How Bad Could This Get?

There's a still a lot of space between where we are now and a long-term outlook of a global depression. Not a much as even last week, but there's still a way out. But in the medium term things could get very, very bad.

Economists are beginning to warn of a depression-like cycle where an inability to obtain credit stalls growth, triggering more defaults and still tighter lending terms. Governments have unveiled one unprecedented move after another in the past three weeks to boost confidence and get banks back in business, yet so far nothing has been able to arrest the fall.

"There's no hyperbole that can describe it," said Kenneth Rogoff, a Harvard University professor and former chief economist of the International Monetary Fund. "It's very, very unlikely (that the world economy will fall into a depression) but we've taken five of the 10 steps we need to get there. Hopefully we won't take the other five."

I'd argue it's more like step 7 or 8, frankly. We're deep in a spiral and the means of getting out will require far more action than has been taken even with today's EU announcements.

"With no desire to exaggerate, this might be considered the financial pre-conditions of a depression," Citigroup economist Steven Wieting wrote in a note to clients.

"Evidence suggests credit rationing is inhibiting day-to-day activities for many firms, with a harsh and worsening backdrop for consumers," he said. "Sadly, some risk exists that financial events could still unfold like a proverbial 'dam break.' This might leave policy-makers treating very serious and lasting damage to the financial system, rather than preventing further erosion."

Already, the crisis has taken a heavy toll on economic prospects. Wieting now expects nominal U.S. economic growth next year will be the weakest since 1954, with unemployment climbing to 8.5 percent from the current 6.1 percent.

And I honestly believe those numbers are far too tame. 2009 is going to be a miserable year. Remember, the same people who didn't believe the housing bubble would burst, that the banks would tumble, that Fannie and Freddie were toast, or that the credit crisis would worsen are the same people that believe 2009 is going to be the start of a massive rally in stocks.

The Dow had its worst week in both point and percentage terms and is down 40.3 percent since reaching a record high close of 14,164.53 on Oct. 9, 2007. In the last eight trading days alone, the blue chip index has lost a staggering 22.1 percent of its value.

Added up, the value of U.S. stocks has tumbled a breathtaking $8.4 trillion in the past year, as measured by the Dow Jones Wilshire 5000 index.

“These are all indicators of a bottoming process,” said David Kotok, said chairman and chief investment officer of Cumberland Advisors. “When you see this array of signs at these levels, three to six months later there was a rally under way. I am becoming very bullish strategically because I don’t think we’re going to have an inflationary Great Depression repeat.”

Keep telling yourself stocks can't go any lower, guys. Keep telling yourself this is another mild recession like 2002. Keep telling yourself this isn't a generation-defining event. Keep telling yourself capitulation selling will solve all the economy's problems.

Keep telling yourself that Dow 14,000 is just a couple of months away again if we just all clap our hands and just believe hard enough...