Why a Repeat of the Great Depression Is Unlikely

There have been a number of analysts like Bob Prechter and Doug Short who believe that the pattern shown by the U.S. stock indices looks like a repeat of the 1930s and the Great Depression.

It is difficult for me to make the case that the current conditions make a repeat of the Great Depression inevitable, or even likely. James Hamilton of Econbrowser commented on Short’s analysis this way:

Among the factors that turned the hoped-for recovery of 1930 into the debacle of the Great Depression were a sharp hike in interest rates in October 1931 and a decline in the overall price level of 10% per year in 1931 and 1932. Whatever else happens, I don't expect those particular mistakes to be repeated by the Bernanke Fed.

In addition to Hamilton’s assertions about the Bernanke Fed, I would add a couple of other points that should be encouraging for the bulls.

Protectionist hounds are in the kennel

Countries raising their protectionist drawbridges was a factor that exacerbated the effects of the downturn in the 1930s. This time, it doesn’t seem to be happening. Recently, the Economist reported that global trade seems to have flattened out. Floyd Norris recently wrote in the New York Times that there are even hints of an upturn in global trade.

Countries all around the world seemed to have learned the open markets and free trade lesson this time around. Consider these headlines in the last few months:

• South Korea and EU reach free trade deal
• GCC, EU may sign FTA in Bahrain next month
• China backed free-trade area in Asia to launch in 2010
• Canadian PM Harper in Panama to sign free trade deal

What’s interesting about some of these headlines is that free trade is being embraced around the world, which is highly encouraging for the long-term macroeconomic backdrop. The fact that the EU, which has a history of bickering and isn’t known for being friendly to open markets, is negotiating free trade deals around the world is a bit of a surprise to me.

What if peace breaks out?

There are also geopolitical wildcards. What if the U.S. and Iran made peace?

Bruce Bueno de Mesquita, a specialist in game theory at NYU, forecasts precisely such an outcome:

Last year, Bueno de Mesquita decided to forecast whether Iran would build a nuclear bomb. With the help of his undergraduate class at N.Y.U., he researched the primary power brokers inside and outside the country — anyone with a stake in Iran’s nuclear future. Once he had the information he needed, he fed it into his computer model and had an answer in a few minutes…

...Iran won’t make a nuclear bomb. By early 2010, according to the forecast, Iran will be at the brink of developing one, but then it will stop and go no further. If this computer model is right, all the dire portents we’ve seen in recent months — the brutal crackdown on protesters, the dubious confessions, Khamenei’s accusations of American subterfuge — are masking a tectonic shift. The moderates are winning, even if we cannot see that yet.

Should these events, which are not on any market analyst’s radar screen, come to pass, oil prices would like fall because of a reduction in the geopolitical premium and equities would rally.

No Armageddon

In conclusion, it is highly unlikely that the world is going to repeat the mistakes of the 1930s. I am concerned, however, that it would make new mistakes.

In the short term, I continue to believe that the market is extremely vulnerable to setbacks. China seems to be the bellwether. The trajectory of the Shanghai Composite seems to indicate that China’s stimulus mini-bubble is bursting and the world is in danger of getting dragged into a double-dip slowdown, as China appeared to be the last engine of growth.

If a double dip does occur, investors should keep in mind that it is only a bear market, not Armageddon.

Comments

[Michael Clark:]

And what if Israel goes to war with Iran? I don't want to be myopic, but that seems like a much more reasonable turn of events than peace breaking out between America and Iran.

As far as protectionism, the Brookings Institute reported in May 2009 that:

Protectionism on the Rise: A Report on the Use of Trade Remedies During the Global Financial Crisis

Trade, Trade Disputes, G-20 Summit, Global Governance, Global Financial Crisis by Chad P. Bown, Nonresident Fellow, Global Economy and Development

May 11, 2009 —
Editor's Note: Despite G-20 promises to reducing trade protectionism and barriers, Chad P. Bown shows through new data and a new report that protectionism increased and spread 18.8 percent during the first quarter of 2009.

www.brookings.edu/arti...

