The Return of the Great Depression 2.0 ?

** The post is scheduled for a significant revision shortly. Kindly check shortly for a revised version. 

This forecast is made using a groundbreaking tool “Hyperforecasting” which utilizes the power of our intuitive spectrum, unconscious decision making, judgement and assertion which work in concert with each other to improve the accuracy and timeliness of the forecasts. For the record, 8 out of 10 our hyperforecasts have been accurate on the timing and accuracy scale and so far, we have not been wrong in all of our 10 forecasts. 

I am not an economics expert and have spent more time studying forecasting and predictive behaviour than studying other vertical domain. As per Seer Sucker theory, experts (hedgehogs) make poor predictive forecasts and foxes do much better by scavenging pieces of information into an aggregate model. In hyperforecasting, we start with aggregation of existing research, move in a cyclical process from thesis to antithesis till the mental frames start stabilizing. We actively search for anomaly insights, actively correct cognitive biases and keep fine tuning the aggregated and synthesized forecast till we get a “Rock Solid Inner Knowing (RSIK).” Another couple of cycles of stress testing and we are ready to make an assertion. Hyperforecasters are humans and are prone to error, so, we offset the error by outlining our path to our forecasts and assertions. This helps the intended audience to draw their own conclusions from the data points. We have empirically learnt during our hyperforecasting journey that advanced beginners are nearest neighbors in prediction accuracy to intuitive experts. Everyone else on the spectrum from novice, advanced beginners, competent, proficient and intuitive experts have poor accuracy rate. 

It may seem like we are peddling a gloom and doom scenario, but note that recessions and depressions are big opportunities for all. Some of the very large and well known companies today were born during the great depression cycle. Your glass may seem half full versus half empty basis your perspective on life. This essay may sound like a long diatribe against the present day economists and policy makers, but, it does not reduce the severity of the predicted problems. To simply this essay, I intend to write a shorter summary, but, if there are key points that you can take away from this essay, here they are :

a) The cure for unpayable debt in current day economics is hyperinflation. Hyperinflation resets the debt cycles.

b) Every dollar spent is not equal. On a spectrum of investment rate of return (both tangible and untangible), we are specifically discussing malinvestment.

c) Every dollar earned is not equal.

d) Dollars earned from malinvested dollars and malinvested themselves lead to chronic economic problems.

e) We have become addicted to consumption. We consume and consume and consumer without any thought.

f) Every economic recession or depression increases the gap between have nots and haves. Do not take the bait, if possible.

It will help if you read this quick read about Brittle Failure (new link opens) as Global Depressions are a result of brittle failure in the interconnected economic system. When Brittle Failure occurs, catastrophic failure comes without any warning. 

Are we headed into a dark depression cycle? 

Ask anyone on the street , an economist modeling advanced macro-economic inputs, or someone gainfully employed and they will scoff at this possibility. Economic recessions and depressions start suddenly and shock a large majority of populace. The shock is proportional to an individual belief/group’s lack of holistic understanding of the global economy versus the unfolding dangers on the horizon. As we will discuss later in this essay, very few people (less than 0.2%) accurately sensed the previous recessions and depressions before they occurred. No one listened to them and many went around stifling their world view. If you are reading this post, you may fall into any category of the two, but, I recommended you read this with an open mind, make your own opinion and call me out if I turn out to be wrong eventually.

My premise is that the world is heading into another global depression (with a “D”) due to the interventionist policies of the government, sustained low-interest rates, lack of productive investments, resultant malinvestments, large government spend burden, and historic business/individual debt levels. If you look carefully, we have very strong indicators that a major depressive economic cycle is making its way to the bottom. Retailers are going bankrupt at an unprecedented rate, weak oil demand continues to rock the commodities market, tech layoffs are surging , most of the startups and even some big tech companies remain unprofitable, increased inventory of used cars due to the ride sharing and increasing global unemployment is putting pressure on auto manufacturers. The global housing markets from Canada to Australia are on the edge and the world is awash in unprecedented public and private debt. The governments have used fiscal and monetary policy to create an illusion of growth, but, in the hidden crevices of the balance sheet are massive portions of unsustainable debt. Unsustainable debt becomes unpayable debt and hyperinflation is the cure that fixes the disease, albeit with a lot of pain.

At the outset, for the benefit of all, let us refresh our understanding of the types of economic theories and their philosophy of economic cycles. There are four major economic philosophies or schools of thought, namely Keynesian Economics, Austrian Economics and Monetarist Economics.

