Over the past few weeks, if you had been glued to news reports from the “mainstream media”, you would be excused if you held the view that the U.S. was on the brink of a second Great Depression. News reports of bank failures, job losses, government “bail outs”, stock market plunges, etc. were omnipresent on television, in the printed media and on the internet. Throw in a hyper-politicized populace weeks from a Presidential election and you have a recipe for emotional boil over. Thankfully for us all, things seem to be calming down a bit now. However, as the dust settles, it is fair to ask the question—are we headed for a depression?
Generally speaking, depressions are unique economic events which are very rare in human history. Recessions—generally defined as two or more consecutive quarters of negative economic growth—are not so rare and are generally considered a part of the business cycle. Depressions are recessions on steroids. They are generally much longer in duration, involve steep and unprecedented job losses and are accompanied by the phenomenon of deflation—when the price of goods and services actually falls for a sustained period of time.
It is generally believed that depressions flow out of a confluence of negative economic events that are exacerbated by government policy mistakes. Looking back at the Great Depression, there were many policy mistakes that contributed to the economic implosion. In the years leading up to the stock market crash of 1929, speculation and excess won out over probity and the market inflated to a level far beyond what mathematics would justify. However, in the years after the market crash, the Fed’s reluctance to loosen its monetary policy caused a bad situation to deteriorate into an economic disaster. Furthermore, protectionist trade policies only worsened the global situation as nations erected barriers to global commerce which—in the end—denied their own businessmen potential customers to sell to.
Do we face such a risk today? Well, there has certainly been more turmoil in the banking and finance industry than at any time since the Great Depression. Most analysts expect this shake out to continue and for there to be far fewer, but generally wiser and healthier financial institutions left when the dust settles. However, the Bernanke Fed (and the Chairman is a student of the Great Depression) is certainly not repeating the mistakes of the Fed of the early 1930s. Combined with other important global central banks, the Fed is flooding the marketplace with dollars. The Fed funds and discount rates, already low by historic standards, are certainly headed to one percent or lower before all is said and done. The historic market interventions orchestrated by Treasury Secretary Paulson—in conjunction with other central bank action—also seem to obviate the possibility that lack of liquidity will worsen the current crisis.
From a general business health standpoint, while the financial sector faces a rough patch, the balance sheets of most non-financial companies are reasonably healthy. Furthermore, emerging economies are flush with cash and—for the most part—are still experiencing positive economic growth. Remember the dissatisfaction as China was only able to grow at a 9% annual rate last quarter. Compared to prior serious economic downturns, including the Great Depression, the U.S. and global economic picture appears to have latent strength and diversity that were lacking in the past. Certainly, the vaunted U.S. consumer—the engine of the world’s economic growth over many years—is going to need to focus on rebuilding his or her balance sheet over the coming quarters. However, it is possible that spending from abroad—either by governments, individuals or both will somewhat compensate for a more thrifty U.S. consumer going forward.
No one honestly believes that the next few quarters are going to be a walk in the park. Most folks probably believe we are in recession now and will probably be so well into 2009. However, talk of depression is just that—talk. There is no rational basis on which to throw that term around, although there may be a political motivation for using that term. At this point, surveying the investment landscape, we cannot help but wonder: what if they threw a depression and nobody came?