Tuesday, March 17, 2009

What chance a US depression - update

A couple of weeeks ago I did some back of the envelop calculations on what the likelihood of a depression (as defined by a > 10% drop in real GDP) is in the US. I concluded:

"Based on all that I'd guess a 50-80% chance of depression. Let's say a 2 out of 3 chance. Certainly even being optimistic I'd find it hard to argue for a less than 50% chance. That's a scenario worth taking seriously"

Since then I've gone back and looked at various current figures on real GDP and found to my surprise that real GDP has only dropped about 1% since the start of this recession. It has just flat lined for about 15 months. Given this, I now believe it is less likely we're going to suddenly fall off the edge of a cliff and have a 10% plus GDP fall from here. So I'd say that given the impact of simultaneous crashes in stock and housing markets along with a financial crisis the powers that be have done a pretty good job at avoiding a real crash in real GDP (though a real bad job in piling up problems for the future and bailing out the undeserving and increasing the likelihood of 10 bad years ahead).

So what's my new guess on the probability of a US depression? Probably 50% maximum maybe a little lower.

On a more practical level I also suggested various actions that may help protect people from the consequences of economic deterioration ahead. Whether we have a depression or a long drawn out period of low growth these actions remain sensible steps in my view.

"1. Save money by finding things you enjoy that don't cost money rather than things that cost a significant amount of money.

2. Give some thought to what you would do if things go wrong for you or your family. e.g. you loose your job and can't find another one, can't get credit, house prices stay down or go lower, stocks stay down or go lower etc.

3. Give some thought to how you might help others if things turn out badly for them. It feels good to help others - here's our chance.
4. Don't go rushing out to buy houses, stocks etc unless you can afford to risk loosing a fair bit of that money in the next few years. Of course even in a depression they may go higher than current prices within 5 years, but who knows, things will be clearer later.

5. Reduce debt.

6. If you're a trader like me be prepared to continue to short the market unless there are some clear early signs of recovery. Given the size and nature of current government interventions be prepared for signs that a recovery stalls and we have a double dip recession like in 1981 then 1982/3 and 1929-33 then 1937/8."

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