  • Marxist Economics – Marxist Economics is named about Karl Max, the Prussian born Philosopher. This theory proposes that productive labour plays a crucial role in the economic growth. They also propose that the cost of goods and service should be proportional to the average number of wage hours spent to create them. In this theory, value of a product or service was measured by labour costs. He was a staunch critic of classical free market economy where capitalists could pay low wages to laborers, keep higher profits, but, still sell higher priced products. He was all for intervention rather a full scale government intervention in markets. Karl Max also wrote the “Exploitation Theory of Capitalism”.
  • Keynesian Economics emerged as a powerful economic theory when classical economics was unable to pull the world out of high unemployment. As per the classical economists, the economy is a self-correcting mechanism which would in time offset unemployment/poverty and create emergent shifts towards prosperity and full employment. Keynes, the grandfather of Keynesian approach, argued that the lack of household savings remain as the main cause of proportionally low investments in the larger industry. He emphasized that for various reasons, if household spending continues to remain depressed, it eventually lead to recessions or depressions. The key leverage area for Keynesians is spending and they believe that if spending is increased, it spurs spending in related, peripheral and downstream industries. On this basis, Keynes became a proponent of government intervention where the government must increase its spend to kick-start the economy. Keynesians believe in taking the economy into the ICU (Intensive Care Unit), carry out  an emergency surgical operation to revive the economy. This group believes that business cycles are natural, but Keynesian approach can intervene and smoothen out the curves. As such Keynesians are interventionists.
  • Austrian economics: This theory has a view that business cycles are an inevitable consequence of banks offering increased credits, amplified by ineffective central bank policies (e.g., low-interest rates, quantitative easing, etc.). Austrians believe that the extended and readily available liquidity eventually causes malinvestments, creates asset bubbles and results in a drop in individual savings. The resultant effect of government intervention creates short term economic growth. However, in the long run, malinvestments and the asset bubble bursts will create a detrimental impact proportional to the degree of intervention. Austrian economists also argue that a recession is a natural part of the business cycle to correct any malinvestments and creation of inflated wages. They  are of a strong view that government intervention sets off distortions in the market which leads to false signals being sent to investors and eventually leads to irrational exuberance. Austrian Economics are akin to the tough parents, who claim that sometimes, wounds will automatically heal on its own making the children psychologically strong.
  • Monetarist economics: Monetarists propose that a view that inflation is a direct result of liquidity in the system and the inflation is proportional to the amount of money printed by the government. Monetarist Theory originated in the 1950’s and 1960’s by Milton Friedman. They propose that money supply should be fairly kept steady, increasing it marginally every year to allow for the natural economic growth. Monetarists emphasize that If the money supply is too high, the inflation rate will increase and if it spirals off, then it leads to recessions/depression. Monetarists blamed the 1930’s Great Depression in the 1930’s on the fact that money supply was reduced in the economy rather than increasing it. Monetarists believe in controlling the flow of liquidity as they believe it is the root cause of inflation/deflation onset. Monetarists, like Keynesians are interventions, they both believe in creating interventions to resolve the abnormal economic cycles. Monetarists, however believe that any attempts to manage demand leads to inflation and hence focus should be on liquidity.

It is easy to see that Keynesians and Monetarists are similar in their approach and philosophy about economic cycles. They believe that intervention using demand improvement or liquidity controls can spur economic growth. They both believe that the various forces in economics can be understood using economic models and that people more or less behave rationally and linearly in the world. Most of the economists today are a mix of Keynesian and Monetarists. Ask an economist or fiscal policy maker on the leverage areas which can spur economic growth and you can easily identify the school of thought. Marxist Economists is more of less dead and Austrian Economics is still existing, however is not mainstream economic theory. I have studied all slant of economics and strongly believe that Austrians have got it right, but their opinions have been stifled. As we will discuss below, it is not surprising that renowned economists were unable to predict the previous recessions and depressions accurately. The largest number of accurate forecasts came from Austrian Economists. I will also offer my commentary on why Austrians have been right towards the end of this essay.

The government can intervene in the markets and economy using many methods, however, there are two major actions available at it’s disposal. They are the “Fiscal Policy” and the “Monetary Policy“. Monetary Policy is the management of interest rates and the total liquidity in the market by central banks such as Federal Reserve and the Bank of Canada. Fiscal Policy controls the tax rate and the spending actions of the government. Both the policies are interconnected as changes to one can influence changes in other policies. As such, a fine balance has to be maintained between the two.Let us now discuss few key economic events in the history of world.

Key Economic Events 

In predictive forecasts, we must always evaluate any lessons learnt from past events as we have recently done in “Will Saudi Riyal Dollar Peg be Abandoned” and then synthesize new information to arrive at assertive judgements. Rare events either lack past precedence or are  Black Swan (low probability, high impact events). To get an understanding of the wide range of possibilities, it is imperative to examine the previous economic events as well as the recessions and depressions cycles. We will start with previous economic events namely the Weimar Crisis, The Dot-Com Bubble Burst and the Housing Crash.

Weimar Germany Economic Crisis

Weimar Germany after World War I is probably the biggest hyperinflation event in the world. The period between June, 1921 and Jan, 1924 was considered a period of hyperinflation in Germany.It all started when Germany financed it’s World War efforts with out sized budget deficits. The “Gold Standard” of currency was thrown into the dustbin and a “Fiat Currency” was established, leading Germans to keep on printing money to meet its needs.

Germans lost the war, price of essential products and services, specifically food increased by around 20 times, while Germany struggled to make reparation payments. During this crisis, the government’s deficit spending followed by interventionist itch led to worlds most dramatic hyperinflation . It led to the collapse of the money power and severe hardships for the Germans.  Inspite of warnings from German economists notably Hjalmar Schacht, that such a move will lead to currency devaluation, the government continued with it’s historic mistake.

The currency known as German Papiermark those days, kept on falling and the government kept on printing more of it to make reparation payments. This event also led to the rise of Anti-Semitism in Germany and the eventual rise of Hitler. A key lesson here is that injection of liquidity into the system by the government caused inflation to spiral which eventually went out of control. Once can read more about this event in this slideshow or for an in-depth study of the political and economic event, I have provided a reading recommendation below.

The Dot-Com Bubble Burst

The Dot-Com Bubble Burst started in April 1997 and ended in June 2003. The government intervention itch again was the root cause of the Dot-Com bubble burst. Policy changes by the government to the Taxpayer Relief Act of 1997 led to capital gains being taxed a lower rate than dividends from 29% to 20%.

A paper by Zhonglan Dai, Douglas A. Shackelford and Harold H. Zhang titled Capital Gains Taxes and Stock Return Volatility: Evidence from the Taxpayer Relief Act of 1997”  pinned the stock market frenzy on this distortion in the market. An Act of Congress had changed the Capital Gains tax rate without changing the Dividend Tax Rate. Investors flocked to high growth tech companies, and the authors of the above paper concluded that while it increased returns for the investors, it led to formation of a bubble.

The government intervention led to an investor frenzy and malinvestment where stupid money combined with greedy minds pumped in a disproportionate amount of money into the tech frenzy. Tinkering with the fiscal regulations led to a distortion in the market.

It signaled to investors that I.P.O exits are the fastest way to make a quick buck. As we can note here, changes in fiscal and economic policy can lead to distortion in signals to the investors, which can have unintended consequences. One can read more in detail about this event in this article. Reading recommendation is offered below.

