[THS] Michael Pento: Why The Greater Depression Still Lies Ahead

[The Harder Stuff in news and commentary]

http://www.informationclearinghouse.info/article25855.htm

Why The Greater Depression Still Lies Ahead

By Michael Pento
Michael Pento is chief economist at Delta Global Advisors

July 01, 2010 "Forbes" -- If policymakers do not understand the real cause of a
problem, they will in all likelihood be unable to provide a genuine solution.

Messrs. Barack Obama, Benjamin Bernanke and Timothy Geithner do not understand
the real cause of this debt crisis. They are politicians first and economists or students
of the market second--if at all. Therefore, it is not wise to count on them to tell us
when the Great Recession is over, or to provide a plan to prevent another one in the
future.

The cause of the Great Depression in the 1930s, and the Great Recession beginning
in 2007, was one and the same: an overleveraged economy. Excessive debt levels are
the direct result of the central bank providing artificially low interest rates and of
superfluous lending on the part of commercial banks.

The easy money provided by banks eventually brings debt in the economy to an
unsustainable level. At that point, the only real and viable solution is for the public
and private sectors to undergo a protracted period of deleveraging. The ensuing
depression is, in actuality, the healing process at work, which is marked by the selling
of assets and the paying down of debt.

Unfortunately, our politicians today are focused on fighting this natural healing
process by promoting the accumulation of more debt.

During this latest economic contraction, the Federal Reserve took interest rates to
near 0%, and the Obama administration is leveraging up the public sector to record
levels in a bid to re-leverage the private sector. The government's philosophy is
tantamount to sticking a frostbitten man in the freezer so he won't have to suffer the
pain associated with the thawing of his extremities.

During the Great Depression, real gross domestic product plummeted 32%. The
Great Recession, which we are still struggling through, began in December 2007,
according to the National Bureau of Economic Research. In contrast to the 1930s,
GDP during this recession shrank only 3.6% from the fourth quarter of 2007 through
its low point in the second quarter of 2009. Between the fourth quarter of 2007 and
the first quarter of this year (the most recent period for which data is available), GDP
contracted a mere 1.1%.

The contraction in GDP during the Great Depression was the direct result of
consumers paying down debt and selling off assets. Household debt as a percentage
of GDP reached nearly 100% in 1929. To put that number in perspective, household
debt did not go back above 50% of GDP until 1985. It was not until the first quarter
of 2009 that household debt once again approached the Great Depression level of
100% of GDP.

Between the start of the Great Depression and the end of World War II, household
debt fell from 100% to just above 20% of GDP. Getting there was a painful process,
but such de-leveraging was the only real cure for an economy swimming in debt.
Thanks to government efforts to carry on our debt-fueled consumption binge, during
today's Great Recession household debt has barely contract at all; it fell to 92.5% of
GDP in the first quarter of this year.

To make matters even worse, during this current crisis our government's response
has been to dramatically increase its own borrowing. At the start of the Great
Depression, gross federal debt was 16% of GDP. It peaked just below 44% when the
Depression ended. While the national debt did increase significantly during that
period, it was still relatively benign when viewed from a historical perspective.
The U.S. entered the current Great Recession with gross national debt equal to 65%
of GDP. It has since exploded to 90% of GDP! Comparing the relatively innocuous
level of the 1930s with today's pile of government debt clearly illustrates the perilous
state of the economy.

National debt did rise dramatically during World War II, topping out at 120% of GDP
in 1946. But consumer debt plunged concurrently. So while the nation was adding
debt to fight and win a global war, households were taking the necessary steps to
ensure their balance sheets were well prepared for the aftermath of the battle.

Today, gross national debt and household debt are both at or above 90% of GDP for
the first time in our history.

Many observers--unfortunately including most of those in power--have concluded
that the government must spend more while consumers rein in their debts. Their
strategy is based on the belief that once the economy perks up they can unwind that
debt.

There are two problems with this Keynesian theory. One is that government spending
doesn't increase GDP; it only chokes off private-sector growth. The other is that
politicians never regard the present as a good time for the government to pay off its
debts.

The result is that the country is left with a private sector reducing a massive
overhang of debt. As households curb spending, GDP slows, and the ratio of debt to
economic output grows even further.

Since we have yet to address the real cause of this recession, we are moving
inexorably closer to causing The Greater Depression. If policymakers do not
understand that the progenitor of a depression is debt, they will also be unable to
provide a genuine solution.

Michael Pento is chief economist at Delta Global Advisors and a contributor to
www.greenfaucet.com .