The World Economy is Still in Depression

The world economy is still in a depression. Whether investors measure it by spreads between safe and risky bond yields, economic growth, inflation, debt levels, or trade balances, the world economy is still in a depression and likely will be for some time.

Start with bond markets and notice that U.S. bonds are trading at all-time low yields. The 10-year treasury yield traded as low as 1.396 percent early Monday, well below current inflation levels of around 1.7 percent. Investors are willing to pay the U.S. government to keep its money. This is a government with spiraling deficits, a lame-duck congress that will do nothing about the deficits, and debt-to-GDP well over 100 percent and climbing.

U.S. bonds are not the only ones to see extremely low yields. Yields on short term bonds in countries such as Germany, France, Switzerland, and Denmark have all gone negative. Germany auctioned one-year bonds at a yield of -0.54 percent. Adjusted for inflation, investors are willing to pay Germany approximately 1.5 percent just to get their money back. It is not so much a question of return ON investment, or ROI, but more of a question of return OF investment. By paying so much just to get most of their money back, investors in the market are indicating that they are just too afraid to own anything risky.

Another indicator of a depression or recessionary economy is the velocity of money. For those less economically inclined, the velocity of money is the rate at which money moves through the economy. As the chart above shows, the velocity of money has fallen to a multi-decade low. The velocity of money is a proxy for credit growth, as banks will send money out as new loans faster in good times and retract lending, hoard cash, and thus decrease its velocity in bad times. As banks continue to hoard cash, the velocity of money slows, credit growth contracts, and the effects of deleveraging hit the economy.

The global economy has been deleveraging since late 2007 after the credit bubble began to burst. Homeowners have either walked away from mortgages, paid them off, or defaulted outright. Individuals may have finished deleveraging in this sense, however they are refusing to take new loans to spur new credit growth. High unemployment, stagnant wages, and inflation in healthcare, food, and education costs are limiting the purchasing power of individuals. Also, low interest rates make any savings earn effectively nothing and make them a losing investment when adjusted for inflation.

Lastly, lackluster GDP growth has seen the U.S. economy approach the so-called stall speed. Stall speed is where the U.S. economy grows just enough so that tax revenues for the government just barely match interest expenses. However, this is also a scenario that causes deficits to spiral. As tax revenues only meet interest expenses, the government has to continually fund itself with new borrowings to fill the budget. Thus, economists conclude that stall speed is as bad as zero growth and is effectively recessionary.

Multiple economic indicators are telling investors that the economy is stuck in a rut. As savings collapse due to low interest rates, growth stalls, and inflation roars, consumers are stretched extremely thin. Eventually, these factors combined with high unemployment and slowdowns abroad could force consumers to effectively give up and start spending less. Once this happens, companies could see revenues start to fall and the dreaded spill-over to the "real economy" could begin. If this happens, pray that Chairman Bernanke can get even more creative with his policy responses.