The Housing Crash

The next event that repeated the previous mistakes was the Housing Crash of 2000.Humans tend to become loss averse due to the “recency principle”. As per the “recency principle”, we have a short memory and tend to overweight the recent successes and failures into our decisions. If the market has been calm in the recent history, we predict that the market will remain calm in the near future. We build some continuity in out mind, which is simply waiting to be surprised by the discontinuity. It is no wonder that within seven years of the Dot-Com crash, the housing crash occurred.

In 2000, the dot-com burst destroyed 6.2 billion wealth over the next few years. In 2007, the housing crash happened destroyed another 6 trillion in wealth. As everyone knows, the housing crash led to the great Recession. After the dot-com bubble burst, the government was keen on kick-starting the economy and tinkered with the policies promoted the American housing dream by making regulatory changes to the mortgage rules. These changes eventually led to financial innovation by the banks who created speculative mortgage products such as interest adjustable loans, interest only loans and zero down loans. As these changes injected more liquidity in the markets, housing demand and speculation increased. The problem was further compounded by the Fraction Banking where every one dollar in deposit allowed banks to give ten dollars in loans. Soon enough, investors wanted more of the these gains and risk taking increased. Now banks and institutional investors started giving sub-prime loans to more risky clients.

Eventually, the risk threshold reached a point where something had to give. In 2006, when the sub-prime loans started to go into default, companies started with Freddie Mac pressed the panic button. Many of these banks had to be bailed out with $ 700 Billion government bailout. This is another example of how government intervention and thereafter lack of effective controls led to a global financial crash. You can read more about this here or see recommended reading below. Here is a link to well explained video on the Housing Crash.

As we can, direct or indirect government policies and intervention itches have led to spectacular crashes in the past. It makes one wonder, how will the era of low interests combined with free reign to banks change things this time around. In 2000, it was the Dot-Com frenzy, in 2007 it was the housing frenzy, in 2017, it is the Silicon Venture Unicorn frenzy. If we do recover from the Unicorn Frenzy, the next frenzy will be AI ventures based frenzy. It is my premise that the Tech Bubble of 2017 has already burst, but, it is less visible as private money is going bust versus public money. It is also my premise that we have already entered the beginning of a recession cycle, which will snowball into depression cycle and the Great Depression 2.0.

A Key Indicator of Recessions and Depressions 

We can analyse recessions or depressions through many variables, however, there are some fundamental variables and the intra-relationships that should be examined first. One of the key indicators of recessive or depressive cycles is the skewed relationship between Income, Consumption, Savings, Production and Debt. Increased Debt can provide an external propelling force to this cycle, however, extrinsic forces lead to asymmetries where savings and production reduce significantly, while consumption, mal-investment and asymmetric income increases. The rich become more rich while the poor go into a downward spiral.

On the other hand, intrinsic drivers i.e. production and savings will automatically seek the most diligent avenues for the money canceling/neutralizing any asymmetric  forces.

The death of the virtuous cycle is a true reflection that the false economic recovery is unsustainable.

What Causes Malinvestments 

Malinvestments can be caused due to a variety of reasons but we will discuss the core reasons for malinvestment here. At the heart of the malinvestments are poorly understood investors’ decisions process or human unconscious decision making (an area I have actively researched for two decades to improve my own poor decisions).Opportunity Recognition is a cognitive as well as intuitive pattern recognition process that is significantly influenced/impacted by our environment. As such, humans tend to get involved in group think or herd mentality when the negative or positive environmental cues are amplified. If one experiences a lot of people in their immediate surrounding generating significant margins in investments, a natural tendency is to indulge in what others are doing and follow the lead. Those who hold off following the environmental cues start experiencing “FOMO” (Fear of Missing Out) and get propelled into action at some stage. As discussed in this earlier hyperforecast “Tech Bubble Burst“, FOMO is what causes venture funds to keep injecting money into pre-IPO rounds as they feel they will miss out on the big party.

Fear is a very powerful human instinct and can lead to inhibitive action (when risks are perceived high) and propelling action (when gains are perceived high). Our research has indicated that when environmental cues are loud and amplified, a vast majority will follow the herd. A small minority who do not follow the crowd also known as contrarians can be segmented into individuals/groups who are passive (have little ambition) or those who are super diligent (contrarian thinkers who can see the pitfalls of following the herd in some situations). Malinvestments are primarily caused by a faulty human response to amplified environmental cues. When government intervention (aimed at increasing aggregate demand or liquidity in the market) creates a frenzy of financial activity, the intrinsic potential of the market and its conditions are inaccurately amplified thereby distorting “opportunity recognition faculty” in investors. As we will discuss in another upcoming piece on this blog, investor decisions are predominantly wrong and only a small group of outliers can actually optimize their decisions in normal contexts. Only a very small percentage of investors have the ability to take right decisions in distorted contexts.

There are other reasons for malinvestments i.e. “misallocation of resources“. Let us assume that you have 1000 Dollars to spend. You can spend it on either educating yourself and improving your skills or to buy a new TV. Money spent on consumerism and consumption creates a short term positive ripple effect. No doubt, the TV manufacturer, and the retailers will make more money if you buy the TV instead of getting an improved skill. However, the gains of the TV manufacturer or retailer will be short lived if income levels of consumers drop. On the other hand, investing in a skill will increase and improve your long-term employ-ability potential and will have a more sustained and elongated positive ripple effect on your earning potential. If done well, you may be able to buy a new TV every two years and even purchase a home theater and other products from the retailers. Basis this, all types of consumption do not create prosperity.

