When I look at past economic downturns, I look at five key components to determine how bad they were and what the capabilities and challenges were in terms of getting the country out of the negative cycle. Those five key components are:

1. Consumer savings and spending/ability to spend
2. Corporate income, health and spending/ability to spend
3. Government financial health and ability to spend
4. The lending and banking system and its ability to extend credit
5. Inflation & scarcity of resources

Some people will look at my list and wonder why I don't talk about unemployment or the price of stocks or other indicators but those items are all symptoms of issues with the five primary items I listed. When corporate income is down affecting corporate health this affects stock prices, causes corporations to reduce spending and also results in layoffs and increasing unemployment. Layoffs and rising unemployment typically cause consumer ability to spend to go down, obviously among the people who are laid off but also among those who fear that they might be laid off and thus need to save their money to prepare just in case they lose their jobs.

The most recent recession of 2001-2002 was a result of problems primarily with #2 and a slight resultant hit on #1. Businesses were struggling and thus were not spending money on non essential items and as a result most firms that rely on corporate customers lost money. When they lost money, they laid people off. Unemployment rose, but those consumers who were not laid off kept spending and this kept the economy from experiencing much more serious issues. Throughout this period, the government was solvent, the lending and banking system lent huge amounts of money to businesses and individuals and prices were flat. With the more severe downturn of 1979, known as a global stagflation, items #1, #2 and #5 were the issues. You had double digit inflation and unemployment, corporate spending was down, it was a real mess. The great depression of 1929 featured massive problems with items #1, #2 and #4. Banks failed en masse, unemployment reached 25% with obvious implications on consumers' ability to spend. If 1/4 of the country's consumers didn't have money to spend, business income went way down and many companies failed completely.  As bad as some of these bad economic times were, none of those historic downturns compare with what is coming.

The depression of 1929 was eventually cured by government spending. There is an argument as to whether peacetime government spending and programs before the outbreak of war officially ended the depression or whether government wartime spending ended it, but there is no argument as to where that spending originated. The government went into the red to spend money on employing people and buying goods and services. That got the economy going again. But the government was solvent going into the depression and was not saddled by trillions of dollars in deficits.  Making it easier was that the depression, along with recessions like the one in 2001-2002 were more traditional downturns in that they did not have an inflationary component. Economists once thought that stagflation, the combination of rising prices and a recession economy, was not possible. The 1979 stagflation proved that it was possible. It creates an entirely new set of issues in trying to get the economy started again because the worry is that any steps that are taken may fuel additional inflation1.

Our current economic picture features serious issues with all five of my key components. Consumers have had a negative savings rate over the last 6-8 years, grew massive credit card and lending debts and have no more money to spend2 . Corporate income is down thus corporate spending is down3. Corporations have generally stopped hiring and some have started to lay people off, the unemployment rate is higher this year in almost every state than it was last year at this time4. The government is running at huge deficits and is hemorrhaging money on two wars after giving several massive tax cut giveaways 5 6 7 8. The government doesn't have the ability to spend us out of a major crisis. The lending and banking system is reeling from the mortgage and credit crises and as a result has very little money to lend to fund new ventures. Examples of this are the collapse of Bear Stearns and UBS' & Deutsche Bank's flirtation with insolvency9. When major Swiss banks like UBS flirt with failing, it's hard to argue against the idea that the economic sky is falling. Finally, inflation is on the rise, most people know about the huge rise in the price of oil and all the downstream price increases that this causes, but few in the US so far are aware that the entire world is experiencing a food shortage and thus food prices are rising separate from the fact that the price of transporting food is also increasing due to increasing fuel prices. We have experienced the beginnings of serious food price increases here in the US, but in the three month period from December 2007 to February 2008, France experienced a more than 40% increase in food prices. US consumer prices were up 4.1% in 2007, the sharpest increase in prices in 17 years (since 1990).1 That is just the beginning of the inflationary problems, particularly if the government starts throwing stimulus money at the situation.

When you have negative pressures from several of the key components, they reinforce each other and work together to drive the economy down. When it is all of them, the combined downward pressure on the economy has got to be immense. We don't know for sure how bad it is going to get because nothing like this has ever happened before. The only things that are better right now versus any other downturn is that if you compare our current issues with the 1929-1939 depression, we haven't had a major crash in stock prices and we have better regulations on the banking and financial markets (particularly on margin buying) as well as some governmental banking insurance like the FDIC. But how much ability does the FDIC/Federal government have to bail out the banks if they start failing with the severe deficits the federal government is already running? The economy is going to be at least bad enough so that we need a new name to call it. A recess is a small indentation while a depression is a larger hole, so I think this new worse economic crisis should by called an Abyssal, and since it comes with inflation, it will be a Stagflationary Abyssal.

How bad could this Abyssal get? It's always risky to try and predict things like this but I expect to see major corrections in the equity markets. I see a Dow in the 7000-9000 range, the S&P 500 struggling to stay over the 1000 mark and a NASDAQ in the 1400-1600 range. I see unemployment and inflation both between fifteen to twenty five percent. I see many consumers defaulting on their credit cards and the major crisis in the banking and lending industry will be compounded by hordes of consumers defaulting on their credit cards. As a result of these credit card defaults, more banks will fail and major banking insurers will fail as a result as well as investment funds and securities that are based on credit card debt. I believe there will be consumer and corporate bankruptcies on a massive scale. My next article will discuss in depth things that could be done to mitigate this coming crisis.

[1] OpEdNews.com - "Stagflation Returning to the US Economy after 30 years"http://www.opednews.com/articles/opedne_steven_l_080118_stagflation_returnin.htm

[2] AP (Via Yahoo)  – US Consumer Spending Stalls, 3/28/2008 http://news.yahoo.com/s/afp/20080328/bs_afp/useconomyconsumerincomespending_080328180248

[3] Yahoo News – Factory, Construction Activity Fall Again, 4/1/2008 http://news.yahoo.com/s/ibd/20080401/bs_ibd_ibd/20080401general   

[4] FXStreet.com – US Regional and State Unemployment Rates for FEB – Stats, 3/30/2008 http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=aea7fdc2-c8df-40a9-b1f5-f6d6c0055879

[5] uuforum.org (uses Congressional Budget Office Data) – US Budget, Deficit or Surplus, 1960-Present http://www.uuforum.org/deficit.htm  

[6] Politico.com – Deficit war funding concerns economists, 4/1/2008  http://www.politico.com/news/stories/0308/9292.html  

[7] Economic Policy Institute - NOBEL LAUREATES, 450 OTHER ECONOMISTS

FAULT BUSH TAX CUT PLAN, Dividend Tax Cut Called "Misdirected"  http://www.epinet.org/newsroom/releases/03/02/030210-econltr-pr.pdf

[8] Wikipedia (quoting deficit data from the Congressional Budget Office) - Jobs and Growth Tax Relief Reconciliation Act of 2003 http://en.wikipedia.org/wiki/Jobs_and_Growth_Tax_Relief_Reconciliation_Act_of_2003