What Would a 21st Century Depression Look Like?

Here is a quick look at an article from the WSJ that asks the question: what might a Depression look like in 21st century America?

(From The WSJ): "In the wake of the biggest financial shock since 1929, economists say the odds of a depression are less than 50-50 -- though still uncomfortably high. But even if a depression comes to pass, a 21st-century version would look very different from the one 80 years ago.

There is no consensus definition for "depression." Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%, and puts the odds of a depression at about 20%. Many economic historians say the line between recession and depression is crossed when unemployment rises above 10% and stays there for several years.

The current recession, though severe, is not at depression levels now. Unemployment in February was at 8.1%, not as bad as in the early 1980s -- the last time the idea of a depression was being kicked around seriously, when it remained over 10% for 10 months. In the Great Depression it reached 25%

...Today's government response is a far cry from the early 1930s, when the Fed raised interest rates, the infamous Smoot-Hawley Tariff Act crushed trade and Treasury Secretary Andrew Mellon's prescription for the economy was "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate."

"The Great Depression was a mass of policy errors that made it worse," says historian and investment consultant Peter Bernstein, 90. "This time we have our fill of policy errors, but at least they're not making it worse."...

...The different structure of today's economy means that a modern depression would differ from the Great Depression of the 1930s. Fewer than 2% of Americans working today have agricultural jobs, compared with one in five in 1930. Three-quarters of today's workers are in service-related jobs, which tend to be more stable than manufacturing, compared with fewer than half in 1930.

And then there are the social-safety-net programs that emerged after the Great Depression to blunt the blows. "There were no unemployment insurance, no food stamps, none of the automatic things that maintain some income for people who are out of work," says former Massachusetts Institute of Technology economist Robert Solow, a Nobel laureate. Mr. Solow, 84, grew up in Brooklyn, N.Y., and remembers his parents' constant worry about the next month's money….

...As a University of Chicago student during the Depression, Mr. Samuelson remembers attending economic lectures that seemed completely out of step with the times, based on laissez-faire principles that stopped making sense after the 1929 crash. "I was perplexed because I could not reconcile the assignments I got from these great economists with what I heard out the windows and I heard from the street," he says.

Starting in the 1980s, the U.S. saw an extraordinary period of economic quiescence, where growth was steady and policy makers dealt with financial crises handily. Economists began to doubt the possibility of a financial crisis so severe it would upend the economy. And that left them as blind-sided as their counterparts when the crisis came 80 years ago."

For the most part I agree with the article's overriding theme: our economy has changed so much that a modern day depression (or severe recession) won't play out like the one from the 1930s. However that doesn't mean that a 21st century won't "hurt" (in relative terms at least) as much as the last one did, nor do we really know how this one will play out against the current structure of the economy. Especially since the current downturn is invalidating a lot of the economic thinking that led us down this path in the first place.

In many ways you could argue that the situation is like your NCAA Tournament Bracket: even if you pick the winning team, you only have a vague idea of "how" they will win and what kind of a game it will be. There are so many unknowns at this point that predicting how a prolonged Depression or "lost period" will affect us is anyone's guess.

I have to admit that I had to laugh at the commentator who said that the current policy mistakes aren't making things worse, as I truly believe that the administration's efforts to fight foreclosures will prolong the housing downturn by several years. Not to mention the fact that many of the policies being implemented seem more aimed at resurrecting the old days, than they are at working towards adjusting and preparing for the new ones.

Perhaps the greatest lesson to be taken from this article is the fact that economists in the 1930s were teaching theories that were out of touch with reality, can not the same thing be said of much of the economic and financial theory being taught today?

In any event if I had to guess what the future holds: I predict that we're going to fall into a multi-year "lost period", where the biggest pain will come from the massive adjustments we'll all have to make with respect to our economic expectations, and in terms of how we manage our finances. While it won't necessarily be an "official depression", the pain inflicted from the readjustment may very well make that official designation moot in the eyes of many citizens. In my view the post recessionary "lost period & adjustment" coupled with the cost of latter day economic interventions, is where the real pain from this recession/depression will be felt.

