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Assessing the Odds of Our Depression's Shape


What will it take to get a V shape, WW shape, or L shape?

World War II ended the Great Depression at a huge expense to the rest of the world.

The US was a shining beacon of growth after the war for the easily explainable reason that our productive capacity wasn't destroyed while productive capacity was destroyed everywhere else.

Debt Implosion

Japan is on the verge of imploding right now with debt-to-GDP at close to 200%. Yet somehow, Keynesian economists think more debt and more stimulus is the answer.

What the administration should have done is let failed banks fail. Instead, we propped them up, just as Japan did.

So much capital has been wasted propping up failed banks, that the risk of another serious implosion has increased. I think it's much higher than the 5% DeLong says.

However, let's be careful here. Social safety nets are much bigger now than in the 1930s. Another Great Depression will look much different because of food stamps, foreclosure policy, unemployment insurance, etc.

In another implosion, expect those nets to expand. Such a policy response would cost jobs and prolong the agony of course, but it will be tried. Indeed, it has already. Fannie Mae (FNM) is renting foreclosed houses back to people.

The US government is in effect the nation's biggest landlord.

Assessing The Odds

I have the odds of a severe downturn at 15% (unemployment exceeds 13% perhaps by a lot) and a less severe fashion at 30% (unemployment exceeds 12% or higher). In both of these scenarios there's a double-dip recession.

This is the "L" or "WW" scenario. In the milder form, we flirt in and out, close to recession for a number of years and unemployment essentially flatlines for years before finally turning lower.

"Muddle through" means things don't get much worse nor do they get much better (unemployment tops out under or near 12% and we don't double dip, or if we do, it's barely noticeable). Unemployment peaks, then very slowly starts to drop. Let's put the odds of "muddle through" at 35%. "Muddle through" might be labeled a U-shaped recovery, but it would feel more like an "L". Realistically this is about the best we can hope for.

Slightly better than muddle through has about a 15% chance (A genuine U-shaped recovery). Unemployment peaks, then drops at a modest pace.

The vaunted V-shaped recovery, with strong growth in jobs, has about a 5% chance in my estimation. Even in a V-shaped recovery, the odds of unemployment dropping to 6% or less by 2015 are close to zero.

In general, expectations about what this recovery will look like are far too optimistic, perhaps even by me.

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