How deep can this recession get? How do we escape from it? by John Silveira

I crossed the parking lot of Backwoods Home Magazine, but as I walked past a van parked there, I paused to look back at it and tried to think of why it seemed familiar. A glance at the plates — California — and I realized the vehicle belonged to Dave's poker-playing friend, O.E. MacDougal. He was probably here in Oregon again to fish the Rogue River.

I stepped into the office and followed the voices until I found the magazine's publisher, Dave Duffy, in the office's kitchen. Seated at the table with him was Mac. They were both finishing their lunches. Each, in turn, greeted me.

Mac was about to take the last bite of his sandwich when Dave asked, "We've got a recession going on, high unemployment, a housing market crash...you know the story...my question is, where do you think the economy's going and what's going to happen to us along the way?"

I wanted him to explain what that meant, but Mac had already put his sandwich down and started answering Dave's question, "There's no simple answer. No one really knows with certainty what direction this recession is going to take. There are so many variables, the best anyone can do is look at the data — unemployment, currency stability, trade, government policy, consumer spending, taxes, deficit spending along the national debt, and anything else he may think is pertinent — and try to see what happened when we had similar conditions in the past and what happened then. But even then, there's no prescribed formula that accurately predicts what's going to happen next, so whatever happened before may not happen now. Having said that, right now, the experts are saying the chances of this being a double-dip recession run anywhere from 15% to more than 50%."

I was surprised. "That's the best they can do? Attach probabilities to it?" I asked.

"Economics isn't an exact science. No one really knows where the economy is going," he said.

"But," he quickly added, "we all know what's taking us there: the stuff I just mentioned and, unlike earlier recessions and depressions, you can add in the bailouts of both Wall Street and some corporations to the mix."

"Dave asked about a 'double-dip' recession. I never heard that term before. Are there different kinds of recessions?" I asked.

"Not all recessions look the same," he replied. "There are three potential scenarios. The first is that this particular recession and its recovery are going to resemble a V, that is, the decline we're currently in will be followed by a sharp rise toward recovery. That," he said in a parenthetical sort of way, "is what I think we'd all like to see."

"The second kind economists are talking about is a U-shaped recession — a decline followed by a long, sluggish bottoming out before we see another recovery.

"The third is a W-shaped recession. Imagine the letter W," he said looking at me and I realized I was about to find out what a double-dip recession is. "There would be a decline, followed by what appears to be a recovery, which is followed by another decline before we see the final recovery. That would be a double-dip recession, and that's what I expect we'll see."

Dave said, "I've heard some economists say this isn't a recession, that we're actually in a depression. Is that true?" Then he quickly added, "Sometimes I think the politicians just don't want to use the 'D-word,' other times I think most of them are too dumb to know, anyway."

"Well, what exactly is the difference between a recession and a depression?" I asked.

"There's actually no standard definition of either. They're a matter of degree. There's an old joke that goes, 'When my neighbor loses his job, it's a recession; when I lose my job, it's a depression.' But ask 10 different economists when a recession should be called a depression, and you're likely to get 10 different answers. That being said, if it's a slight economic downturn, you're safe to use the word 'recession,' and in a very bad downturn to use the word 'depression.' The debate is where you want to draw the line between the two. But, let's for now call what we're in a recession."

I interrupted, "Before we get into what kind it is, what gets us into recessions and depressions...or, better yet, what got us into this one?"

Mac turned to me. "Every economic downturn, whether it's called a recession or a depression, is brought on by a combination of factors. But ultimately, they all result in a drop in consumer spending which leads to a decline in business sales which leads to layoffs — read that as unemployment — and a decline in consumer confidence which leads to even less spending. Housing sales including 'new-home starts' fall off and fewer large ticket items, often called durable or hard goods, such as cars, washing machines, and refrigerators are sold. All this reduced demand leads to more unemployment. There's also an increase in bankruptcies, business closures, less investment by companies in expansion, and fewer new business starts."

"Which means jobs that would have been created, aren't," Dave said, as if completing Mac's thought.

"You get it. Also, the stock market falls. This isn't so much a cause of a recession as an effect, but as companies become less profitable, the values of their stocks fall and that is going to contribute to delaying recovery."

"Keep in mind the stock market represents a significant portion of some people's savings as well as many retirement plans. This means that, when the markets are down, people are going to be reluctant to spend from their savings. But another factor is that with a decrease in stock values, companies are less apt to invest money in expansion, expansion that could mean new jobs. A lagging stock market also means there will be less investment capital for new start-up companies that want to raise funds with IPOs — that's Initial Public Offerings — again meaning the new jobs these new companies bring will not be appearing.

"These are some of the factors which brought us to this recession. However, while a drop in housing sales is typically the result of a recession, in this case, when the housing bubble burst, it was another driver."