If you agree with this argument of mine, you may also see the point that Keynesians/Monetarist economists and politicians ( the majority of the world politicians, economists and policy makers are Keynesians and monetarists) do not clearly understand the concept of mis-allocation of resources and resultant malinvestments. In their mind, they have oversimplified the connection with consumer spending, liquidity and economic growth. They think that any effort to improve aggregate demand or liquidity in the system (by printing more money, by increasing government spending, by quantitative easing etc) will lead to increased GDP and spur economic growth. They forget that by taking these actions and by not allocating financial resources appropriately, they are distorting the markets. They are also tinkering with the “Opportunity Recognition Signals” of individuals which are already naturally pre-dis-positioned to be faulty. They also fail to understand that by increasing liquidity in the markets, people and companies will take on more debt and allocate the new financial resources at hand towards a sub-optimal, unwanted or hyped projects. All these factors caused the previous housing crash, Dot-Com Bubble burst, and the Great Depression.

As we have discussed above, if the government wants to tinker with the markets, they also need to regulate the spending framework to ensure that hyped frenzy is not a resultant effect of distorting market signals for investors and public alike. Few individuals in position of power will always attempt to increase the market frenzy towards projects from which they stand to gain. When people do not have money, they want more money, when they have more money, they want to buy influence so that they can keep the cycle going. Government intervention in free markets without any regulatory controls can benefit these advocates of hyped investments with agendas.

Saudi ARAMCO IPO Risk Analysis InvestorsGovernments love to intervene in the markets when demand is dropping. We have already discussed on another article “Saudi ARAMCO IPO – Great Opportunity or Riddled with Risks” that the demand for commodities is reducing, production levels are dropping in the West, while consumption in non-subsistence items is increasing. The government will eventually want to intervene by injecting liquidity in the market or by offering cheaper credit. Hyperinflation is the cure for market intervention and we will soon see another cycle of the historical process. As we will discuss below, the government can sometimes inadvertently intervene in the markets in the right way leading to creation of scientific capital as it the United States government did in 1900’s. Other than these rare instances, government action has always led to trouble in the end. I have been a hard core interventionist for the first 30 years of my life. After that, significant learning curve forced me to seek the core reasons why interventionists fail. I will briefly touch on this topic at the end of this essay.

The Abolition of the Gold Standard, Introduction to the FIAT Currency and Intrinsic Value of FIAT Money

Keynesians and Monetarists hate the idea of the Gold Standard as it creates significant constraints on their policy interventions. As a matter of fact a poll carried out in 2012 indicated that Zero economists thought that Gold Standard has any value at all. The Gold standard prevented banks from printing money and tinkering with the economy. If we have the gold standard and carefully thought of intervention, we probably would not need so many economists ?. Even Atlantic defended the abolition of Gold Standard in “Why the Gold Standard Is the World’s Worst Economic Idea, in 2 Charts”. We can guess that a Keynesian/Monetarist wrote the article.

We have already discussed, how Weimar Crisis developed after Gold Standard was abolished and Fiat Currency was introduced by the government. There was however, another event that changed the dynamics of capital flows and economic policies around the world. On Aug 15, 1971, Richard Nixon, the former president of the United States killed the gold standard by ending the Bretton Woods system of fixed exchange rates established at the end of World War II – (Source – US Office of the Historian). Some people view the abolition of the gold standard as a major negative event in the world. The Keynesians could print any amount of money and this led to a fundamental shift in the economic structure for the policy makers. Recently a Forbes contributor offered a contrarian view on “Nixon’s Colossal Monetary Error: The Verdict 40 Years Later“. Recently contrarian voices have been raising the chorus.

And finally, since Nixon killed the gold standard, the world has suffered from 12 financial crises, beginning with the oil shock of 1973 and culminating in the financial crisis of 2008-09 and now the debt crisis in Europe, and the growing deficit crisis in the U.S – Charles Kadlec , Forbes

The FIAT currency always has an intrinsic value and during “gold standard”, there was a common consensus amongst the countries to use a singular intrinsic standard. There are also cases where intrinsic value can be measured against commodities. Tide Detergent” was used a currency standard for exchanging drugs or crack. In prisons, cigarettes are used as an intrinsic value standard. The new standard on the horizon is Bitcoin which may guide the fiat money’s evolution further. The abolition of the gold standard by Nixon in the 1970’s allowed various governments to keep printing more money when required thereby increasing the debt load in the world by trillions. In essence, the governments have been creating money out of thin air and some claim that all fiat money tends towards an intrinsic value of zero in time. A research of multiple currencies in the world has highlighted that all fiat money eventually collapses causing and causes hyperinflation.

Poor Prediction Rate of Economists 

I have nothing against economists, but economists are similar to strategy consultants who do not understand that intervention in complex systems leads to unintended consequences or failure. On top of it, the key indicator of intelligence or domain expertise is the ability to accurately predict what is likely to occur in the future. As we will discuss below, Economists have a very poor record of accurate predictions. Specifically, the Keynesian and Monetarist Economists. Based on extensive empirical data, whenever I come across one of these economists, I mentally shut off. Why should we listen to those, who have always got it wrong in the past.Economists are very poor at predicting the next big crises except when they are very close to the event or well after they have crossed the curve. It is natural to be concerned about reading a forecast from a non-expert. So, it may help to highlight how accurately were the expert economists in predicting the previous recessions. This may give you some solace that our hyperforecast may be more accurate as it is a contrarian view.

In a paper critical of most of the economists titled  “The Financial Crisis and the Systemic Failure of Academic Economists“, few contrarian economists emphasize that academic economists are too disconnected from reality to predict economic recessions and depressions. Their claim is that most of the economic models use exceptional from of reduction-ism to evaluate a holistic system such as global economy. As such, surprises emerge from the blind spots. Their conclusion highlights a serious flaw in current system where economists are living in their own bubble.

We believe that economics has been trapped in a sub-optimal equilibrium in which much of its research efforts are not directed towards the most prevalent needs of society. Paradoxically self-reinforcing feedback effects within the profession may have led to the dominance of a paradigm that has no solid methodological basis and whose empirical performance is, to say the least, modest.

