Jason Dorrier
Into Perspective

Depression Economics II

By, 07/02/2010
Let's bring back cummerbunds, fedoras, and plus-fours. Fashion is cyclical, and so is economic debate. It was widely popular to compare late 2008 to the onset of the Great Depression, and now a second round of dour comparisons are appearing—this time to the Depression era's second act in 1937. There's another comparison to the troubles of 1873 and beyond (if only because the lesser severity makes up for earlier erroneous forecasts of another Depression). But that comparison lacks bite. The statistics back then are sketchy and annual only—not to mention the country was in monetary disarray after the Civil War, we had no central bank, let alone fiscal strategy, and the US was itself an emerging market, not a developed juggernaut.

First things first. Let's take a look at just how nonsensical Depression comparisons seem when you put the numbers side by side. (BEA figures here.)

1.       The Great Depression (starting in 1929) knocked 50% off nominal GDP over 3½ years. It's a little tricky calculating real GDP back then and official numbers are annual—which is significant because annual data cuts off the September 1929 high and the March 1933 low. But even annually and after accounting for the buoying effects of deflation, GDP shrank roughly 27% from 1929 to 1933.  

2.       GDP shrank 2.7% nominally and 3.8% on a real basis peak-to-trough in this recession. Both are a fraction of the Depression's first year real loss, and about one-tenth the size of total real GDP losses. You'd need roughly 10 recent recessions—back to back—to match the Great Depression. It wasn't just more severe—it was much, much, much more severe.

Magnitude alone shows how very different these two episodes were. And some skeptics admit this—even take credit for it. So, we avoided another Great Depression—the argument concedes—by learning from our mistakes and dosing markets with massive monetary and deficit-financed fiscal spending.

But back then, the government lacked the gumption to keep stimulus in place until we'd fully recovered. FDR tried to balance the budget, and we got round two of the Depression in 1937-38. With austerity en vogue, are we in danger of making the same mistake? Depression-heralds thinks so. Nominal GDP declined a whopping 16% in less than a year in 1937-1938—the decline was so fast, annual real GDP doesn't do it justice. So let's say today's austerity efforts (which are all currently mostly "proposed" austerity efforts—ultimately politicians may lack the will to follow through), if enacted, stay true to scale at one-tenth the Depression era—maybe we get a -1.6% decline? Not great, but not disaster. And, again, best guesstimates say all that planned "austerity" doesn't fully materialize. The US notably has yet to jump on the austerity bandwagon. Even the cuts in the biggest European countries aren't that draconian.

Admittedly, there are troubles in Europe, and some of them are material. That region might very well experience slower growth going forward. But on a global basis, most fears seem overdone. So far, most economic stats, even through the European debt crisis so far, continue to expand.

And here's something else of note you'll not have heard emphasized many places. Those arguing we'll see a 1937 redux mostly assume we pull the fiscal rug before the economy fully recovers from the first round of losses. But nominal GDP exceeded its previous peak (an all-time high) in Q1 2010—nine months after the Q2 2009 trough. Real GDP is just 1.3% below its previous peak. I'll say that again—we're basically at past economic output highs! Even a couple quarters' marginal economic growth pushes real GDP back above that peak level. And incidentally, real GDP below nominal GDP shows moderate inflation—a far healthier sign than the alternative.

No one seems to be noting nominal GDP is already higher than its previous peak, or that real GDP is just behind it. Maybe that's the reason the argument glosses over economic growth and emphasizes unemployment. Granted, unemployment is no fun, and the human element hits home for almost everyone. But in the last major recession in 1981-1982, unemployment jumped above 10% for 10 months and took a couple years to gradually settle back to more reasonable levels. Meanwhile, economic growth moved ahead meaningfully. The two don't move in lock step, and never have. Extended high unemployment alone doesn't make for economic depression. (And remember "high unemployment" is as relative as GDP losses—unemployment hit 25% in the early 1930s, and after declining dramatically into 1937, spiked again, not dropping below 10% until 1941.)  

One last point. This argument seems to favor fiscal conservatism as the primary cause of Act Two of the Depression in 1937. But at most, it shared that dubious distinction with another major monetary error on behalf of the Federal Reserve. Worried about inflation, the Fed used its new power over bank reserves to crank requirements higher over ten months beginning August 1936. After each move, banks, still in a conservative mood, scrambled to reestablish their previous level of excess reserves—tightening money far more than the already extremely tight reserve requirement implied.[1] The money supply hit a brick wall in June 1937, falling 2.4% over the next year, the third most severe contraction in history to that point, outpaced only by the contractions in 1920-1921 and 1929-1933.[2]

If Ben Bernanke was such a fine student of history in 2008, I doubt he's going to walk into another 1937 blindfolded. The target rate continues at a very low 0%-0.25%, and the Fed remains committed to keeping it there for an "extended period." Additional liquidity programs, begun in the panic, have expired because no one's using them, but the framework's in place if needed. Monetary policy around the globe remains easy and flexible overall. Only the countries on the leading edge of the recovery, many of them in Emerging Markets, have begun to dial back monetary ease.

The economic pain of the Great Depression reverberates to this day. No one wants a sequel. But before we jump headlong into Depression-sized forecasts, we should get relative. We've just had a severe recession. But does today resemble the 1930s? Not so much.



[1] Milton Friedman and Anna Schwartz. A Monetary History of The United States: 1867-1960. Princeton University Press, Princeton, 1963. Page 518-527.

[2] Milton Friedman and Anna Schwartz. A Monetary History of The United States: 1867-1960. Princeton University Press, Princeton, 1963. Page 544-545.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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