You Think I'm STILL Depressing?

I'm a veritable font of puppies and rainbows and crap compared to this guy.

Societe Generale said on Thursday that the United States' economy looks likely to enter a depression and China's could implode.

In a highly bearish note, veteran cross asset strategist Albert Edwards said investors should now cut equity exposure after a turn-of-the-year rally and prepare for a rout.

He predicted that the S&P 500 index of U.S. stocks could be set for a fall of around 40 percent from recent levels.

Edwards also raised the danger of a global trade war with China.

"While economic data in developed economies increasingly reflects depression rather than a deep recession, the real surprise in 2009 may lie elsewhere," Edwards wrote.

"It is becoming clear that the Chinese economy is imploding and this raises the possibility of regime change. To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression."

Edwards has long been one of the most bearish analysts in London, first with Dresdner Kleinwort and then with SocGen.

If Edwards is right, China's economic collapse will knock us square into the ten-year stag-deflation nightmare. Without the ability to purchase our debt, China devaluing the yuan would almost immediately cause the US to go belly up and take the global economy with it. China has become the world's third largest economy now, but that has all but fallen apart in 2009.

The central government has believed that as the demand for exports softened recently due to the global recession, the country's new middle class would continue to help GDP growth through consumption.

The plan has fallen apart like a cheap watch. According to The Wall Street Journal, "China's exports in December fell 2.8% from a year earlier to $111.16 billion, while imports in the month fell 21.3% to $72.18 billion."

What was unimaginable a year ago has now happened. China has entered a recession and it may end up being deeper than the one in the U.S. It is not clear that the government can mount and manage a plan to create about 10 million new jobs. This will be an even more difficult task if exports continue to fall sharply. China does not have a service industry which is anywhere close to being as large a part of the GDP as it is in the U.S.

The illusion developed over the last decade was that China had become an independent power with a population which could make and consume goods at levels which have never been seen before. During the last two quarters, it has become clear that the the opposite is true. China's economy may be the most dependent large economy on earth.

If GDP in the U.S., E.U., and Japan contract at 5% this year, China's economy is very likely to shrink faster. It will be faced with a sharp drop in what it makes and exports. More importantly, large numbers of Chinese are leaving the huge new industrial cities and going back to rural regions where they can at least find work growing their own food. What is more than a trickle now could become a flood. Those who have gone back to non-industrialized sections of the country will not be net consumers at all.

With a short-lived and dwindling middle class, China no longer has the economic core to continue the "miracle." China has just become another big country in trouble.

In other words, China's raging dragon of an economy has burned itself out. It's going to have to take (fittingly) draconic steps in order to right the sinking ship, and the fact of the matter is China is going to call in the trillions of debt we owe it in order to help it out.

And when we can't pay up, we lose. As Roubini will tell you, our choices at this point are a nasty 24-month or more "U-shaped" recession, or a decade-long "L-shaped" depression, Japan-style. The jury's still out on which one we're facing. Keep in mind the 2-year recession is in fact the best case scenario at this point: we still have another 12 months to go of truly bad economic conditions, millions of lost jobs, thousands of businesses going under and probably a few hundred more big companies.

For a few weeks since late November equity markets ignored the onslaught of much worse than expected macro news (and all the new were really worse than awful) and had a nice 25% bear market sucker’s rally. But the drumbeat of terrible – and worse than expected - macro news and earnings news and financial news has finally taken a toll on the delusional market belief that the worst was over for financial markets and for equity markets and that the US and global economy would recover in the second half of 2009. So equity prices have already reversed more than half of their most recent bear market rally as the lousy macro news have finally shocked in the last week the wishful thinkers.

Indeed, the retail sales figures published today confirmed a shopped-out, saving-less and debt-burdened US consumer is now faltering as job losses, income losses, fall in home wealth, fall in equity wealth, high and rising debt and debt servicing ratios and a severe credit crunch take a severe toll on the ability of consumers to spend. And reduction in spending and deleveraging of the US consumer will take years to rebuild the savings rate of a household sector now hit by a severe shock to its net worth (as equity and home values fall while debts have been rising) and shocked in its ability to generate income as job losses mount and the unemployment rate surges.

In other words, we're in no shape to help out anyone. Like a group of massive dinosaurs who have wandered into the tar pits at the same time, there's not going to be anyone on the outside big enough to pull us out of the muck.

The only option left is to sink.