Deleveraging — It’s Like Moving Mountains: Near Impossible

Most people like to be right. So do I, but not about predictions I made about a year ago about the economic environment that we find ourselves in these days. For months now, I’ve written in “Profit Confidential” about deflationary risks and my general lack of faith in the recovery. After the credit market first exploded and then collapsed on the tails of the asset bubble bursting, all I see in the near term is more volatility, albeit perhaps not as intense as the fourth quarter of 2008 was.

History shows that balance sheet recessions are anything but your plain vanilla kind of recessions. Typically, it can take between five and 10 years to transition to the next sustainable expansion cycle and marked bull market. And, on the road to sustainable recovery, the journey is laden with numerous setbacks.

I know I sound like another Dr. Doom, but I’m sure I’m seeing the same things you are — we haven’t progressed that much compared to a year ago, have we? What may obscure the big picture for many are the government spending-induced rallies in the equity markets. But not much has changed on the unemployment front and the gigantic deficit front. I’m afraid that the illusion of recovery is nothing more than an illustration of a typical philosophical loop humans are so prone to: wanting to believe that the market knows best when it is those believers who are the market.

By all means, since the March 2009 lows, the market has bounced and rallied nicely. But similar bounces and rallies occurred off the Great Depression lows in the 1930s. In early 1930, the equity markets gained close to 50% following the crash of 1929. A huge part of the euphoria must have been rooted in people’s overwhelming desire for the worst to be over. Yet, when we think of the 1930s rallies, the images typically conjured up are not those of joy and of profit-making, but those of despair and loss.


I agree that, while there are certain similarities, the Great Depression and the Great Recession are not entirely alike. What we are dealing with is perhaps more understandable if we transplant it into the context of the post WWII era, for example. Unwinding of the excesses created during the credit cycle on steroids that last nearly a decade is like moving mountains — nearly darn impossible.

The first lineup of baby boomers is retiring, leaving behind a lesser pool of people capable of buying obscenely expensive homes. The Fed is realizing that the U.S. is on track to follow in Japan’s footsteps right into a decade or more of severe deflation. The U.S. balance sheet is triple its normal size and heavily weighted down with the budget deficit of $1.44 trillion, representing approximately 10% of GDP. The number of officially unemployed persons has exceeded over 14 million, or 9.5%, while the unofficial number is much higher at over 25 million unemployed.

I believe that money can be made in any market, but I believe more in recognizing when the game has changed. We are operating in an entirely new context and the old rules of thumb most likely no longer apply. The lows we are currently seeing in many market segments are not the same lows we are accustomed to seeing when the economy hits the bottom. These lows could be disguised black holes, because there is simply too much debt polluting individual, corporate and government balance sheets. Don’t forget the deleveraging that has happened so far has just touched the tip of the iceberg. We are still years away from truly repairing our balance sheets, if this is possible at all.

I think that the stages of emotional recovery almost perfectly apply to the stages of economic recovery from the crash of 2008. We have survived the stage of confusion and agitation and in my opinion are now deeply in denial. If and when we emerge from the denial stage, we will likely spend the next little while angry and depressed before we accept the new reality. Once we accept the new norm, it will still be a while longer before we adjust to it.