Here’s Why The Next Recession Will Spiral Into A Depression

Friday, October 12, 2018
By Paul Martin

by Charles Hugh Smith via OfTwoMinds blog,
Fri, 10/12/2018

Here’s the difference between a recession and a depression: you can’t get blood from a stone, or make an insolvent entity solvent with more debt.

There are two basic differences between a recession and a depression:

1. Duration: a recession typically lasts between 6 and 18 months, while a depression drags on for years or even decades, often masked by official propaganda as “slow growth” or “stagnation.”

2. The basic dynamic: recessions are business / credit cycle events that wring out the excesses of credit expansion (i.e. lending to unqualified borrowers who subsequently default) and mal-investment in low-yield, high-risk speculations and projects that only made financial sense in the euphoria of bubble psychology (i.e. animal spirits acting as if bubbles never pop).

Recessions are brief because the basic dynamic is to write down defaults, tighten up credit and absorb the losses from failed speculations. As consumers and enterprises cut back borrowing, they trim spending, leading to lay-offs, reduced tax revenues, contraction of credit and all the other consequences of wringing excesses out of the economy.

But once the losses have been absorbed and insolvent households and enterprises have worked through bankruptcy, then the decks are cleared for a renewed credit / business cycle expansion.

Depressions, on the other hand, are generated by self-reinforcing feedback loops: insolvencies beget more insolvencies, reduced prices for assets beget lower prices for assets, and so on.

There are two critical differences between the two dynamics: high fixed costs and dependence on credit / asset bubbles for “growth.” Recessions clear excesses in otherwise healthy economies with low fixed costs, rising productivity, broadly distributed gains in earned income, safe yields on capital set aside for savings and retirement and high returns on productive investments. Growth is the result of rising productivity of labor and capital.

Depressions are the result of the opposite set of dynamics: growth is the result of a vast expansion of credit that drives mal-investment and risk-laden speculation. Productivity stagnates as capital flows to speculative gambles (“sure things” in a bubble euphoria) and expansions of capacity that far outstrip demand.

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