Something I point out in presentations and in writing are the differences between recession, depression and financial panic. They can arrive together (as happened in 1929 and 2008), but usually the three conditions emerge separately and for different reasons.

A recession is a decline in output accompanied by rising unemployment. Recessions are usually short (two or three quarters, rarely longer) and mild (the recessions of 1990 and 2001 were mild although the recessions of 1974, 1980–1982 and 2008 were more severe) and are part of the business cycle.

Depressions are more rare (we had one from 1929–1940 and arguably have been in a new depression since 2007). Depressions can be much more severe (from 1929–1933 the Dow Jones index fell over 80% and unemployment reached 20%). Depressions may begin with panics or recessions but are extended due to policy uncertainty and liquidity constraints. A depression is not a mere business cycle blip but represents a prolonged period of below-trend growth.

Financial panics are different than both recessions and depressions. Panics are mainly psychological and represent a sudden desire for liquidity at all costs and widespread dumping of risk assets without regard to valuation metrics.

Panics emerge seemingly from nowhere. They can be brief, but also severe in the losses produced. Panics can be truncated by private intervention (J.P. Morgan in 1907) or public intervention (Ben Bernanke in 2008) or they simply run their course like an epidemic once the victims either die or recover.

This article features an interview with well-known analyst Mike Pento. He understands the recession-depression-panic distinction described above and argues that something like a panic followed by a depression is highly likely given stretched valuations, reduced liquidity and the inability of central banks to end a crisis as they did in 2008.

You don’t have to agree completely with Pento in order to take heed and make at least some preparation for the worst.

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