We might not be in such a pickle now if economics had started to become more of a science and less of a religion by following Fisher’s lead, and abandoning key beliefs when reality made a mockery of them. But instead neoclassical economics completely rebuilt its belief system after the Great Depression, and here we are again, once more experiencing the disconnect between neoclassical beliefs and economic reality.

Amen. It’s not what you don’t know that gets you, it’s what you know that isn’t so.

The Legislature and Gov. Arnold Schwarzenegger are facing increasing criticism from the public and each other that they lack a sense of urgency to pass a budget that solves the state’s $19 billion deficit.

In past years, the state’s top five political leaders would be negotiating behind closed doors, working nights and weekends to pass a late spending plan. Not this year.

The legislature doesn’t want to deal with the problem because the controlling Democrats now that they are the problem, that they have been bribed and browbeaten by the state employee unions into providing ludicrously excessive compensation and benefits to state employees. Governator Schwarzenegger is demanding at least baby steps towards solving the problem, but of course the unions will not tolerate them.

But here’s the plain truth: California simply cannot solve its budgetary problems without addressing government-employee compensation and benefits.

True enough, but the baby steps are not nearly enough. The whole problem can be solved by bringing state employee compensation back to private sector parity – that is, cut it in half. Not going to happen until the eventual collapse, of course. But not doing it guarantees the eventual collapse.

But that doesn’t matter to the boyz, who will take any excuse to deny reality. And every time they do so, they steal from the future.

In the real world, economic collapse is coming closer every day. I know I was going to lay off reposting stuff from zero hedge, but for archival purposes I do record the following from Albert Edwards at SocGen, arguing for a target of 450 on the S&P :

Investors cannot move for the weight of broker research comparing the current conjuncture in the US with Japan a decade ago. While bond markets at least, move to discount deflation, most sell-side analysts still say the current situation is unlike Japan a decade ago. They are right. Things now in the US are much, much worse than Japan a decade ago.

Equity investors are in for a rude shock. The global economy is sliding back into recession and they are still not even aware that these events will trigger another leg down in valuations, the third major bear market since the equity valuation bubble burst.

This lack of awareness reminds me of reports this week that a 35 year old Polish man hadn?t noticed for five years that he had a bullet lodged in his head. Like the equity market in 2000, the Polish man had been partying too hard to notice that he had been shot. The BBC report the police as saying “He told us he remembered having a sore head, but that he wasn’t really one for going to the doctor.”

As the equity bloodbath of the last decade enters its final, even bloodier phase, investors continued optimism also reminds me of the Black Knight in Monty Python & the Holy Grail – link. Despite being grievously wounded by King Arthur, the Black Knight makes light of his injuries which he dismisses as a flesh wound. The vast bulk of the investment industry fails to appreciate that we are locked in a structural bear market and about to enter Act III.

Personally, I think he’s on the high side. But, whatever. I would take it.

Now we’ll tell you why this is a depression, and not just some garden-variety recession. For all the chatter about whether the recession that started in December 2007 ended sometime last year, here is what you should know about the historical record. The 1930s depression was not marked by declining quarterly GDP data every single quarter. In fact, the technical recessionary aspect to the initial period following the asset and credit shock goes from the third quarter of 1929 to the third quarter of 1933.There was another deep downturn in 1937-38, but the initial recession lasted four years and if you read the Benjamin Roth diary, you will see the euphoric response to any piece of good news — as brief as they may have been. Such is human nature and nobody can be blamed for trying to be optimistic; however, in the money management business, we have a fiduciary responsibility to be as realistic as possible about the outlook for the economy and the markets at all times.

What is important to know is this. In that initial four-year economic downturn, from 1929 to 1933, there were no fewer than six — six! — quarterly bounces in the GDP data. The average gain in these up-quarters was 8% at an annual rate! But because they proved not to be sustainable, the National Bureau of Economic Research (NBER) refused to declare that the recession officially ended, even though the stock market rallied 50% in the opening months of 1930 on the belief that the downturn was about to end. False premise. And guess what? We may well be reliving history here. If you’re keeping score, we have recorded four quarterly advances in real GDP, and the average is only 3%.

It wasn’t really until we could put together a string of very solid GDP data in 1934, 1935, and well into 1936 that the recession definitely had come to a close and at least an intermitted period of solid growth took hold. That is, until the policy mis-steps of 1937. All that second recession of the decade proved was just how fragile the post-bubble recovery really was.

The 80% rally of 2009 that whipped up so much excitement at the time and reignited all the criticism over the “bears” and how they didn’t understand the power of stimulus and how their call over the 2007-08 meltdown was just dumb luck, will be remembered in the future about as much as the 50% rally of the 1930. It’s funny how nobody seems to recall that massive dead-cat bounce off the lows; people just remember 1930 was a period of soup lines, bread lines, and unemployment lines. Maybe it’s because we ended up with a classic Bob Farrell-like third wave — the fundamental downtrend to a new low over the next two years, and the overall economic malaise with double-digit unemployment rate lasted for another decade even with massive doses of government intervention.

Then the Jerome Levy Forecasting Center weighs in:

The dominant influence on price trends in the near future and for years to come will be the deflationary influence of chronically high unemployment. The economy not only has gone through a deep recession but also has entered a contained depression, a long period of substandard economic performance, chronic financial problems, and generally high unemployment. The contained depression is likely to last about a decade; it will end in the latter half of the 2010s at the earliest and could stretch into the 2020s

In the years ahead, chronic high unemployment will weigh heavily on labor costs; chronic economic weakness will tend to keep profit margins under pressure and firms focused on cost control; and global instability and large areas of depression (contained or otherwise) will reduce upward pressures on prices of imported commodities and are likely to cause these prices to fall much of the time.

Even if imported commodity prices, most notably oil prices, rise sharply at times, they will not have a large, lasting effect on inflation as long as labor costs are decelerating or actually falling.

Labor costs are the dominant inflation influence not only because they are the single biggest component of prices, but also because labor costs are heavily affected by compensation rates, which fuel consumer spending and are therefore tied to the ability of firms to pass on inflationary price increases to consumers.

The driver is excess debt, which must be reduced to a sustainable level before the economy can resume a growth trajectory. Just look here and you will see why, the aftermath of the housing bubble. And the folks who brought you a succession of such bubbles are still in charge, serene in their beliefs and utterly and completely oblivious to the disastrous effects of their attempts to manage the economy.

And by the way, a “contained” depression? Where have we recently heard that word?