April 14, 2020
Gary Schlossberg, Global Strategist
A Nation in Depression?
- Signs of more than a severe recession are emerging early in this deepening economic slump, ranging from surging unemployment to a steep decline in real gross domestic product (GDP) and proliferating bread lines across the country.
- Lessening the threat of a depression are more proactive government policies than the damaging monetary policy measures during the deep 1930s’ slump, an ability of households to boost spending, and less debilitating disinflation than the double-digit price declines nearly 90 years ago. Still unclear, however, is how effective each will be in containing the economy’s early free fall.
What it may mean for investors
- Slim prospects for a depression discourage excessively conservative investment strategies tilted toward cash. Prospects for a short, severe recession, rather than a deep, extended economic decline, favor a more diversified portfolio of higher-quality, more liquid assets in the U.S.
The economic free fall of the past month is like none in recent memory. From prosperity in February, the economy has been churning out numbers—and images—that are reminiscent of the 1930s’ depression. A surging unemployment rate, likely peaking below its 1930s’ high of nearly 26%, is rising far more rapidly than it did nearly 90 years ago. Wall Street and Main Street also are bracing for a double-digit decline in second-quarter real (inflation-adjusted) GDP that may be greater than in any single quarter during the depression. Starker still are the growing number of bread lines accompanying the rising tide of coronavirus victims at the nation’s hospitals.
With images like that, why isn’t the U.S. economy’s free fall being dubbed a depression instead of something akin to a “Great Recession 2.0”? Some may feel that such a stark conclusion risks aggravating the current slump in confidence and spending plans as the pandemic subsides. More to the point is the lack of a clear-cut distinction between a recession and a depression, like that between economic growth and recession. The tongue-in-cheek distinction between a recession when your neighbor is out of work and a depression when you are out of work simply points to the lack of clear guidelines between the two.
Depression rules of thumb
Still, useful benchmarks are available, including the depth and length of the economy’s decline and the threat of accompanying “deflation.” Soaring unemployment and the expected depth of the current economic downturn by midyear, if realized, will check one of those depression boxes. However, the “one to more than two” year rule of thumb for a depression’s length is a far cry from the current economic decline expected to last three quarters—bracketing a steep, second-quarter decline with more moderate slippage in the first and third quarters. Contrast that with the 1930s’ depression that was saddled with double-digit rates of decline in 11 of the 17 quarters between late 1929 and the end of 1933 (Chart 1).
Differences between the three-quarter slump expected in this cycle and the more drawn-out declines in the 1930s’ depression—and deep recessions since that time—speak to the self-inflicted catalyst for the U.S. economy’s setback this time. That leaves the economy better-positioned to avoid extended financial and other adjustments if the recession is as short as is expected. Put another way, the willingness of households to boost spending will be more an issue in the next recovery than is their ability to boost demand.
A more stable, services-oriented economy also is less accident-prone than the one nearly 90 years ago, far more oriented toward economically sensitive agriculture and manufacturing. True, the services sector is leading the way lower at the moment, but frontline travel, leisure, and entertainment now are a considerably smaller share of the economy than combined manufacturing and agriculture was in the 1930s.
Aggressive fiscal and monetary stimulus is a third line of defense against a depression. Early and aggressive financial support from the government, bridging the economy’s deep freeze until the outbreak subsides, is in contrast to the Federal Reserve’s policy mistakes that served to deepen and prolong the 1930s’ economic slump. Federal Reserve policy, largely tied to the deflationary gold standard, aggravated an early-1930s’ depression, then short-circuited powerful, double-digit economic growth in 1934-1936 to precipitate a severe recession in 1937-1938.
Failure to contain the spread of the initial shock in this cycle through aggressive liquidity increases would expose the economy to a more extended decline directly, by adding to business closures and unemployment, and indirectly, by undermining consumer confidence and spending ultimately needed to ignite a recovery. That said, depressions aren’t preordained during a pandemic, as the economy’s resilience to the 1918 Spanish flu epidemic demonstrated.
Beyond policy miscues, deflation exposes the economy to a depression, through: 1) debt payments on fixed obligations that are financed with diminishing income, 2) the risk of burdensome interest rates falling more slowly than prices, 3) the incentive to delay spending as prices move lower, and 4) weak business “pricing power” capable of squeezing margins enough to discourage hiring, investment, and other spending. The good news is that modest price declines expected in the coming months will be a far cry from the double-digit deflation of the early 1930s, triggered by a gold standard that forced higher interest rates and cuts in the money supply to stem movement of the precious metal abroad. We believe that dollar strength is the chief deflation threat overseas today, and, by depressing import prices, also here in the U.S.
A sudden and unprecedented shock to the economy is forcing a “rewrite” of the rule book on dealing with an economic slump that takes on the dimensions of more than just a severe recession. The outlook for the U.S. economy—not to mention the human toll of lives and jobs lost—is disturbing enough. The hope is that the lessons learned during the 1930s and the severe recessions that followed will allow policymakers to prevent the current free fall from becoming more than a “Great Recession 2.0.”
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