Now, let us move to accuracy of their predictions. Nate Silver cites in his book “The Signal and the Noise: Why So Many Predictions Fail–but Some Don’t” that when economists are not busy failing to predict recessions that have already begun, they are busy predicting recessions that never arise. Silver also points out “one actual statistic is that in the 1990’s, economists predicted only 2 of the 60 recessions around the world a year ahead of time” and also that “a majority of economists did not think we were in one when the three most  recent recessions, in 1990, 2001, and 2007, were later determined to have begun” .

one actual statistic is that in the 1990’s, economists predicted only 2 of the 60 recessions around the world a year ahead of time” and also that “a majority of economists did not think we were in one when the three most  recent recessions, in 1990, 2001, and 2007, were later determined to have begun – Nate Silver 

The reason for such poor predictive accuracy being a growing emphasis on mathematical models in the conventional economy which fails to take into consideration the facts that economics is a social science. Human behaviour can be irrational and predicting the complexity of human behaviour requires a deep understanding of human behaviour and a little understanding of economics. Average people on the main street can feel the slumps much before economists forecast it.

Average people on the main street can feel the economic slump long before economists forecast it !

Economics is a complex science with so many hidden variables that the only way to accurately predict the future is to rely extensively on a trained intuitive spectrum which has a precedence of accurate forecasts. The “Intuitive Spectrum” is poorly understood and human intuition has been considered a black box so far, mainstream scientists and experts have relegated the role of intuition in predicting the future. As it happens, recent research has indicated that human brain is a natural predictive mechanism. If well trained, it can accurately predict the developing future over short-term and create a predictive range over the long term. Wharton points to a possible reason for this failure in it’s paper titled “Why Economists Failed to Predict the Financial Crisis“. As per them, economists suffer from the control illusion that using their rational, educated and expert brains, they are in full control of the future and can predict most of the events accurately.

There is a great quote which says “The future is already here, but it is not evenly distributed.” Our research has shown that a fully developed and trained intuitive spectrum has the ability to pick up weak signals out there in the future. In our work with our clients, we have also repeatedly demonstrated that these weak signals can show up in a manner that one can easily reject them leading to inaccuracies. The lack of ability in economists to pick up weak signals is the key reason why global recessions begin immediately without any warning. As Robert Schiller writes in “Listen Carefully for Hints of the Next Global Recession“we must carefully listen to the hints of next global recessions. Recessions and Depressions almost always, comes unannounced.

The Case for Next Great Depression

In the rest of the post, I will build a case for why I think; we are headed into a great depression instead of another recession. I outline my variables so that they can be critiqued by others as well as continuously evolved as time evolves.

Causes of Recessions and Depressions

There can be many reasons for recessions and depressions in the economic cycle. For all academic and theoretical purposes, a Recession implies a fall in real GDP. A predominant view is that recessions and depressions are caused due to demand side shock or supply side shock, both lead to a drop in aggregate demand. Aggregate demand shock can be caused by macroeconomic or low probability high impact macroeconomic events. As the world has become globalized and interconnected, we are more and more prone to the butterfly effect i.e., a small incident in Indonesia could cause the next depression or recession. Globalization had led to improved economies, however have also led to challenges for many due to labour arbitrage. The election of Donald Trump in the United States and the emergence of the far right in Europe is caused by widespread anger against the elites who have significantly benefited from globalization at the expense of others.

What can we learn from the previous Recessions and Depressions. What caused them and are there any lessons we can learn from them avoid another repeat. We have already highlighted that government policies led to the Housing Crash which led to the last Recession. Let us also understand the causes of the previous Great Depression.

The Great Depression of 1930’s

The Great Depression is known to have lasted from 1929-1939, and it was a historic decline in economic activity. The 1920’s saw an unsustainable credit boom in which also coincided with the personal used car revolution in the United States pioneered by Ford. Wages increased, stock markets boomed to historical levels; debt rivers soared, and this began the story of the “American Dream”. However, it soon went downhill.

744 US banks declared bankruptcy by early 1930’s; savers queued up in lines to withdraw their savings, confidence in banking system collapsed and thus began an unprecedented and a historic economic collapse. The United States went into a deflationary cycle; unemployment soared, and the multiplier effect of reduced consumer spending and investments flight led to a downward spiral. Various schools of thought attributed different reasons for this crash. Globally, 90000 banks collapsed and millions of people were unemployed and homeless.

Keynesian Economists pointed to the the drop in aggregate demand and failure of classical economic theory to be reasons of this crash. Marxists saw this as a collapse of Capitalism. Austrian view was that credit boom and a subsequent inflation caused a loss of faith in the banking system. Monetarists blamed the fact that the money supply was reduced by 1/3rd which turned an ordinary depression into the Great Depression. So, who was right ?

There were many reasons for this crash as occurs in a complex system. First, the stock market crashed on October, 29, 1929 due to the stock bubble that crashed. It was the peak of disconnect between economic fundamentals and speculation. Second, around 9000 banks had failed by the end of 1930, majority of the bank deposits were insured and people lost their savings. This created a drop in consumer spending and aggregate demand. Third, the fear and panic led to inhibited sales, a drop in demand and significant layoffs in the industry. Fourth, the protectionist stance by the American Government against Europe, namely imports levied on imports through the Smoot-Hawley Act led to drop in trade.  If we carefully look at the core reasons for the Great Depression, they were caused by speculative behaviour of wall street bankers. Speculative behaviour occured as asset bubbles formed and stock market went up by 20% since 1922. Such asset bubbles and speculative behaviour only forms due to the government intervention using fiscal or monetary policy. So, this is what happened which led to a cascading negative effect forward. The technological progress of 1910’s and 1920’s increased throughput and subsequent rise in industrial productive capacity. The capacity increase was not accompanied with a rise in wages and consumer spending. As  Bernard C Beaudreau writes in this book ” How the Republicans caused the Stock Market Crash of 1929″, the government tried to solve the under-income with increased import tariffs. This caused distortion in the investor sentiment and eventually led to the 1929 stock market crash. As one can see, once against, intervention without much thought led to unintended consequences. 

