Nobel laureate Joseph Stiglitz is on the tapes saying that with all deference to the blowout Q2 German GDP data, the continent is facing growing recession risks amid the radical cutbacks in government spending. Bank of England official Martin Weale pretty well told the London-based Times the same thing about the U.K. economic outlook. And don’t look now but credit default swaps in poor Ireland, which has tried to do everything right to turn its fiscal ship around, have widened 100bps in March to nearly 300bps, which implies a 22% chance of default within five years. Hey, where is its bailout?

Meanwhile, long-time bull, David Wyss, who is Chief Economist at S&P, said at a Tokyo speech (how a propos) that “I think there is still a realistic possibility in the U.S. that it’s slipping into this pattern like Japan has – 10, 20 years of stagnation.” Sacrilege! How can he get away with saying such a thing? And, if you want to know what Japan looks like — a decade after rates went to zero and with a 200% government debt-to-GDP ratio.

But look at the bright spot, we are finally exiting the denial stage and heading towards acceptance. That is progress in its own right. When Washington realizes that the solutions lie in supply-side policies that will promote growth in the capital stock and hiring/work incentives — education, infrastructure, payroll taxes, a coherent energy strategy (nuclear!) — and begin to abandon failed policies such as this ongoing emphasis on Keynesian short-term spending quick fixes, the adoption of “too big to fail” strategies, initiatives aimed at bailing out delinquent homeowners, measures that actually try to prevent market forces from working, initiatives that pay people to stay off work for 99 weeks with no thought behind skills improvement and training in return, and attempts at influencing the equilibrium level of asset prices, such as real estate, then indeed, when we have finally broken free from these failed interventionist and distorting manoeuvres, then we will likely have much more reason to turn optimistic.

Why 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.

We can understand how emotional the debate can get over whether or not we have actually just stumbled along some post-recession recovery path or whether or not this is actually a depression in the sense of a downward trend in economic activity merely punctuated with noise that is influenced by recurring rounds of government intervention. The reality is that the Fed cut the funds rate to zero, as was the case in Japan, to little avail (perhaps only making a bad situation less bad). Then the Fed tripled the size of its balance sheet — again with little sustained impetus to a broken financial system (see the op-ed on page A15 of the WSJ by George Melloan — The Fed Can Create Money, Not Confidence).

Keep in mind that by now the Fed was suppose to be shrinking its pregnant balance sheet but has refrained from doing so, though the Bernanke-led move to sustain its incursion in the capital markets is not being universally supported (have a look at the front page of the WSJ — Fed Split on Move to Bolster Sluggish Economy). Also keep in mind that the Fed sliced its economic forecast twice in the past two months and we are coming off a Q2 GDP growth pace that was likely little better than a 1% annual rate (as we will see post-revision this Friday). When you cut your forecast and the economy is barely growing faster than 1%, a renewed contraction cannot be ruled out (in fact, the monthly data showed this erosion to be taking place as we type).

How’s that for a reality check. It’s not too late, by the way, to shift course if you have stayed long this market.