From recession to depression

The week ended with the release of preliminary estimates on U.S. real GDP for the 4th quarter of 2008.

The "advance" estimate released on January 30th had already been heavily negative, with a decrease of 3.8% annualized, but today's review of the data - to be considered, therefore, more "accurate" even if not quite definitive - is truly daunting: from the 3rd to the 4th quarter the U.S. economy registered a contraction of 6.2% annualized, the worst result since 1982, due to all major components of real GDP, according to the statement released by the BEA (here), and especially to exports, personal consumption and residential investment.

The -6.2% in the last quarter of 2008 is a figure which shows much clearer than the -0.5% of the 3rd quarter that the current U.S. recession is increasingly shaping as really serious, and that it is entirely reasonable to ask if it's slipping towards the situation that analysts define as economic depression (technically, a decline in real GDP by over 10% compared to the previous peak).



Global Contraction

But the picture has become critical everywhere and the economic contraction may well be defined as synchronized on an international level.

Japan, the world second largest economy, recorded a -3.3% annualized in the last quarter of 2008 and I believe that the data of the Eurozone, equal to -1.5%, may still be revised downward, according to the most recent indicators, eg. the synthetic one reported in the following figure (the so-called €-coin index):



The ongoing global crisis is comparable, as size, to that of the early '80s. For 2009, estimates of total annual growth stood at around +0.5%, which implies a serious economic downturn in developed economies (in the U.S. and in the Eurozone the forecasts are for an annual GDP decrease of 2% approximately) and a very marked slowdown in the emerging countries. The year 2010 is expected by many as the year of recovery, although the indications so far are very few.

The basis of this negative view is the process, already in place, of a strong reduction of the leverage by households (particularly in the U.S. and UK), as well as by the major international financial institutions, which will still take considerable time to complete.

• the need for a strengthening of households wealth, placed at a severe test by the contraction of real estate and financial assets, as well by the risk - more and more concrete - of job lost, is causing an increase in the savings rate (even in the U.S. ) and then, a simultaneous decline in real consumption;
• the crisis in the banking system has enormous proportions, and, looking to history, it will take no less than 3 - 5 years before it can be consider passed (and, in this respect, the role of government and monetary authorities will be decisive), with heavy consequences on the mechanisms of credit and thus on overall economic growth.
  

2009 Forecast

For the current year, therefore, the expectation is for a significant increase in global output gap, for a decline in aggregate demand, for a general deterioration in the labor market, with peak unemployment of up to 9-10% in the U.S. The resulting reduction in the marginal cost of labor, combined with falling commodity prices, could fuel a deflationary phase, against which, however, the economic policy is working.

In this context, the financial markets could anticipate some time the achievement of the minimal point of the economic cycle, and undertake a first phase of stabilization, and then start to recover, but, in the short term, risk and volatility are certainly still very high.

The approach to investments at the moment can only remain extremely cautious and selective: it does not mean that one must stay completely out of equity and other risky assets, but I think it's not time still to weigh portfolios more than normal.


Original post: Da recessione a depressione