"While housing prices were high, people were cashing in on their equity and spending it. Other people were simply buying new homes, hoping to get on the bandwagon, not wanting to miss out on the ride they thought would go on forever. But the housing bubble was like the dot-com bubble of a few years earlier. People began to believe it couldn't end, but as we all know it inevitably did. When the housing market crashed, refinancing became almost impossible, the spending stopped, and millions discovered they suddenly owed more on their houses than they're worth. All of this, of course, resulted in less consumer spending, more bankruptcies, as well as a stagnant housing market."

"You're saying the housing bubble burst became one of the factors causing the recession rather than an effect of it," Dave said.

"Yes. Also," he continued, "you should realize that a recession that begins in this country doesn't stay in this country. Because we are the world's largest economy, when we experience a recession, the rest of the world feels its impact. When we import less, it causes unemployment in other countries. This means our economic woes become the economic woes of the world."

"And they in turn buy less from us which results in even more lost jobs in this country," Dave said.

"That's right," Mac said. "Recessions and depressions also cause an increase in the federal budget deficit, that is, the shortfall between what the federal government spends and the taxes it takes in, and that affects recovery."

"In bad economic times, voices to increase government spending grow louder. We've already seen the bailouts. The federal government is becoming the last resort for everyone. So, in 2011, government spending is expected to increase to record levels as the current Administration tries to spend its way out of the recession/depression. But, because businesses are faltering and millions are unemployed, tax receipts from both corporations and individuals are going to be less, so the budget deficit will climb to even higher levels."

"But why are the budget deficit and the national debt so important in a recession?" I asked.

"In part because the government's tax receipts fall. But it also means the government enters the financial markets to borrow money to make up for its shortfall. This demand for money sends interest rates higher. Higher interest rates make borrowing money more expensive for everyone, including businesses, meaning it costs more to expand or create new jobs."

Mac responded. "But the problem is that taxes take money out of the pockets of consumers, and we need consumer spending to lift us out of this mess, and it also takes it away from businesses, and they not only spend it on goods, they need it to create new jobs."

"In some ways, it is, and taxes are another thing that figure into why this is likely to be a double-dip recession. A lot of tax cuts are due to expire at the end of this year. Because of anticipated tax increases, all due to begin after the New Year, businesses, along with those who are wealthy, are shifting whatever they can that's taxable into 2010 to avoid receiving it in 2011 and having to relinquish more money to Uncle Sam.

"Because of that the government is going to have to borrow more, sending the national debt to greater heights."

"But doesn't the money the government raises from taxes, then spends, constitute spending?" I asked. "Isn't that what the stimulus package is all about? It would seem consumer spending and government spending are the same."

"The government doesn't spend money the same way consumers do," Mac said. "It doesn't spend money efficiently. The simplest way to think about it is that government spending is often directed at an already bloated bureaucracy or pet causes such as green programs, and they consume wealth, but they produce nothing. On the other hand, tax cuts leave money with businesses, and they're not going to hire you unless you produce something. In other words, unless you contribute to the economy. That's how the wealth we need to prosper comes about.

"A specific example is the stimulus package initiated a few years ago. It didn't bring the hoped-for recovery because it was spent mainly on government projects. In spite of this, government is planning yet another stimulus package, this one totaling $50 billion.

"What President Obama is apparently trying to do is follow Franklin Roosevelt's blueprint, trying to buy his way out of bad economic times with government spending and, eventually, inflation. During the Great Depression there were programs to pave roads, build bridges, create parks, plant trees, and more. Yet, the Great Depression dragged on and, in his 12 years as President, Roosevelt never saw a day with a good economy. Many economists say his government spending programs were the reason the Depression deepened in 1937-38. It was a depression within a depression the same way many economists are predicting today we're going to have a recession within a recession.

"Don't get me wrong, we need roads and bridges, and it's nice to have parks, but it's not the kind of spending that creates wealth that creates the kinds of jobs that reignites the economy. The problem is that government spending didn't work as hoped in the 1930s, and I don't think it will now."

"There are economists who think the man he should be looking to is former President John Kennedy, who also inherited a bad economy. Though most of Kennedy's advisers warned him not to do it, he believed that, instead of creating public works programs, it was better to cut taxes to allow private businesses to help grow the economy, and that the government itself would also benefit because greater corporate and individual incomes would lead to greater tax revenues. Though he didn't live long enough to see the results of his programs, we now know he was right. Both the economy improved and government receipts increased."

"So, increased taxes, along with the competition created when the government gets into the borrowing market, are what you think will cause the double-dip in 2011 and beyond," Dave said.

"What about inflation and deflation? Isn't there a bunch of economists saying that because of current monetary policies we're headed for inflation while there are others who are saying we're headed for deflation?" Dave asked.