It doesn’t take much intelligence to notice that all the causes of the last depression are replaying right now in the global economy. Irrespective of which theorist wins the argument, it doesn’t change the fact that we have not learnt anything from the previous debacle. My premise in this post is that that increased liquidity in the system, government intervention itches, resultant malinvestment into asset bubbles will eventually lead to a stock market crash, drop in aggregate demand, loss of individual savings and finally nothing left to try to revive the economy. As we will discuss further , this time around, there are some new factors that are aggravating the previous conditions which will make the conditions far worse in the coming months.

The Austrian theory views business cycles as the consequence of excessive growth in bank credit, due to artificially low-interest rates set by a central bank or fractional reserve banks through expansionary monetary policy (also called money printing). The Austrian business cycle theory originated in the work of Austrian School economists Ludwig von Mises and Friedrich Hayek. Hayek won the Nobel Prize in economics in 1974 (shared with Gunnar Myrdal) in part for his work on this theory.Proponents believe that a sustained period of low-interest rates and excessive credit creation result in a volatile and unstable imbalance between saving and investment.According to the theory, the business cycle unfolds in the following way. Low-interest rates tend to stimulate borrowing from the banking system. This leads to an increase in capital spending funded by newly issued bank credit. Proponents hold that a credit-sourced boom results in widespread malinvestment. A correction or “credit crunch” – commonly called a “recession” or “bust” – occurs when the credit creation has run its course. Then the money supply contracts (or its growth slows) causing a curative recession and eventually allowing resources to be reallocated back towards their former uses – Source – Wikipedia

Role of Government in spurring Productive Investments and Malinvestments

We have built our premise so far that unwarranted intervention itch by government causes a credit boom and liquidity in the system, leading to malinvestments, hyperinflation, and a subsequent recession phase. That said, there have also been rare instances when government intervention has led to significant long-term gains. Let us evaluate the productive investment examples so that we can build a case for government intervention that leads to a better future.

Vannevar Bush was born in 1890 in the United States. By 1940, America had become the global capital for science, innovation, and military advancement. This seems like a rare case study where politicians and the government were forced by circumstances to intervene in the economy making America the scientific capital of the world for many years and even led to rise of the famed Silicon Valley.

Bush, who was a distinguished MIT professor and a co-founder of the multi-billion dollar firm Raytheon was the founding architect of the American military-industrial complex. Bush took upon himself to defend engineers against the absurd claims that science and technology caused the great depression. Building upon his wide academic, industrial, and government contacts, Bush played a seminal role in directing the marriage of government funding and scientific research. In a report to Truman in 1945 named “Science, The Endless Frontier“, he emphasized the role of government-funded “fundamental research” to build scientific capital for the country.

The report led to the creation of famed organizations like DARPA (Defense Advanced Research Projects Agency) and National Science Foundation amongst other organizations. All the advanced innovations that leapfrogged United States into an enviable position were the result of Bush’s vision and government spending. DARPA is responsible for many of the world’s significant and scientific breakthroughs. The Internet, GPS, the Radar, World Wide Web, Videoconferencing, Google Maps, Siri, Self-Driving Cars, Microchips and even the iPhone was a last mile innovation piggybacking on government funded fundamental research. Needless to say, every dollar spent in building this scientific capital returned multiples over many years to come. The government inadvertently intervened by funding research for war machinery from which emerged innovative commercial products and technological feats for many years to come. We must remember that private sector could not have invested in these long lifecycle research projects, many with dead ends and noting that there were no immediate effects on the GDP or economy. However, the multiplier effect is still being reaped by the rest of the world due to a productive investment the government made many years ago. The impact was very different when the government injected liquidity into the market creating Dot-Com asset bubbles and the housing related innovative financial products like the CDO (Collateral Debt Obligations). We did not have to wait long enough to experience the negative effects of these malinvestments.

Apparently, a large finance sector is considered a result of malinvestments that spurred two previous crashes as well as the current “Unicorn” frenzy. Every dollar spent in the financial industry returns a fraction of the investment while every dollar devoted to building scientific capital creates a positive multiplier effect. IMF released a detailed research report that validates this premise.Basis this, Austrian Economists may have been somewhat wrong that no intervention by government automatically heals the markets. Instead, a strategic intervention by governments around the globe in building intellectual and scientific capital can have long term gains for the local and global economy. Entrepreneurs can cash on the basic research funded by the government to generate last mile innovation. As we have highlighted here, even iPhone was a last mile innovation impact of government funded research for which Apple should thank the government.

We will now highlight how malinvestments into ventures like “Uber,”Amazon” and “AI Projects” (which want to kill full salaried jobs and even eliminate humans from the productive workforce) spurred by low-interest rates will create significant problems for the future. These ventures will aggravate the conditions of 1930’s and lead to a more sustained depression period this time around.

Good Innovation/Bad Innovation

Investors and Entrepreneurs unconsciously wait for market signals to invest capital and to start productive ventures. Most investors have their skin in the game for “ROI” a.ka “Return on Investment, but entrepreneurs were supposed to be a different breed. Real entrepreneurs are trying to resolve an ethereal itch to take their intuitive ideas to conscious reality while meeting customer’s unmet needs. The primary objective of entrepreneurship was self-fulfillment and freedom to follow their heart. The secondary side effects were fame, wealth, and servitude. Entrepreneurs and investors co-exist together to help each other achieve their aims.

The market is always signalling to both these segments about the prospective timing of the launch of invested ventures. Entrepreneurs play a vital role in economic development, and young firms create most of the new jobs. As Kauffman Institute research demonstrates, the net job creation is almost always catalyzed by young and dynamic ventures. Entrepreneurs create new markets, force incumbents to remain on their toes, create new jobs and prosperity and create incremental to breakthrough innovation advancing scientific human capital.

