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The Recession Tracks The Great Depression

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The recession tracks the Great Depression

Green shoots are bursting out. Or so we are told. But before concluding that the recession will soon be over, we must ask what history tells us. It is one of the guides we have to our present predicament. Fortunately, we do have the data. Unfortunately, the story they tell is an unhappy one.

EDITOR’S CHOICE

Martin Wolf: This crisis is a moment, but may not be a defining one - May-19

Martin Wolf: Why Obama’s conservatism may not prove good enough - May-12

Economists’ forum - Oct-01

Martin Wolf: Tackling Britain’s fiscal debacle - May-07

Two economic historians, Barry Eichengreen of the University of California at Berkeley and Kevin O’Rourke of Trinity College, Dublin, have provided pictures worth more than a thousand words (see charts).* In their paper, Profs Eichengreen and O’Rourke date the beginning of the current global recession to April 2008 and that of the Great Depression to June 1929. So what are their conclusions on where we are a little over a year into the recession? The bad news is that this recession fully matches the early part of the Great Depression. The good news is that the worst can still be averted.

First, global industrial output tracks the decline in industrial output during the Great Depression horrifyingly closely. Within Europe, the decline in the industrial output of France and Italy has been worse than at this point in the 1930s, while that of the UK and Germany is much the same. The declines in the US and Canada are also close to those in the 1930s. But Japan’s industrial collapse has been far worse than in the 1930s, despite a very recent recovery.

Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression. Indeed, the decline in world trade in the first year is equal to that in the first two years of the Great Depression. This is not because of protection, but because of collapsing demand for manufactures.

Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.

The two authors sum up starkly: “Globally we are tracking or doing even worse than the Great Depression . . . This is a Depression-sized event.â€

Yet what gave the Great Depression its name was a brutal decline over three years. This time the world is applying the lessons taken from that event by John Maynard Keynes and Milton Friedman, the two most influential economists of the 20th century. The policy response suggests that the disaster will not be repeated.

Profs Eichengreen and O’Rourke describe this contrast. During the Great Depression, the weighted average discount rate of the seven leading economies never fell below 3 per cent. Today it is close to zero. Even the European Central Bank, most hawkish of the big central banks, has lowered its rate to 1 per cent. Again, during the Great Depression, money supply collapsed. But this time it has continued to rise. Indeed, the combination of strong monetary growth with deep recession raises doubts about the monetarist explanation for the Great Depression. Finally, fiscal policy has been far more aggressive this time. In the early 1930s the weighted average deficit for 24 significant countries remained smaller than 4 per cent of gross domestic product. Today, fiscal deficits will be far higher. In the US, the general government deficit is expected to be almost 14 per cent of GDP.

All this is consistent with the conclusions of an already classic paper by Carmen Reinhart of the university of Maryland and Kenneth Rogoff of Harvard.** Financial crises cause deep economic crises. The impact of a global financial crisis should be particularly severe. Moreover, “the real value of government debt tends to explode, rising an average of 86 per cent in the major post–World War II episodesâ€. The chief reason is not the “bail-outs†of banks but the recessions. After the fact, runaway private lending turns into public spending and mountains of debt. Creditworthy governments will not accept the alternative of a big slump.

The question is whether today’s unprecedented stimulus will offset the effect of financial collapse and unprecedented accumulations of private sector debt in the US and elsewhere. If the former wins, we will soon see a positive deviation from the path of the Great Depression. If the latter wins, we will not. What everybody hopes is clear. But what should we expect?

We are seeing a race between the repair of private balance sheets and global rebalancing of demand, on the one hand, and the sustainability of stimulus, on the other.

07b1fc8c-5aa1-11de-8c14-00144feabdc0.gif

Robust private sector demand will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging is a lengthy process. Meanwhile, the federal government has become the only significant borrower. Similarly, the Chinese government can swiftly expand investment. But it is harder for policy to raise levels of consumption.

The great likelihood is that the world economy will need aggressive monetary and fiscal policies far longer than many believe. That is going to be make policymakers – and investors – nervous.

Two opposing dangers arise. One is that the stimulus is withdrawn too soon, as happened in the 1930s and in Japan in the late 1990s. There will then be a relapse into recession, because the private sector is still unable, or unwilling, to spend. The other danger is that stimulus is withdrawn too late. That would lead to a loss of confidence in monetary stability worsened by concerns over the sustainability of public debt, particularly in the US, the provider of the world’s key currency. At the limit, soaring dollar prices of commodities and rising long-term interest rates on government bonds might put the US – and world economies – into a malign stagflation. Contrary to some alarmists, I see no signs of such a panic today. But it might happen.