The rise of White Nationalism in Europe and America and the increase in anti-semitism in both places is quite reminiscent of the 1930's. Do a google search on "The rise of white nationalism in Europe" and you will get a slough of tasteless anti-Jewish blogs, such as the one listed below:

news.ronatvan.com/2009.../

Note to the right on this page, the movie: "Blondes are Becoming Extinct."

I think you can make an argument that today is quite a bit like the 1930's in some ways.

Aug 23 07:31 AM

[Dave Wrixon:]

I too don't see much of a Geopolitical Premium at the moment but I could see a spike in Oil prices as speculators short the dollar.

Bernanke has no real control over interest rates. The markets will dictate those and they are about to go a lot higher.

As for the protectionist dogs being kenneled, that is only going to be effective if America can regain some level of competitiveness.
I agree it not desirable, but I would not say that it is unlikely.

Aug 23 08:10 AM

[Stephen Met...:]

Data fed into a computer model, and presto! peace breaks out between the U.S. and Iran? Why am I not overwhelmed by this argument? The points about the lack of parallelism to the 1930s are well taken, however. We have another problem, pointed out by many analysts, which the potential for significant inflation. Then, as advocated by Obama supporters, George Soros and Warren Buffet, the Fed must be prepared to drastically raise interest rates. Now, if this scenario plays out, we might indeed have increased similarities to the 30s.

Aug 23 09:45 AM

[socrateazz:]

The Great Depression was not armageddon either. And any depresssion is not likely to mirror past depressions unless the same cures are undertaken! How much can that be expected? Everything is fluid. One decision or action is unlikely to change the total markedly. The composite of all decisions do change things. Does a composite of all decisions lead to a greater probabillity of economy improvement? What is the real problem in the economy? Why? What will change things? Why? Was the great depression called the great depression while it was happening? What caused the name? Different areas act differently. Where I currently live actually survived the great depression better than most for varying reasons. But in the 1980's this area went through a depression length recession of greater than 10 years. What caused it? The loss of the major employer. Housing cost went from 20% greater than the national average to 50% below the national average. The first home buyers Got burned and were forced out. At one point almost half of the homes in the area were for sale. All because 7% of the area people lost their jobs. Once the trends changed negatively, more people supported by those workers lost their jobs, snowball effect took place. Once prices bottomed out, those who bought really saw the home prices permanently set lower. Most builders from that time went out of business or left the area. Twenty years later a new group of builders started to fill local building needs. Fortunately this area has not yet started to overbuild marketedly. I expect areas of excess building will experience serious problems. The Idea....If you build it, people will come will work when wanted or needed for the price paid will justify the building. If something prevents people from buying or needing what is built then there will be pressure on production. If their is enough pressure on production, then a price snowball effect will take place. Remember snowballs build as they go down hills, but other forces can cause anything to happen. Hope for the best. But expect the worst. Was a saying of the depression era. Why was that? Think about it.

Aug 23 09:58 AM

[prudentinve...:]

Everyone fully agrees that Bernanke will not repeat what he perceives were mistakes made in 1930, notably raising interest rates when they saw recovery as iminent.

However, it appears that Bernanke is making the same mistake that Greenspan made early in this decade, i.e. keeping interest rates artificially low for too long. This resulted in the housing, credit, and over-leverage bubble, which brought about the current crisis.

The consequences of creating an even larger debt bubble, whether government debt or private debt, are unknown, and may be even worse than the consequences of the known 1930's mistakes.

Aug 23 03:43 PM

[Ricard:]

I'd argue the Japan case - they've kept interest rates at near zero for more than a decade, and have yet to see another asset bubble.

But, anything is possible.


On Aug 23 03:43 PM prudentinvestor wrote:

> Everyone fully agrees that Bernanke will not repeat what he perceives
> were mistakes made in 1930, notably raising interest rates when they
> saw recovery as iminent.
>
> However, it appears that Bernanke is making the same mistake that
> Greenspan made early in this decade, i.e. keeping interest rates
> artificially low for too long. This resulted in the housing, credit,
> and over-leverage bubble, which brought about the current crisis.
>
>
> The consequences of creating an even larger debt bubble, whether
> government debt or private debt, are unknown, and may be even worse
> than the consequences of the known 1930's mistakes.