The market can, however, sometimes create distortive signals which leads to race to the top of the wealth circuit for some. Low-Interest rates and easy credit is responsible for some of these distortive signals that assist in creating asset bubbles which eventually go bust. These distortive signals also lead to an entrepreneurship frenzy where entrepreneurs acquire the motives of the investors, i.e., to become as rich and famous as swiftly possible. A divorce occurs between the ethereal motives and the cerebral motives of entrepreneurs who become disruptive to the society they wanted to serve instead. This is how bad innovation start taking shape. Another problem is that the intrinsic value of companies in low-interest rate environments also get severely distorted.

As Charlotte Kennedy writes in the Guardian, “Sure, let’s get excited about innovation – but only if it makes our lives better” some innovations like Uber and Amazon are making their owners rich, but the society poor.  These bad innovations are creating a Utopian future for the next generations.

“It is practically impossible to know the true intrinsic value of a company when the interest rates are zero”

Recently, there was a widely reported investigative report on Amazon where the company was accused of ruthless management practices. While white collared, well-educated and highly skilled workers claimed to work in hellish conditions, the unskilled and casual workers were treated like “use and throw” commodities who struggled to make ends meet due to a rise in “temp employee” preference. Huffingtonpost chronicled the story of Jeff Lockhart Jr., a 29-year warehouse worker in Amazon who died of exhaustion on duty. I am certain that no one wants to leave such a world for our future generations where bad innovation is creating different new variants of indentured slavery in our society. All this is occurring while some investor entrepreneurs are buying islands for their personal use and some low-income families cannot even buy “breakfast eggs” more than once in a week.

The “temporary employee/contractor” preference and the rise of the shared economy may seem like good news to some, but it is a disaster waiting to happen. Steven Hill writes in the Slate “Even as corporations have seen a 30 percent rise in profits since the Great Recession in 2008, wages as a share of national income fell to their lowest point since after World War II”

My point is that government intervention driven by the Keynesian philosophy is creating poverty of the future for the masses by spurring bad innovation.

Good Innovation sustains during Gloom and Doom

Real entrepreneurs can weather the storms, and the most determined will start ventures even during gloom and doom. The scarcity of capital does not worry them and ideas of the venture concepts and its timing of the launch are not distorted by the market signals of easy liquidity.

“Those who have a vision will pull the resources to fructify the vision. Those who have the resources without a vision will take the resources for granted and squander them”

Market distortions create herd mentality which are solely responsible for the creation of asset bubbles due to FOMI (Fear of Missing Out). Real entrepreneurs have created the best companies during depression and recession phases. Good Innovation does not require easy capital to sustain itself; it requires a fixation on concepts, an ethereal desire to take intuitive ideas to conscious reality. They did not need government intervention to start, sustain and grow. As a matter of fact, there are distinct advantages of starting a company during recession or depression.Companies started during the recession are more profitable than those started those slump cycles. Here are some businesses that were created during the gloom and doom days.

  • 3M
  • Tyson Company
  • General Motors
  • Proctor and Gamble
  • Camel Cigarettes
  • Walt Disney
  • Motorola
  • HP
  • Xerox
  • Texas Instruments

Lack of government action and lack of market distortion spurs real entrepreneurs into action which lead to sustainable ventures which create prosperity, new jobs and improve the quality of life of all participants. Good Innovation does not require government intervention as it is a slow process that unfolds over time. However, occasionally, the government may take actions that sustain good innovation. The United States government triggered good innovation inadvertently to prop up weapons research which led to the creation of scientific capital. As we have discussed in the “Tech Bubble Burst of 2016”, the ventures that are created are examples of unsustainable bad innovations spurred by distortive signals initiated by easy liquidity.

The Unprecedented Rise in Global Debt

Government Intervention is triggered by a Keynesian belief that aggregate demand can be increased by lower interest rates and by increasing government deficits thereby somehow spurring economic growth. Debt grows faster than income growth and eventually has to be restructured, i.e., everyone loses in the end. Since 2007, global debt has grown by US$57 trillion and it’s had disastrous results. Greece, Detroit, Puerto Richo, Venezuela are just the beginning of this trend. Soon, it will be followed by larger countries like China and United States.

In spite of this, politicians and global leaders are doing everything to increase the debt Ponzi scheme. Government deficits, negative interest rates designed to spur aggregate demand will also stimulate debt spirals and asset bubbles eventually ending the party badly. The debt reckoning of the increasingly indebted world cannot be deferred indefinitely. The new elephant in the room is slowly waking up with the crash of the commodities and the trending slowdown.

Unplanned Impact of Natural Disasters

Natural Diasters are on the upward swing. A natural disaster causes significant turbulence to the local and global economy. In this paper “The Indirect Cost of Natural Disasters”, the author makes a great case that if a pre-disaster economy is already depressed, natural disasters catalyse significant volatility in the global economy. The cost of recovery makes a massive dent on the government revenues leading to stronger deficits, pressurising the government to intervene. As the government intervenes, it uses the old singular tactic of lower interest rates thereby driving up malinvestments. In the first depression, there were three climate events that made the depression worse. The Dust Bowl of 1930’s, The Tornado Outbreak in 1929 and the South Tornado in 1932. There are already indications that 2016 has been the year of most severe weather disasters. There are predictions of major earthquakes in California , Vancouver and even the Himalayas.  From United States to Oil Sands Fire in  Canada, right across to Japan and many other countries in the world, these recovery costs will soon become unsustainable. When they do, policy makers and economists will feel the itch to act. Act when they do, they create more long term pain than desired.

Rising Unemployment

The labour participation rate across the world is dropping rapidly. You may be inclined to believe the official unemployment numbers, but, they are a poor indicator of employment statistics. Let us take the United States as an example. The labour participation rates have dropped way below the rates when 1980’s recession unfolded. Note that the below statistics does not take into account the major layoffs in 2016. Some of these 2016 layoffs included Goldman Sachs and CISCO. Some analysts are predicting that layoffs will increase to 330,000 in 2016 only in the Tech Sector. Oil and Gas Sector have had significant layoffs due to the crash in oil prices, more tech Layoffs are coming and this is not a good sign.