Mac thought a moment. "If there's inflation," he began, "especially hyperinflation, the last thing you're going to want is cash because it's going to become worth less every day and your money will buy you less and less as prices rise.

"On the other hand, if we enter a period of deflation, first, money will be golden. As the money supply shrinks, the money that's out there will become more valuable as prices on goods drop."

"No one knows, but given that the prices of gold and silver keep rising, I'd say the markets are betting on inflation, even if we first have a period of deflation, I think inflation is inevitable in the long run."

"Fear of inflation is the reason the prices of gold and silver are going through the ceiling," he said. "Their current prices reflect how little money people think our money is going to be worth in the near future.

"Also, governments actually like inflation. It allows them to create money and spend it, now, while it's worth more, but its inflationary impact isn't felt until later. It also allows the government to borrow dollars now and pay them back with cheaper dollars, later.

"The history of this country, since the founding of the Federal Reserve in 1913, is that we've had 'manufactured' inflation. Today, the dollar has the purchasing power that four cents had almost a century ago. Bet on it! I think there's a real chance that those in government are counting on inflation to bail them out on Social Security as well as the insane deficits they've created.

"But keep in mind, inflation doesn't hurt everybody," Mac said. "Some people benefit from it. Try to make yourself one of them."

"I'll just give a few examples. In an inflationary period, as money becomes worth less and less, people on fixed incomes, such as many retirees, are hurt because prices go up while their incomes don't. Debtors, on the other hand, have an easier time paying off what they owe. Lenders don't like inflation unless it's predictable, then they can loan money with relatively precious dollars, today, knowing that though they'll get paid back with cheaper dollars in the future, they can compensate for it by setting interests rates that take that into account.

"From a taxpayer's point of view, inflation is bad because the government — read that as the IRS — doesn't index taxes to inflation. So, as inflation increases, your income will increase, but you won't see an increase in purchasing power. However, you will find yourself moving into a higher tax bracket, thereby paying proportionally more of your income to the taxman. So, wage earners may see an increase in absolute dollars, but a decrease in purchasing power."

"You're saying being in debt may not be so bad if you can count on paying your debts off with inflated dollars," Dave said.

Then Dave said, "I guess the flip side would be that if we go into a period of sharp deflation, it's going to be harder to pay loans off because money will be worth more and, because of that, wages will fall so borrowers will be unhappy, but the banks will love it."

"That's exactly what happened in the late 19th century," Mac said. "This country went through a deflationary period. An example of the kind of people who were hurt were farmers. They had borrowed from banks but, as deflation set in, money became more valuable. Therefore, prices dropped. In other words, it took less money to buy a bushel of wheat or a side of beef. So, the farmers got paid less, but their loans remained the same. Many, although still busy and productive, lost their farms because they couldn't make enough to pay the banks. It was one of the reasons William Jennings Bryan struck a chord with the electorate. We were on the Gold Standard and he wanted to tie money to silver, too, the idea being that if we expanded the money supply it would ease the burden on debtors."

"This is getting complicated," I said. "I feel like my head is going to explode."

"What should someone, say our readers, do to prepare for whichever comes?" Dave asked.

"If you're expecting inflation, this is the time to borrow. But take the money and buy hard assets such as real estate, barter items, precious metals. Hard assets are a great investment if you can count on inflation. Most people count on inflation to help them when they buy a house. But even a $30 box of ammunition is a good investment if a year from now you can sell it to someone for $40 and use the money to buy other things that have gone up in price. For the same reason, expecting inflation is a great reason to buy junk silver coins and gold. If we really do have inflation, the prices of both gold and silver are going to continue to reach historic highs."

"The converse," Dave said, "must be that if you're expecting deflation, you want to remain liquid. In fact, if you hold junk silver coins, like John has, sell them now because you can buy them back, later, at a cheaper price, and have money left over. You also want to pay off your debts, now, otherwise, you're going to be paying them off with dearer dollars, but if we have long-term deflation it would work against buying a house."

"You've caught on," Mac responded. "If you expect deflation, investing in hard assets is a mistake, you're smarter to hold onto your cash.

"There's no way the government and Federal Reserve can create money the way they did for the bailouts and the stimulus package, and now possibly another one, without it eventually leading to inflation. More importantly, as I said, the money markets think it's coming. That's why the price of gold and silver are going up. The spot prices for those two metals reflects what the markets think is happening to the dollar. I'd listen to them."

With that, Mac finally took the last bite of his sandwich. He was tired of talking about economics, so we started to talk about fishing the Rogue River.

How deep canthis recession get?How do weescape from it?

By John Silveira

How deep can
this recession get?
How do we
escape from it?