This is What it Looks Like Right Before a Depression Starts

Oct 3, 2023

What Happens Right Before a Depression Starts

In the world of economics, there exists a fascinating concept: the calm before the storm. It's that moment when everything seems prosperous, and yet, lurking just around the corner is the impending darkness of an economic depression. Many of us might wonder, "How did things go from being so incredibly good to so devastatingly bad so quickly?" To understand this phenomenon,

we delve into the intriguing realm of the boom-bust cycle, also known as the business cycle or the debt cycle. Contrary to what some may believe, it's not solely the result of free market forces but rather a complex interplay involving fractional reserve banking and central planning. Let's break it down with a simple example. Imagine a small, isolated economy where money is sound, and borrowing is limited to what others are not currently spending. However, when a bank starts offering loans, they essentially create new money without any tangible backing. This injection of "phantom" money leads to an artificial boom, where prices soar, and people's incomes seem to increase.

Yet, all booms have their peak, and that peak often coincides with the moment when loans need to be repaid. If the interest rate is lowered to keep the boom going, it can lead to an even more precarious situation. However, if the debt is intentionally repaid by raising interest rates, it results in deleveraging, exposing the malinvestment and resource misallocation that occurred during the boom. This is the heart of the boom-bust cycle, a product of fractional reserve banking and central planning, not a free market phenomenon. Bringing this theory to reality, we can look at the actions of institutions like the Federal Reserve. Lowering interest rates to stimulate economic activity might seem like a good idea, but it can lead to malinvestment and misallocation of resources, as witnessed before the Great Financial Crisis. Instead of allowing the bust to unfold naturally, the Federal Reserve has repeatedly lowered interest rates and engaged in monetary stimulus. In recent years, we've seen inflation on the rise, prompting the Federal Reserve to increase interest rates rapidly in an attempt to force deleveraging. This has resulted in a contraction of the money supply, reminiscent of the Great Depression. Signs of malinvestment and misallocation of resources, such as excessive supply and unfinished investments, have started to emerge, painting a worrying picture of the future.

Examining various sectors, we find further evidence of economic strain. Car companies like Jeep, Chrysler, Dodge, and Fiat are grappling with an inventory surplus, leading to significant price cuts. Fiat's sales have been abysmal, raising concerns about the stability of its parent company, Stellantis. The luxury watch market also offers insights. Used Rolex prices have been plummeting as supply outpaces demand, reflecting economic hardships where even coveted items become more accessible. Housing affordability is another issue. High living costs are evident in both rent and home purchase prices. With most borrowers locked into mortgages below five percent, the majority can't afford to move to new homes due to the high-interest rates. Credit card delinquencies are on the rise, surpassing levels seen before the money printing frenzy of 2020. This indicates growing financial strain for individuals and, ultimately, the economy. Banks tightening lending standards suggest that accessing funds is becoming more challenging, reducing the flow of money in the economy. The commercial real estate market is facing trouble, with many banks exceeding recommended loan concentrations, potentially leading to a crisis. Lastly, the stock market shows signs of overvaluation, with price-to-earnings ratios at historically high levels. While a correction has occurred, the risk remains high, indicating that economic shocks may just be beginning.

In conclusion, the signs are unmistakable. The road to economic depression is marked by malinvestment, misallocation of resources, and the unwinding of artificial booms. This is the inflection point, the moment when the boom turns to bust. While it may seem like prosperity abounds, it's essential to recognize these signs as a harbinger of economic turbulence. The pain is just getting started, and we must brace ourselves for what lies ahead.

"typically when this price to earnings level reaches around 30 that is the top like it did prior to the Panic of 1901 like it did prior to the Great Depression and like it did prior to the tech bubble but in the last 20 years we've seen unprecedented amounts of money Printing and lowering of interest rates what does this do this causes the boom to continue pushing the valuation of this traditional 60 40 portfolio to 130 year highs yes there has been a correction"

"pain is just getting started this is what it looks like prior to the bust this is the inflection point the change from the boom to the bust these are the signs the malinvestment and the misallocation of resources are just now beginning to be exposed asset valuations are just now starting to realize the destruction that is built in" What happens before a depression starts

Before the Great Depression, the narrator was fascinated by

what life was like during that time and how things went from being good to devastatingly bad.

The narrator would ask their grandpa about it, who would try to explain the mechanisms and valuation, but most of it went over the narrator's head.
Many people do not consider the possibility that things can change quickly and economic pain may be right around the corner.
Historically, some of the most economically painful times have been preceded by times of fake abundance.

"How did things go from being so incredibly good to so devastatingly bad so quickly?"

The boom-bust cycle and its causes

The boom-bust cycle, also known as the business cycle or the debt cycle, is a result of fractiona

l reserve banking and central planning, not free market activity.

A small isolated economy is used as an example to explain how the cycle works.
Initially, the economy operates with sound money and borrowing is limited to money that someone else is not spending.
However, when the bank starts offering lending services, they create new paper money without any backing.
The bank can lend money into existence without giving up any of their own purchasing power, leading to an increase in debt.
The availability of cheap credit leads to an artificial boom, where prices are bid up and people feel an increase in income.

