Is This How a Depression Starts?

Today I received an e-mail from noted economist, Brad Schiller, suggesting that the economy was rolling along fine. The United States's Gross Domestic Product (GDP) was up recently, way up. I believe Brad was preparing his newsletter before the stock market's Black Monday or Wednesday, and of course prior to AIG's implosion on Black Tuesday. Even so, you may be wondering: is all the news bad, or are these good little tidbits like Brad's GDP an indication that the weak nature of the economy is being blown out of proportion?

The simple answer is that this is how the Great Depression started. People and businesses lost confidence in the financial system and many didn't want to trade until that confidence was restored. Don't let anyone including an economist or a parent convince you that we aren't slipping into depression, because nobody knows for sure.

On the other hand, there are many differences between the circumstances leading up to the Great Depression and what's going on today. Before the Depression, we had no FDIC insurance, and the government had no authority to buy failed businesses such as Freddie Mac, Fannie Mae, or AIG. So far, investors have taken some comfort every time the government takes over another failed institution. We have believed that the government will keep the business running satisfactorily.

What then does Bill Conner think will happen to the economy over the next several months to a year? Well I have no crystal ball, but I am a student of history and economics so here goes: I believe the government will satisfactorily keep us out of depression by operating these failed financial institutions. Apparently, even if this means imposing temporary martial law in the financial markets as they would in say communist Russia or China.

Government control will come at a price. We may pay operating costs for these institutions by taxing, borrowing money, or printing it. Small tax increases may be possible, but anything large enough to be substantial would slow private spending and could cause depression by weakening demand for goods and services. If the government borrows from private investors or even other countries, this will be borrowing. Like taxing, this option will take money out of other areas of the world financial system and could weaken demand for goods and services.

This may leave the government to borrow from itself or banks, and it will be as if the Treasury's printing presses were used to print new money. I suspect this option as being the most feasible. To the extent the government prints a lot of new money though, there will be additional pressure on inflation. Inflation will quite possibly increase to significantly higher levels than it is today. That won't be good, but it will be better than a depression.

So what are the odds that I'm wrong about inflation, depression or some unnamed new problem? I don't believe there is an economist, a psychic, or a minister that knows. It's all uncharted territory much like it was in 1929.