Aug 23 04:12 PM

[Jasper M:]

Author assumes the Fed controls interest rates. That is not borne out by history.
If you plot a history of Fed funds rate vs. the (market determined) T-bill rate, it seems pretty clear to me that the Fed does not lead - it Follows.
When the next leg down comes, and chain defaults and bank runs begin, you can bet your sweet behind that potential lenders will demand higher rates for putting their money (very much) at risk. Rates Will go up, and the Fed will accommodate, or be run over.

And very little of our current problems trace back to Iran. Like most dictatorships, they are sliding towards their own economic ruin, quite independent of the any military action by themselves or anyone else. Thus peace with them, while desirable, will not help the world much.

Aug 23 05:21 PM

[Mark Bern:]

There were computer models that predicted that housing prices would keep going up forever. Economist use models that continue to have little predictive value. I am sure that many of the commenters, including myself, have built computer models. We all know that the model is only as good as the assumptions that are built into it and that the assumptions are generally based upon historical precedents. I really don't think that there is a precedent for Iran/US relations,. especially since leadership changes and foreign policy changes occur in each over time. I'd love to see peace break out. I just don't trust a model that assumes (based upon its creator's bias) that it will happen.

Aug 23 05:24 PM

[Jimbo:]

I am inclined to agree with Jasper M. However, it is my understanding that interest rates are being held down right now by cooperative foreign governments buying Treasuries with currency they have exchanged with the Fed. Allegedly, this makes Treasury auctions look like a success with nominal interest rates. If this tactic is true, how long can it continue before the little dog, Toto, pulls the curtain back and exposes the "Wizard"?

Aug 23 06:29 PM

[Khyber Pass:]

Seems to me that greed and avarice on the part of those who ran the political and financial affairs of the country and those who lived on rents forced money to "trickle" upward, had a lot to do with the depression. When the ordinary folks don't have work for any reason, the depression will hit those at the lower levels first. Then the pain works it's way up to the bank manager level. The people who rake in the biggest bucks make sure they get paid first, while their bookkeepers and clerks take pay cuts. Scrooge had it right.
There is no depression to those who can afford to party on while the ship of state slowly sinks. They will always have plenty while those at lower economic levels get squeezed.
The corporate powerholders always rule, and the little guys have no way to take back their country. What's changed in the big picture since the 30s? Darned little, I'd say.

Aug 23 07:26 PM

[Erick Tippett:]

I find some of these assertions rather humorous in light of
historical cycles since 1873 here in which depressions have
followed on the heals of inflation followed by the deflation of
credit. "hints" of an upturn in global trade, U.S. and Iran making
peace?, these are more fantasy when one realistically exams
euro-american meddling in the middle east since before the
Balfour agreement . As far as Iran building a nuclear bomb is
concerned, I certainly hope Mr. Mesquita's "computer model"
is far more reliable and accurate than those used by U.S. banks
in projecting exotic stock market packages before foisting them
on the American public! "Market analyst's radar screen'', where
was this wonderful device in October 2008, or had you noticed
what happened to our indexes at that time? And the final dot on
all of this "Highly unlikely the world is goint to repeat the mistakes
of the 1930's", get a life fella, aren't you reading the headlines on
unemployment? And incidently, according to a study of over three
hundred years of market movement of British and American stock
markets indicates quite clearly that from 1720-1932 there occured
three depressionary declines in the markets. This study is based
on data from the British-American Stock Price Record 1700-2002!
Go study it, real hard!

Tally ho!
E. Tippett
Chicago, Illiniois

Aug 24 12:45 AM

[aNewEraBegins:]

"he fed it into his computer model and had an answer in a few minutes"


Really??? With a "source" like this in your article you may be a closet bear in bull's clothing.....

Seriously??? Were you TRYING to discredit yourself? I mean we know how well computer models worked on derivatives and credit default swaps.... I guess the "computer modeling industry" is about to turn it all around with this Iran prediction.

"Every computer model is constructed by a group of tainted, biased biological creatures, who ultimately impress their own flaws and inadequacies into the results." - J.T. Hutton

I for one am waiting for real A.I. to come out before I trust a computer model. Wait......

Sep 10 11:34 AM