In addition, as we discussed in the article “The Tech Bubble Burst of 2016”, bad innovation is fundamentally altering the employment landscape pushing people from full-time jobs to contract jobs. As less and fewer people contribute towards tax collections for the government, the government will move into negative interest rate territory.

As cited in this article, Silicon Valley has more Tech workers than during dot-com time. The company valuations are finally becoming more grounded, new funding was difficult to come by and companies like Uber are finally thinking of pivoting to a business model with higher capital expenses. The market dynamics are either forcing companies to layoff entire workforce or significantly reduce the size (right size). As valuations drop further, commodity sectors crack and investment banks take on more losses, a further malinvestment or hoarding of cash will catalyze conditions to develop into a major recessionary or depression.

Most in the Silicon Valley suffer from a disease called “Irrational Exuberance” and another one called “Braggadocio”, but, there is one firm, Snow Ventures, which is finally shorting the startup world. Their pitch is “Winter is Coming”

Our Intuitive Mind is neurologically structured to feed familiar information in our consciousness and one may not be able to see beyond the halo effect. The truth is that the average citizen of the world is becoming poorer and less employable as they move ahead in time. Thousands of computer science graduates will not be able to find jobs for years to come, once the Tech bubble fully unravels. There are already cases where graduates with Oil and Gas degrees and even experienced geologists are unable to find minimum wage employment.

Summation

The Keynesians and the Monetarists have dominated the global economic policy and academic space for many years and will continue to do what they have always done leading to side-railing of the economy. Keynesians and Monetarists think that they can somehow smoothen the boom-bust business cycle curves by taking actions that increase aggregate demand and consumption. They believe in patchwork that works on the symptoms and not the causes. Keynesians are suffering from a tunnel vision, where the only variable they want to intervene in are aggregate demand and consumption. They do not care about the long-term impacts of this poor vision as they will most likely will not be in their existing roles by the the damage is beyond economic repairs (BER).

Keynesians and Monetarists think that they can somehow smoothen the boom-bust business cycle curves by taking actions that increase aggregate demand and consumption

The patch work done by injecting liquidity into the markets during the dips reminded me of an incident many years back. I used to work in the naval dockyard in India and used to lead teams in the dry docking division for few years. We once started sand blasting a warship’s hull for inspection and repairs. Sand Blasting is the process of chipping the paint from the ships hull so that each zone can be inspected for structural integrity. We received a vessel in the dock which seemed in good operational state at the first look and had been seaworthy for the last two years. Once we started sandblasting the paint, we found many places where there were big holes in the hull, but multiple layers of paint on top of each other had somehow prevented a leak. The patch work was responsible for giving an external experience of seaworthiness. In reality, it was a disaster waiting to happen.

The predicament of our global economy is similar to that ship’s hull in the dock. Everything looks good outwardly as instead of taking the economy for a midterm refit and repair to improve the structural integrity, the Keynesian and the monetarists have been painting the economy in layers deferring the disaster by some time. It has led to significant inequality, creating a large “have not” population pitched against the 1% wealthy hoarders. The dam is about to break unleashing an economy fury of an unprecedented type.  I forecast the recession phase to start no later than Q3 of 2016 and a depression cycle to commence no later than Q2 of 2017.

My premise is that the world largest economies will soon enter a phase of double dip deflationary recession retrospectively which will lead to a spiraling of government debts caused by budget deficits and negative interest rates. As Keynesians and Monetarists have always done, they will make policy choices which will cause significant hyperinflation and a subsequent collapse of most fiat currencies in an attempt to prevent deflation. This will lead to enhanced currency wars, protectionist economic trade wars, a full unraveling of public and private markets, loss of individual savings and atleast a decade to a two-decade long healing phase of the Global Depression 2.0. This depression will be worse than the 1930’s slump as defective government policies have created asset bubbles and bad innovation that is fundamentally altering the structure of labour participation in the economy.

The key lesson here is that “Intervention”, rather “Direct Intervention” never works. Intervention in the economy, in global conflicts, in business creation only creates more chaos than before. If the intervention has to be attempted, it should be done at multiple levels, in successive approximations. Precision as an intervention strategy always fails. In an upcoming article that I am writing on popular request from my clients “The coming disruption of conventional strategy”, we make a case with interesting examples, how precision as an outcome and strategy aimed to achieve precision has caused more heartburn in the world than anything else.

Our monetarists and Keynesians apply precision as a strategy. Whenever the economy goes into a dip, they feel obligated to responded by tinkering with the monetary policy and by lowering interest rates. These interventionist actions lead to a creation of asset bubbles and asset bubbles eventually pop. When they do, the damage is exponential and in hindsight, a different strategy should have been used. Hindsight is rarely used by economists to develop foresight and this article is an attempt to convince everyone that “history does repeat itself” and it will without much variation this time also.

These interventionist actions lead to a creation of asset bubbles and asset bubbles eventually pop

We are entering a phase of extreme volatility in the markets and for those who are unprepared, a macroeconomic shock could become a personal economic disaster in the making.Our premise is that we are heading into Depression 2.0 and it is not very far away.

In the next post, we will highlight strategies to protect one from the impact of this economic Armageddon that is approaching us in the near future.

All Rights reserved 2016 @ Perchingtree Inc, 2016. Except for excerpts and reproduction with full citings, no copying permitted.

By |21 November, 2017|

About the Author:

Based out of Calgary, Canada, Rohit Sharma a.k.a Wikimonk is an astute Hyperforecaster who regularly writes on Technology, Psychology and all things Bizarre. With 9 out of 10 hyperforecasts accurately delivered todate, he works with various clients to devise strategies to manage Uncertainty. Click on the name above to read more him !