Welcome to the New Depression... The real definition of a 'depression'... Until this happens, the economy won't recover... This poses the greatest danger to your wealth... How to prepare for what's coming next...
Editor's note: The Stansberry Digest team is traveling today, so we're taking this opportunity to feature some excellent economic commentary from Jim Rickards.
Regular Digest readers are familiar with Jim's pedigree. He's a financial lawyer with a doctorate and multiple advanced degrees. He is also a hedge-fund manager, a New York Times bestselling author, and a go-to resource for many media outlets, including CNBC and the Financial Times.
Today, he serves as an advisor to the Office of the Director of National Intelligence, which oversees more than a dozen U.S. intelligence agencies. He authored one of the biggest "must read" books we've read in a long time – The Death of Money – and recently partnered with our corporate affiliate, Agora Financial, to help his subscribers protect themselves from the global "currency wars."
The following excerpt comes from a recent issue of Jim's Strategic Intelligence newsletter. We hope you enjoy...
The United States is living through an economic depression that began in 2007. It's part of a larger global depression, the first since the 1930s. This New Depression will continue indefinitely unless policy changes are made in the years ahead.
The present path and future course of this depression have profound implications for you as an investor. If you don't grasp this once-in-a-lifetime dynamic, you are at risk of seeing all of your wealth wiped out.
Calling the current economic malaise a depression comes as a surprise to most investors I speak to. They have been told that the economy is in a recovery that started in 2009.
Mainstream economists and TV talking heads never refer to a depression.
Economists don't like the word depression because it does not have an exact mathematical definition. For economists, anything that cannot be quantified does not exist. This view is one of the many failings of modern economics.
But no one younger than age 90 has ever experienced a depression until now. Most investors like you have no working knowledge of what a depression is or how it affects asset values. And economists and policymakers are engaged in a conspiracy of silence on the subject. It's no wonder investors are confused.
The starting place for understanding depression is to get the definition right. You may think of depression as a continuous decline in gross domestic product (GDP). The standard definition of a recession is two or more consecutive quarters of declining GDP and rising unemployment. Since a depression is understood to be something worse than a recession, investors think it must mean an extra-long period of decline. But that is not the definition of depression.
The best definition ever offered came from John Maynard Keynes in his 1936 classic, The General Theory of Employment, Interest and Money. Keynes said a depression is, "a chronic condition of sub-normal activity for a considerable period without any marked tendency towards recovery or towards complete collapse."
Keynes did not refer to declining GDP ; he talked about "sub-normal" activity. In other words, it's entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or staying ahead of the national debt. That is exactly what the U.S. is experiencing today.
The long-term growth trend for U.S.
For a three-year stretch from 1983 to 1985, during the heart of the Reagan boom, growth in the U.S. economy averaged more than 5.5% per year. These two periods were unusually strong, but they show what the U.S. economy can do with the right policies. By contrast, growth in the U.S. from 2007 through 2013 averaged 1% per year. Growth in the first half of 2014 was worse, averaging just 0.95%.
That is the meaning of depression. It is not negative growth, but it is below-trend growth. The past seven years of 1% growth, when the historical growth is 3%, is a depression exactly as Keynes defined it.
Pundits point to 4% GDP growth in the second quarter of 2014 as proof that the economy is expanding robustly. Talk of depression seems confusing at best and disconcerting at worst. But second-quarter growth was driven by inventory accumulation, which adds nothing to GDP in the long run. When inventories are converted to final sales, U.S. growth was only 0.65% in the first half of 2014. That is not a pace that will sustain an economic recovery.
Other observers point to declining unemployment and rising stock prices as evidence that we are not in a depression. They miss the fact that unemployment can fall and stocks can go up during a depression. The Great Depression lasted from 1929 to 1940. It consisted of two technical recessions from 1929-1932 and again from 1937-1938.
The periods from 1933-1936 and from 1939-1940 were technically economic expansions. Unemployment fell and stock prices rose. But the depression continued because the U.S. did not return to its potential growth rate until 1941. Stock and real estate prices did not fully recover their 1929 highs until 1954, a quarter century after the depression started.
The point is that GDP growth, rising stock prices, and falling unemployment can all occur during depressions, as they do today. What makes it a depression is ongoing below-trend growth that never gets back to its potential. That is exactly what the U.S. economy is experiencing. The New Depression is here.
