Current Recession Is No Great Depression (We're being excessively pessimistic)

I've been complaining for years about how excessively pessimistic everyone has been about the economy and the stock market. But I have to admit, now that the economy is in recession and the stock market has taken a serious hit, all the pessimism is serving some useful purposes.

First, pessimism has driven stock prices down to levels that make them terrific bargains. If you've been a long-suffering value investor, frustrated by decades of high prices, then your day has come. Stocks are cheap -- at last. Second, pessimism has given everybody a healthy respect for the risks that our economy faces now. Sure, it's annoying when people falsely compare today's economy to the Great Depression. But because we're talking about it, that means that we're unlikely to repeat the mistakes that created the Great Depression in the first place.

Now put those two ideas together. Stocks are so cheap they're priced as though the economy was going into a depression. But it's not, because we've learned how to avoid that kind of horrible economic catastrophe. That means stocks really are a buy.

Imagine you were living in 1930. It looked a lot like today. The booming economy suddenly stopped cold. The stock market had just crashed. Everyone was up to his eyeballs in debt and struggling to get out of it. But at that point it was still just a recession. You wouldn't have known then you were headed for a depression and certainly not the Great Depression.

What went wrong? What turned a recession into a depression. And what made that depression great?

For one thing, Herbert Hoover raised taxes. Then Franklin Roosevelt raised them again. The theory was that falling tax revenues were putting the government into debt, and all that debt would hurt the economy. No one seemed to realize that you hurt the economy even more when you raise taxes.

Fortunately, our president-elect seems to realize that. Barack Obama campaigned on the promise to repeal the 2003 tax cuts rather than just let them expire naturally in 2011. Now he's let it be known that he won't be repealing them, so taxes are going to stay low -- on incomes, dividends and capital gains. I never thought I'd be so glad to see a politician break a campaign promise.

In 1930, America enacted the Smoot-Hawley Tariff Act, which raised taxes on international trade. The idea was that protectionism would be good for American jobs and American tax revenues. But other nations retaliated, and the volume of global trade collapsed. It took more than 50 years for the percentage of world GDP contributed by global trade to recover to 1929 levels.

There's been a lot of talk about protectionism over the last several years, thanks to the rise of China and India as manufacturing superpowers, and the trend toward outsourcing low-end U.S. labor to them. But as the recession has set in for real this year, for some reason we're suddenly not hearing very much about it anymore.

In fact, when the G-20 group of nations met in Washington to discuss the global recession last month, the members pledged not to use protectionism as a tool for creating local recovery at the expense of the global economy. That's great news because protectionism is a lose-lose proposition. By destroying the efficiencies of cross-border trading, it hurts everyone everywhere.

Worst of all, in the early 1930s the Federal Reserve just sat there doing nothing while thousands of banks failed. And once that happened, the Fed tightened the money supply. From the peak in 1929, the Fed reduced the money supply by 28% over four years. You really couldn't come up with a more effective way to strangle an economy.

Today's Fed is doing precisely the opposite. After a series of bungled interventions earlier this year in which several banks and brokers not only failed, but in my opinion were forced into failure by speculation and regulatory mismanagement, the Fed and the Treasury are now dedicated to propping up the banking system at any cost.

When Citigroup (C: 7.02, -0.41, -5.51%) got into trouble last month, the Treasury invested $20 billion in new capital on top of the $25 billion they'd invested a month earlier. And the Fed put a guarantee on $262 billion of Citi's "toxic" assets to assure that the bank's balance sheet would stay strong.

And money supply? Don't get me started. The "monetary base" -- the best measure of pure money creation by the Fed -- grew at a 740% annualized rate over the last three months. The Fed's balance sheet has tripled. It's now equal to 20% of the balance sheet of the entire commercial banking system.

The Fed's move to lower interest rates to near-zero this week is part of that, but it's not itself especially relevant. The important thing this week was when the Fed announced that it intended to keep its balance sheet huge and even grow it from here by buying mortgages, Treasurys and who knows what else.

Put it all together, and it means that the four worst mistakes that caused the Great Depression -- tax hikes, protectionism, bank failures and tight money -- are most assuredly not being repeated today.

So I'm quite confident we're not moving from recession to depression. That makes me think that a lot of the massive "stimulus" that Washington is talking about will end up being a big waste of money. By the time we do it, it won't be necessary. And even if it were, I worry that a lot of it is really just an excuse to implement politically popular spending programs using an economic emergency as the excuse.

