There’s a debate going on among investors as to whether or not we have bubbles or distortions built up within the economy to the degree that a recession may be necessary to liquidate distortions, mal-investment, and the misallocation of resources.

The bulls say "no". They point to a profits recession, the absence of inflation, and the sluggishness of business, the consumer, and the economy. They believe the worst is ending, and the economy will improve from here.


The bears say "yes", and point to the Feds money creation allegedly causing artificially high stock and bond prices. They point to sky high art prices, increasing rents, and the disparity between the rich and the poor. They argue the whole economy is distorted by artificially low interest rates.


I want to argue a third perspective. None of the factors above, pro or con, are sufficient to cause a recession. But the crashing commodities sector is. Such was the case in the lead-up to the Great Depression. There were many contributing causes of that event including a trade war and the extremely expansionary and eventually contractionary monetary policies of the Fed. Leverage in the form of margin encouraged by the Fed, led to wild speculation in stocks and housing.


But one event was a less publicized cause of the Great Depression; it was the deflation in the agriculture sector. As stock prices soared and the "roaring 20's" was in full bloom, agriculture prices began to fall. The industrial sector continued unaffected, but the fall in commodity prices became so extreme, many companies could not survive and went out of business. The depression in the agriculture sector became severe. It was characterized by massive bankruptcies and unemployment and it led to those affected no longer being able to afford the products in the industrial and service sectors.



This huge distortion led to continuously evaporating demand in the economy in general and suddenly prices began to fall in the economy as a whole. Home prices began to fall and foreclosures began to increase as many in the economy could no longer afford their mortgage payments. All those with debt began to feel the pain of falling wages and incomes. The burden of debt brought loan defaults, and de-leveraging began in earnest.


The stock market crashed. Margin loans were called and as stock prices fell, wealth evaporated and consumers stopped buying. The economy imploded. Banks closed as a run on cash emerged, bankruptcies ensued, and unemployment soared. Importers couldn't import due to a worsening trade war as trade tariffs and quotas were imposed. And exporters couldn’t export because of our once trading partners imposing their own tariffs and quotas in retaliation. Real estate sales came to a stand-still. Farmers lost their farms. And investors lost their fortunes.



It is this current ongoing crash in the resource sector including commodities, energy, and agriculture that is the greatest threat to the economy. This alone can lead this nation into a recession. As we speak leading indicators in the manufacturing sector are falling throughout the country. Manufacturing could be being pulled down by the falling resource sector just as it was decades ago. I seriously doubt that this will cause a depression, but a recession may be in the making.



To preempt this trend, the Fed needs to adapt an anti-deflationary monetary policy. So far no central bank has been able to do that. And the federal government needs to stimulate the economy by reducing taxes and regulations that are suffocating the economic productivity of this nation. Yet, we see the Fed raising interest rates and talking about contracting the money supply as was done prior to the Great Depression.


Since none of the measures outlined above are likely to happen any time soon, we can only stand by and hope that this commodity deflation will run its course and the market will right itself. As they say, "the cure for low prices is low prices". Either we are approaching the end of the deflationary recessionary bias plaguing the world – or the beginning.



Paul Nathan