Last year the world economy tipped over into a slump. The policy response has been massive. But those sure we are at the beginning of a robust private sector-led recovery are almost certainly deluded. The race to full recovery is likely to be long, hard and uncertain.

We are indeed following the same path, but with more zeal.

What's next?

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The graphs make it look bad. but from the activity on the M25 this morning (my bellwether) there are still plenty of people working.

I'm waiting for wave 2...

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good find, thx for posting

edit so thats how we get the MILTON in Milton Keynes?

I always thought it meant bleach the place.

Edited by loginandtonic

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The graphs make it look bad. but from the activity on the M25 this morning (my bellwether) there are still plenty of people working.

I'm waiting for wave 2...

Oddly .. I drove into Mayfair this morning .. No traffic .. Nada .. Sod all ..

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There's another nice set of charts in this PDF by Paul Swartz of the Council on Foreign Relations which shows the current US downturn vs post-WWII recessions, and also a set which compares it to the Great Depression.

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There's another nice set of charts in this PDF by Paul Swartz of the Council on Foreign Relations which shows the current US downturn vs post-WWII recessions, and also a set which compares it to the Great Depression.

Great post/link thanks.

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good find, thx for posting

edit so thats how we get the MILTON in Milton Keynes?

I've wondered that too. Apparently...

Re the article:

The question is whether today’s unprecedented stimulus will offset the effect of financial collapse and unprecedented accumulations of private sector debt in the US and elsewhere. If the former wins, we will soon see a positive deviation from the path of the Great Depression. If the latter wins, we will not. What everybody hopes is clear. But what should we expect?

...

Two opposing dangers arise. One is that the stimulus is withdrawn too soon, as happened in the 1930s and in Japan in the late 1990s. There will then be a relapse into recession, because the private sector is still unable, or unwilling, to spend. The other danger is that stimulus is withdrawn too late. That would lead to a loss of confidence in monetary stability worsened by concerns over the sustainability of public debt, particularly in the US, the provider of the world’s key currency.

Surely the bigger danger is that stimulus simply defers the pain without purging the debt-overload? I mean they used this recipe in 2001 when the problems were laughably small by current standards, and here we are today...

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On the industrial output chart. If you assume it started with sub-prime in 2007 it's looks like we'd be exactly on a green-shoots inventory restocking bull trap at about the 20 month point on the x-axis.

If we start getting people suddenly talking about that kind of thing we'll really be on the precipice of a sh1tstorm. :unsure:

Edited by Soon Not a Chain Retailer

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I've wondered that too. Apparently...

Re the article:

Surely the bigger danger is that stimulus simply defers the pain without purging the debt-overload? I mean they used this recipe in 2001 when the problems were laughably small by current standards, and here we are today...

exactly.

the 'keynesian clowns' are demanding no let up in the fiscal stimulus, central banks are concerned [or should that be unconcerned] about raising rates from a ZIRP and exiting a queasing policy 'too soon', and yet it was the same dire warnings in 2001, this threat of deflation of what happened during the great depression is just the ticket for getting the ear over govt. at the slightest hint of a bump in the road.

I believe another poster quoted krugman talking in 2001 of the need for greenspan to blow a housing bubble following the collapse of the nasdaq stock bubble......now i don't know if that was genuine or a tongue in cheek comment, but it wouldn't be out of character for a keynesian clown to make such assessments. We've got helicopter ben from tha infamous speech, and the economist who suggested the fed bury money in the ground [think that make have been krugman aswell].

And that talk of forming one bubble to replace another is precisely the outcome this time. We may even get several bubbles, such is the unparalleled scale of interference. Forget deflation, double dip recessions, the greatest danger is a consumer/houshold that isn't forced to deleverage......they'll try to blow another bubble or two and we'll kick the debt problem down the road. again.

We're clearly being run by an economics profession in central banks and treasuries around the world who don't even consider the problems of business and household debt, who've zero concept of moral hazard, and are currently trying out economic theory on the rest of us.

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There's another nice set of charts in this PDF by Paul Swartz of the Council on Foreign Relations which shows the current US downturn vs post-WWII recessions, and also a set which compares it to the Great Depression.

First class article.

Bump.