In any event the article is a good read and you can find more here, you can also find an interactive graphic that looks at past recessions and recoveries here.

Sources:

The Wall St. Journal: "How a Modern Depression Might Look -- If the U.S. Gets There" -- Justin Lahart, March 30, 2009.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[Dave Wrixon:]

I think the problem most people are having problems getting their head around is the linkage between depression and price deflation and the confusion of language associated with both.

In real terms we are going to see a huge and on going destruction of wealth, whilst at the same time seeing ever greater circulation of money. All the goal post will be moving at once, thus leading to widespread confusion. And of course that confusion is deliberate.

Inflation is and will continue to be significantly understated, so the interest rates are and will continue to lower than can be economically justified particularly in the US. This in turn will mean that GDP figures, which will include ever increasing amounts of waste and ever less value will be increasing overstated due to the deliberate underestimation of rising living costs. And of this is being done to try to ensure that Uncle Sam can spend his way out of trouble without incurring dollar collapse or high interest rates costs.

Of course, it is highly unlikely that the World will be fooled for long enough for Obama to get away with this ruse, so the dollar will collapse and that will cause hyperinflation in the US, but that in turn will only provide increased scope to overstate GDP, thereby proving that there was never really a significant recession in the first place. However, the average American, dispite his educational disadvantages will probably notice that his living standards are not what they were. Standing in the cold queue for soup leaves a lasting impression on even the most hardy optimist.

Apr 01 08:03 AM

[paxjds:]

21st Century Depression is the following:
1.Deflation with Massive Government Bailouts
2. Fake Boom/recovery for 2 years or so due to massive Bailouts
3. Then Very high inflation and Taxes for years to come that will have us in the longest recession in history.

Apr 01 08:43 AM

[kelm:]

We are a much more fragile society today than we were then because we have become so dependent on an input of resources to live our everyday lives. For example, vast numbers of people live in locations where an automobile is essential requiring a constant draw of resources for something as simple as going to the store for groceries. In the 1930's you either could walk, take your bike, or ride a buggy in the countryside (if you didn't grow it all yourself).

True many of our jobs are service but we have been graduating more hair stylists and massage therapists for some years than engineers. Those low rung jobs will disappear very quickly. So we will find ourselves beset by a set of very different problems.

Taleb stated some weeks ago that he regarded the US and Britain as the two most fragile societies because they were the two most advanced and so removed from daily hardship. By contrast, India or China would hardly notice the disruption.

Apr 01 09:07 AM

[MGA_1:]

Well, a *lot* of people can't afford their home loans and are in default. This is only going to get worse. Commercial real estate is going to start getting worse. So, a lot of people out of their houses. Many more banks going bust. Ghost malls. I don't trust the govt stats and people are always revisionist with economic descriptions. I hesitate to call this just a recession.

Apr 01 09:07 AM

[Ferdinand E...:]

Interesting article, though with several defects. One thing however is certain, economists today are much, much, much ,,,,,MUCH smarter than those at the disposal of Presidents Hoover and Roosevelt. How do I know this? The answer is that I read many of the economics textbook written by those earlier economists. Robert Solow and Paul Samuelson were mentioned in this article. both are Nobel laureates, Solow is brilliant and Paul Samuelson is more than brilliant.

Apr 01 09:32 AM

[jay fredric...:]

The WSJ article is well done, the rest is babble from someone most folks have never heard of. Giving us your opinion of a coming depression is worthless. Who cares?

Apr 01 11:22 AM

[cabaretewil...:]

A recession is when my neighbour loses his job. A depression is when I do. Seriously, here are some differences between 1930 and 2009. Back then they patiently lined up for soup and bread. Now the hungry hordes will take clubs to the stores and steal what they want. Back then those responsible for lost fortunes jumped off of high buildings. Now those responsible accept millions in bonuses and put their money in the Cayman Islands where they can be found on the beaches and golf courses. Back then a WWII pulled the country out. Now.....