Investors are also confused about depression dynamics because they are continually told the U.S. is in a "recovery." Year after year, forecasters at the Federal Reserve, the International Monetary Fund, and on Wall Street crank out forecasts of robust growth. And year after year, they are disappointed. The recovery never seems to get traction. First, there are some signs of growth, then the economy quickly slips back into low-growth or no-growth mode.
The reason is simple. Typically, a recovery is driven by the Federal Reserve expanding credit and rising wages. When inflation gets too high or labor markets get too tight, the Fed raises rates. That results in tightening credit and increasing unemployment. This normal expansion-contraction dynamic has happened repeatedly since World War II. It's usually engineered by the Federal Reserve in order to avoid inflation during expansions and alleviate unemployment during contractions.
The result is a predictable wave of expansion and contraction driven by monetary conditions. Investors and the Fed have been expecting another strong expansion since 2009, but it has barely materialized.
Growth today isn't strong because the problem in the economy is not monetary, it is structural. That's the real difference between a recession and a depression. Recessions are cyclical and monetary in nature. Depressions are persistent and structural in nature. Structural problems cannot be solved with cyclical solutions. This is why the Fed has not ended the depression. The Fed has no power to make structural changes.
What do I mean by structural changes? Shifts in fiscal and regulatory policies. The list is long but would include things like lower taxes, repeal of Obamacare, approval of the Keystone Pipeline, expanded oil-and-gas production, fewer government regulations, and an improved business climate in areas such as labor laws, litigation reform, and the environment.
Power to make structural changes lies with Congress and the White House. Those two branches of government are barely on speaking terms. Until structural changes are made by law, the depression will continue and the Fed is powerless to change that.
The difference between 3% growth and 1% growth may seem small in a single year, but it's enormous over time. From the same starting place, an economy that grows 3% per year for 35 years will be twice as rich as one that grows 1% per year. After 70 years, about an average lifetime, the 3% economy will be four times richer than the 1% economy.
These differences not only affect your wealth but also the ability of the economy to service its debts. The 3% economy can manage annual deficits of 2% of GDP . The 1% economy will eventually go broke with the same deficits. The difference between 3% growth and 1% growth is lost wealth that can never be recovered. It is the difference between the United States' success and failure as a nation.
Depressions pose other grave dangers to your wealth. In a depression, there is always the danger that disinflation – or falling inflation – tips into outright deflation. Deflation increases the real value of debt and forces many companies, and ultimately, the banks themselves into bankruptcy.
On the other hand, the Fed may try so hard to fight the deflation that it ends up causing inflation that destroys the real value of your savings, insurance, annuities, retirement checks, and any other form of fixed income. So far, the Fed has managed to walk a fine line between deflation and inflation, but the situation is highly unstable and is likely to tip one way or the other quickly and soon.
The depression in the U.S. will continue indefinitely until structural changes are made. The 25-year depression in Japan that began in 1990 is a perfect example of this. The U.S. is now like Japan, and the rest of the world is heading in the same direction. Investors like you are in constant danger; both deflation and inflation are real threats.
The good news is that structural changes do not happen overnight. They require action by the White House and Congress and such action is the product of debate and compromise that we can see coming.
If no action is on the horizon, the depression will continue and you can seek shelter from inflation and deflation.
A balanced portfolio of cash, gold, land, fine art, government bonds, alternative investments, and stocks in the energy, transportation, agriculture, and natural resource sectors should do the job. If, however, action is on the horizon, investors can prepare for the expected boom by positioning in technology, venture capital, financials, and other pro-growth cyclical sectors.
You cannot know which outcome will prevail. But with the right understanding of these depression dynamics, my subscribers know the signs of change and see what's coming.
Regards,
Jim Rickards
Editor's note: Jim just launched a brand-new service with a single mission: to help ordinary investors make extraordinary gains from the ongoing currency wars. According to Jim and his team, investors using his new "IMPACT" strategy could have made 530% in less than eight months from a major move in the U.S. dollar... 848% in less than seven months in the euro... and 2,196% in just 10 days in the Swiss franc.
Normally, we take claims like these with a grain of salt. But Jim has testified before Congress about the risks facing the global financial system... authored two bestselling books on economics... and advised the CIA and the Department of Defense. And if he is willing to put his reputation on the line with this service, we wanted to make sure you knew about it. To learn more about Jim's proprietary trading system, click here.
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