Great Depression 2.0 Is Not The Original

Includes: ERX, IAU, SBM, SPY, VBK
by: MissionIR

When, in recent months, television viewers were treated to scenes of mile high dust storms rolling across parts of Texas and Arizona, the eerie sense of history repeating itself was inevitable and widespread. Even a decade ago, such events would not have been so quick to conjure up comparisons with the Dust Bowl of the 1930s and the Great Depression. In the context of today’s economic turmoil, it’s unavoidable.

Nobody suggests that the economic structure, along with the systems and technologies that support it, are the same now as they were at the outset of the Great Depression in 1929. Instead the concern seems to be that there could be some sort of larger underlying principles, lessons not learned, driving America, and perhaps the world, down a catastrophic path uncomfortably parallel to the past. Not lost in the comparison is the fact that the county’s greatest depression also ended in the country’s, and the world’s, greatest war. Few people are around now who actually lived through those times, but they could be forgiven for feeling that the world they entered bears an unnerving resemblance to the world they’re now preparing to exit.

And yet, although there are similarities with the Great Depression, including falling real estate values and a plunge in home ownership, many traditional measurements serve to separate the two greatest economic crises of the past 100 years.

  • In the three year period between the beginning of 1930 and the end of 1933, over a third of America’s banks had gone out of business. Compare this to the three year period between the beginning of 2008 and the end of 2010, where a total of 322 banks failed, less than 4% of FDIC-insured commercial banks. So far, in 2011, there have been less than 100, trending down from the peak year of 2010.
  • In 1933, unemployment approached 25% of the workforce, a number made even more impressive considering the fact that women were less likely to provide a second income. As of October, 2011, the U.S. unemployment rate remains at just over 9%. Although certain accounting differences come into play, the two rates are still far apart.
  • On September 3, 1929, the Dow Jones Industrial Average ended a climb that, except for a down year in 1923, had gone on since 1921, and had seen the Average go from less than 68 to a September 3rd high of just over 380, before beginning its long slide. On October 28th and 29th, 1929, the slide turned into an avalanche, with a 22% drop in two days. Three years later, in July of 1932, the DJIA hit its low of just over 41. It was a loss of approximately 90%. The market wouldn’t return to its 1929 high until late 1954.

Beginning in the mid-1980s, the market took off again. Although there were serious dips along the way, such as the record breaking but quickly reversed 1987 hit of 22%, the DJIA finally reached a new peak of approximately 14,000 in 2007. By spring of 2009, the recession had hit, knocking it down to around 6,600, a huge drop, though nowhere near 90%, and, of course, it has recovered substantially since then, to the 12,000 range.

  • U.S. GDP fell by over 30% between 1929 and 1933, before beginning a fairly sharp climb, reaching its former high in 1936, and then peaking in 1944. By comparison, there was a 3%-4% drop in U.S. GDP in 2009, based upon purchasing power, the first such drop in decades, but minor compared with the Depression.
  • International trade plummeted in the Great Depression, aggravated by well-intentioned protectionist policies designed to protect workers. The volume of American exports was cut in half, with agricultural exports being hit especially hard, putting many farmers out of business. Today, free trade is more likely to be seen as a solution than a problem, with Obama signing free trade deals despite opposition from labor leaders and members of his own party.
  • Finally, although images of mountain-sized dust storms have made the news, they owe their appearance more to the increasing prevalence of cell phone videos than to a Dust Bowl rebirth. Anyone living in Phoenix, can tell you that dust storms are a normal occurrence, though the recent droughts have boosted the dust supply. The Dust Bowl was fueled not only by drought, but by improper land management and large tracts of abandoned farmland, making possible dust storms of immense proportions, some of which blew all the way across the country to the cities of the East Coast.

None of this, of course, does anything to suggest that current economic travails could not get far worse, following a path that eventually surpasses the Great Depression in both scope and depth. The question is not how the current situation is like the Great Depression, but rather how it is qualitatively different and potentially more earthshaking, the single most visible difference being the federal debt.

Until World War II, U.S. federal debt had remained well under 50% of GDP, increasing in times of war and then falling back to the 10% to 20% range. By 1920, following World War I, gross federal debt had risen to 30% of GDP, but then decreased from 1920, until 1930, when it reached approximately 20% of GDP. Although the federal debt exploded during World War II, exceeding 100% of GDP, by 1980 it had dropped back to the 30% range. However, between 1980 and now, the debt has again exploded, due to increases in defense expenditures applied to win the cold war and the war on terror, and more recently to decreases in tax revenue from the slow economy along with expenditures to stimulate the economy. In addition, entitlement programs (especially Medicare, Medicaid, and Social Security) have increased with the growing cost of healthcare, together with an aging population.

Gross federal debt now exceeds 100% of GDP, as in World War II. It’s a situation that can be reversed with economic growth and careful reductions in spending. But the ultimate concern is that we might not get there before debt grows so large that interest payments reach a tipping point, a percentage of GDP where a default of some sort becomes imminent.

Great Depression 2.0 is a dramatically different version from the original, and it’s because investor approaches are coming in from so many varied directions. Is gold another bubble, or the only solid ground left on which to stand? Will the value of cash be wiped out by hyperinflation, or will all physical assets follow the deflationary trail of real estate? Is the market ready for a second fall, or will it match the 25-year run from 1942 to 1967, where the DJIA went from 95 to nearly 1000? More importantly, will Europe and the U.S. get their acts together, encouraging growth and financial responsibility, or will politicians and big finance put their own short-term interests above the good of the people?

If you’re not Warren Buffett, and feel diversification is the only safe way to approach absolute uncertainty, consider a diverse collection of ETFs, including the following five popular prospects:

  • VBK - Vanguard Small-Cap Growth

(Moderate to aggressive small-cap growth portfolio)

  • IAU - iShares, Gold Trust (Not a standard ETF, it seeks to correspond to the day-to-day movement of the price of gold bullion)
  • ERX – Direxion Daily Energy Bull 3X Shares (Seeks high daily investment results following Russell 1000 Energy Index)
  • SPY – SPDR S&P 500 (Corresponds to the price and yield performance of the S&P 500® Index)
  • SBM – ProShares: Short Basic Materials (Corresponds to the inverse of the daily performance of Dow Jones U.S. Basic MaterialsSM Index)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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