Apr 01 12:34 PM

[nukldrager:]

Great comment especially the splendidly scary juxtaposition in the last paragraph


On Apr 01 09:07 AM kelm wrote:

> We are a much more fragile society today than we were then because
> we have become so dependent on an input of resources to live our
> everyday lives. For example, vast numbers of people live in locations
> where an automobile is essential requiring a constant draw of resources
> for something as simple as going to the store for groceries. In the
> 1930's you either could walk, take your bike, or ride a buggy in
> the countryside (if you didn't grow it all yourself).
>
> True many of our jobs are service but we have been graduating more
> hair stylists and massage therapists for some years than engineers.
> Those low rung jobs will disappear very quickly. So we will find
> ourselves beset by a set of very different problems.
>
> Taleb stated some weeks ago that he regarded the US and Britain as
> the two most fragile societies because they were the two most advanced
> and so removed from daily hardship. By contrast, India or China would
> hardly notice the disruption.

Apr 01 01:19 PM

[henarl:]

In the 30s the population was more spread out in small towns and farms and there was no TV and internet to disseminate bad news so rapidly. Today people are much more concentrated in large cities and their suburbs and a daily ration of bad news is prevalent. This leads to a much more volatile society that no longer has the same respect for government authority or law and order and there will be riots, looting, racial and class warfare, instead of docile soup lines.

Apr 01 01:24 PM

[Larrysyr:]

2 percent of our population produces plenty of food for everyone. There's lots and lots of surplus housing. We have the means and the capacity (if not the will) to distribute necessities to the needy.

While the economy will never be the same again, especially for autos, banking, and newspapers, this is not a repeat of the 30s.

Apr 01 03:06 PM

[n6532l:]

I hope you are wrong but I am not going to bet against you.

Apr 01 11:29 PM

[Gregman2:]

Justin Lahart's spin amounts to lipstick on a pig. "Gee, when we were young we had to walk 5 miles to school in the snow--compared that, you kids have it easy." Rubbish. Very few economists really grasp the full magnitude. It's folly to think otherwise.

Apr 02 12:19 AM

[Preston Pou...:]

The thing I find most interesting is that the Wall Street Journal, which one would expect to defend the free market, is helping to foster the idea that the free market failed us during The Great Depression.

Andrew Mellon, Secretary of Treasury, did suggest liquidation to Herbert Hoover. That was in 1929. Hoover ignored his advice and instead launched a host of government sponsored price support and public works programs. This article does not mention this but instead leads us to believe by inference that Mellon's advice was followed and exacerbated The Great Depression.

The article then goes on to quote Mr. Samuelson pontificating that these laissez-faire principles "stopped making sense after 1929." Well policy makers at the time certainly seemed to act like it. Both Hoover and FDR launched the largest government intervention programs this country had ever seen at that time. These programs did little to actually end the depression. Given that our flirtations with Communism only seemed to prolong the depression and since the free market combined with hard money had never produced such a long and protracted downturn, one would have thought that someone at the Wall Street Journal might have pointed out that laissez-faire principles work just fine.

Of course, you know what they say about those on Wall Street. They scream laissez-faire when they're making money and call for Socialism when they're broke.

Apr 02 12:46 AM

[Larrysyr:]

History is littered with economic downturns longer and more severe than the Great Depression.

1873-1896 in the U.S. springs to mind. The South Seas Bubble in England and the Tulip Mania craze in Holland both led to long depressions.

Or maybe the fall of the Roman Empire. That one took about 1000 years to recover from.

My point is that the "free" market, left to its own devices, does not necessarily self-correct, and historically has not necessarily benefitted the majority of the population. Government is needed to provide the infrastructure of property and contract laws. Government is also needed to prevent the outright banditry that destroys confidence in the market (see Bernie Madoff).

Left without constraints, the market also tends to produce monopolies, which benefit the owners of the monopoly but no one else.

The argument that government involvement and capitalism are incompatible misses the point. They are inextricably intertwined, and our economic system depends on a balance between the 2. The correct balancing point is a subject of debate, but dividing the 2 into polar opposites simply ignores the real and necessary interconnections.

Phrases like "our flirtations with Communism" may grab attention, but serve mainly to cut off debate rather than advance it.

Apr 02 10:12 AM