Eventually, the loans have to be repaid, marking the top of the boom, and if the interest rate is lowered, the boom can continue higher.
If the debt is allowed to be repaid intentionally by raising interest rates, it results in deleveraging and exposes the malinvestment and misallocation of resources that occurred during the boom.

"The boom-bust cycle is a product of fractional reserve banking and central planning, not a product of free market activity."

Application of the theory to reality

The Federal Reserve's manipulation of interest rates reflects the theory of the boom-bust cycle.
Lowering interest rates stimulates economic activity and can lead to malinvestment and misallocation of resources, as seen before the Great Financial Crisis.
Instead of allowing the bust to unravel, the Federal Reserve has repeatedly lowered interest rates and engaged in monetary stimulus.
In 2020, inflation started to rise, and the Federal Reserve began raising interest rates at a faster pace in an attempt to force deleveraging.
The

increasing amounts of money printing and rising interest rates have led to the money supply shrinking at a faster pace than since the Great Depression.

Signs of malinvestment and misallocation of resources, such as overabundance of supply and investments that cannot be completed, may start to emerge.

"All the malinvestment and misallocation of resources gets exposed during the bust, but the damage is done during the boom."

Inventory Piling Up

Many car companies, like Jeep, Chrysler, Dodge, and Fiat, are experiencing a buildup of inventory.

Prices of cars, such as the Gladiator, have been slashed by up to twenty thousand dollars.
The sudden drop in car prices indicates the economic difficulties faced by American car companies.
"Across the Nation for car cars from companies like Jeep Chrysler Dodge and Fiat Now cars like the Gladiator are seeing their prices slash by up to twenty thousand dollars"

Fiat's Troubles

Fiat, with 357 dealership locations nationwide, has sold less than 50 cars per month so far this year.
The total number of cars sold by Fiat for the entire year is 280, which is less than the number of dealerships they have.
Fiat's poor sales performance raises concerns about the financial stability of its parent company, Stellantis.

"So far this year they have sold less than 50 cars per month which brings their total sales number to 280 cars total sold for the entire year Fiat has sold less total cars in the entire year then they have dealerships which leads me to believe that parent company Stellantis is [in trouble]"

Declining Rolex Prices

Used Rolex prices have been dropping and supply is increasing.
This phenomenon suggests that people who buy used Rolexes primarily desire to feel wealthy.
When economic hardship sets in, the availability of desired goods becomes more challenging, as reflected in the decreasing prices of luxury items like Rolexes.

"We are seeing used Rolex prices drop and Supply surging now one of the major signs of economic hardship is just that the things that people want and need are difficult to attain"

Housing Affordability

The high cost of living is evident in both rent prices and home purchase prices.
Currently, 90% of borrowers have mortgages at a rate below five percent.
The majority of mortgage holders (approximately two-thirds) have mortgages below four percent.
Given the low mortgage rates, only a small percentage (26%) of homeowners can afford to sell and move to a new home.

"[...] if any of these homeowners sell their homes to move, they would be trading that mortgage out for a new mortgage over seven percent. This means nobody can afford to sell right now so both rents and the price to buy are staying extremely high making the cost of living very painful for most Americans"

Rising Credit Card Delinquencies

Credit card delinquency rates are currently at 2.77, which surpasses the peak of 2020 before the increase in money printing.
The delinquency rate is the highest in over a decade, since Q3 of 2012.
The recent surge in interest rates on credit cards contributes to this increasing trend of credit card delinquencies.

"credit card delinquencies are now at 2.77 which may not seem like a lot but it's higher than the peak in 2020 before the money printing started and you have to go all the way back to Q3 of 2012 to find a higher delinquency rate"

Tightening Bank Lending Standards

Banks are tightening their lending standards at a pace reminiscent of previous recessions.
The tightening of lending standards indicates that borrowing money is becoming more difficult.
With less money circulating in the economy, the overall economic situation is expected to become more strained.

"very simply money is getting harder to borrow which means less money in circulation which means things are about to get tight"

Banks Exceeding Commercial Real Estate Loan Limits

Around 700 U.S. banks are surpassing the Federal Deposit Insurance Corporation's (FDIC) guidance on the concentration of commercial real estate loans.
This excessive concentration of loans indicates a potential crisis in the banking sector.
The misallocation of resources and malinvestment during the boom phase becomes apparent during the bust and can cause significant damage to the economy.

"with about 700 U.S banks now exceeding the FDIC's guidance on the concentration of commercial real estate loans the boom causes malinvestment and a misallocation of resources that is exposed during the bust the damage is already there"

Overvaluation in the Stock Market

The price-to-earnings ratio of the traditional 60-40 portfolio of stocks and bonds has reached historically high levels.
Previously, such high valuations preceded significant downturns in the market, like the Panic of 1901, the Great Depression, and the tech bubble.
The unprecedented money printing and the lowering of interest rates in the past two decades have led to an extended boom phase, pushing the valuation of the portfolio to 130-year highs.
A correction has occurred, but the risk remains high, indicating that the pain of economic shocks is just starting.