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They'll keep on borrowing and wondering why the underlying economy isn't reacting until we are all paupers. And ignore things like trade deficits, illegal wars, authoritarian regimes, widespread near-slave labour and poverty.

Miserable bastards.

This only means one thing though... house prices will go up!!

Numberwang!! :lol:

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I believe another poster quoted krugman talking in 2001 of the need for greenspan to blow a housing bubble following the collapse of the nasdaq stock bubble......now i don't know if that was genuine or a tongue in cheek comment, but it wouldn't be out of character for a keynesian clown to make such assessments.

The plan is perpetual bubbles.

We have a global economy based on bubbles funded by debt.

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They could have read my posts from a year ago when I was saying the central states will have to spend huge and sustained for far longer and far bigger than anyone thinks to get out.

Edited by aa3

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Fixed.

Time will tell. I wouldn't underestimate there ability to create another bubble. It won't be easy but not impossible, one option is a green technology bubble that promises miracles. It doesn't have to deliver the promises just that enough people believe in it.

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Interesting quote from the original article, perhaps relevant to spivtastic's point

Again, during the Great Depression, money supply collapsed. But this time it has continued to rise. Indeed, the combination of strong monetary growth with deep recession raises doubts about the monetarist explanation for the Great Depression.

Edited to add: Isn't the "monetarist explanation" Bernanke's pet theory?

Edited by Har Fast

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Edited to add: Isn't the "monetarist explanation" Bernanke's pet theory?

http://blogs.wsj.com/economics/2007/06/15/...-matters-today/

Ideas that Ben Bernanke pioneered years before becoming Federal Reserve Chairman could prove important in evaluating how financial stress, such as the subprime mortgage mess, affects the economy.

Since becoming Fed Chairman, Mr. Bernanke has spoken on countless issues ranging from China’s economy to free trade. But to understand where his economic heart truly lies, read the speech he delivered at the Atlanta Fed today, “The Financial Accelerator and the Credit Channel.â€

As an academic in the early 1980s, Mr. Bernanke pioneered the idea that the financial markets, rather than a neutral player in business cycles, could significantly amplify booms and busts. Widespread failures by banks could aggravate a downturn, as could a decline in creditworthiness by consumers or businesses, rendering them unable to borrow. Mr. Bernanke employed this “financial accelerator†theory to explain the extraordinary depth and duration of the Great Depression. (Much of that work was done with New York University’s Mark Gertler, now a visiting scholar at the New York Fed.)

A lot has changed since the 1930s, but the financial accelerator is still relevant. Although Mr. Bernanke doesn’t say so specifically, the record level of consumer leverage today means a change in asset prices (such as homes or stocks) can produce a much larger change in consumers’ net worth, and as a result their ability to borrow and spend. “If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect,†that is, the tendency of a changes in asset prices to make consumers feel more or less wealthy, and thus spend differently. That is because “changes in homeowners’ net worth also affect their … costs of credit.â€

This tendency of changes in net worth to have knock-on effects on credit availability and spending could “intensify†the effects of Fed actions, Mr. Bernanke said.

Even though bank weakness is less likely to hurt the economy today given banks’ reduced importance as lenders, the financial accelerator is still relevant. That is because “nonbanks†— lenders, such as standalone mortgage companies, that don’t accept deposits — also “have to raise funds in order to lend, and the cost at which they raise those funds will depend on their financial condition — their net worth, their leverage, and their liquidity.â€

Mr. Bernanke doesn’t say it, but the current crisis in the subprime mortgage market may be a perfect illustration of the financial accelerator at work today. Many subprime borrowers are facing bankruptcy because their net worth has collapsed and they can’t get new credit. Similarly, numerous subprime lenders have gone bankrupt because they could not get financing to continue operations from newly skeptical Wall Street lenders. As yet, there has been little spillover from these developments into consumer spending or the economy overall. But given his historical interest in the subject, Mr. Bernanke will certainly be on the alert. –Greg Ip

Is the financial accelerator a monetarist argument?

http://press.princeton.edu/titles/6817.html

Reviews:

"Mr. Bernanke certainly knows the importance of well-functioning markets. In Essays on the Great Depression he wrote persuasively that runs on the banks and extensive defaults on loans reduced the efficiency of the financial sector, prevented it from doing its normal job in allocating resources, and contributed to the Depression severity. The Depression-era problems he studied are mirrored by similar issues today, and they need urgent attention."--Robert J. Shiller, New York Times

Bernanke on the Great Depression

An interview from 2005.

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