But let's not pick nits. The point is that we're not headed into a depression. All the rest is details.

If I'm right, and this view starts to gradually seep into public consciousness, then stocks are going to keep working higher, as they have for much of the last month. There will be scares. And there will be big downdrafts as investors who didn't sell on the way down use rallies as an opportunity to get out while the getting's good. But I really think the bottom is in and that stocks are headed for a very nice rally from here.

If nothing else, a rally is due just from sheer exhaustion of selling. Late November was surely a "selling climax," and even if we ultimately have to retest those levels, we can still have a nice rally in the meantime. When stocks have moved somewhat higher a month or two from now, we can stop and reappraise. But for now, the course of least resistance is higher.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.

Your first Jefferson quote is bogus for sure. The UVA library has a terrific site with every valid Jefferson quote searchable by topic, he was a prolific letter writer so the site is a gold mine. He has at least 20 quotes on banks etc, but that is not one of them. Here is a real one, taken from the UVA library Jefferson collection.

"The crisis of the abuses of banking is arrived. The banks have pronounced their own sentence of death. Between two and three hundred millions of dollars of their promissory notes are in the hands of the people, for solid produce and property sold, and they formally declare they will not pay them. This is an act of bankruptcy, of course, and will be so pronounced by any court before which it shall be brought. But cui bono? The laws can only uncover their insolvency, by opening to its suitors their empty vaults. Thus by the dupery of our citizens, and tame acquiescence of our legislators, the nation is plundered of two or three hundred millions of dollars, treble the amount of debt contracted in the Revolutionary war, and which, instead of redeeming our liberty, has been expended on sumptuous houses, carriages, and dinners. A fearful tax! if equalized on all; but overwhelming and convulsive by its partial fall. Everything predicted by the enemies of banks, in the beginning, is now coming to pass. We are to be ruined now by the deluge of bank paper, as we were formerly by the old Continental paper. It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who, instead of employing their capital, if any they have, in manufactures, commerce, and other useful pursuits, make it an instrument to burthen all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs. Prudent men must be on their guard in this game of Robin's alive, and take care that the spark does not extinguish in their hands. I am an enemy to all banks discounting bills or notes for anything but coin. But our whole country is so fascinated by this Jack-lantern wealth, that they will not stop short of its total and fatal explosion."

~~Thomas Jefferson to Dr. Thomas Cooper, 1814

Those links are videos of people who know what they are talking about.

Who do you think is getting paid these billion of dollars in bailout money?
“Dollar Collapse - Jim Rogers - The Fed Has Given Up”
http://www.youtube.com/watch?v=8-NQYrJgMzQ&feature=related

You don't think the managers of Bear Sterns, JPMorgan Chase, the Deutch bank, Hedge fund operators, etc, etc, haven't made billions? Go to 3:15 into this video:
“Deutch bank writes off 3.5 billlion in bad loans, and shows a profit”
http://www.youtube.com/watch?v=s9K1lSA9AHE&feature=related

All the while collecting money from the bailout at taxpayers expense!

“Bernanke Is A Liar”
http://www.youtube.com/watch?v=drJ6QxSO5gw&feature=related

Do you think these investment bankers/ Fed reserve members are in the business for charity?

Saving our Economy by Destroying the Dollar
http://www.youtube.com/watch?v=s9K1lSA9AHE&feature=related

If you want to put on your monica lewinski knee pads and suck up to these international bankers, be my guest.

Who do you think is getting paid these billion of dollars in bailout money?

Paid? Loaned.

You don't think the managers of Bear Sterns, JPMorgan Chase, the Deutch bank, Hedge fund operators, etc, etc, haven't made billions?

The Chairman of Bear Stearns, Jimmy Cayne, lost about $1 billion when Bear tanked.

“Deutch bank writes off 3.5 billlion in bad loans, and shows a profit”

Wow, their profit before the writeoff was greater than $3.5 billion! So what? By the way, that video was over a year old.

Do you think these investment bankers/ Fed reserve members are in the business for charity?

No, do you?

If you want to swallow bad information (The Fed is privately owned. LOL!), be my guest. If you want to repeat bad info and sound like an idiot, go right ahead.

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