If you’re breathing a little easier because the Great Recession seems to be ending, consider this: the U.S. economy may remain in a “contained depression” for months or years to come. That warning comes from economist David Levy, chairman of the Jerome Levy Forecasting Center, an economic research and consulting firm. Levy originally coined the term to describe the recession of 1990–1991 and the subsequent halting, jobless recovery. Earlier this week, he talked with CFO about the prospect of a similar scenario unfolding today. An edited version of the interview follows.
What is the state of the economy today?
We’re in for a much longer period of contained depression [than we saw in the 1990s]. The single most overlooked observation about the U.S. economy in the postwar period is that balance sheets grew faster than incomes, decade after decade, both assets and liabilities. The problem is that asset values have to be justified by returns they can earn — or by expectations of future capital gains, and that’s where you get into bubbles. What went on in the postwar period couldn’t go on indefinitely. We were able to make it go on longer by dropping interest rates in the last two recessions, but we can’t do that anymore. We have to shrink the value of assets on balance sheets and shrink liabilities. And that makes it very difficult for the economy to operate.
In fact, without the government sector, the economy would collapse. If you look at the second and third quarters of this year and analyze the sources of profits in the economy — and if you take government out of the picture — everything added up to a net loss, for the first time since the 1930s. But because we had an enormous injection of monetary wealth into the economy by the federal government, we were able to pump up profits and help them climb back to a much better level than they were at during the worst of the recession.
Fortunately, we’re not going to have the 1930s all over again, although unemployment will be very high. The banking system will continue to function. The government at times may try to reduce the deficit, as the Japanese government has tried to do as they have been dealing with their own kind of contained depression. But every time you do it, profits are undermined, things get worse, and the deficit widens anyway — and then you feel pressure to do something to stimulate the economy. It’s very hard not to run very large deficits.
In Japan, they wasted a lot of time actually getting to the financial problems and writing off bad loans and cleaning them up. We’re doing a much better job, and it won’t take us as long. But this is essentially the kind of problem we’re dealing with. We’re not going to see anything like the bubble-and-boom of the last couple of expansions or what we think of as more-normal business cycles.