treasury bonds? Investors are happy; it looks like the financial sector is making money again. And the feds are happy; they’re able to finance their deficits.

Who’s not happy? So far, so good. But hold on…

“This is not a sustainable recovery,” says fund manager Crispin Odey in The Financial Times.

read the entire essay

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