"A Tale of Two Depressions"

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Posts like this one at VoxEU, from Barry Eichengren and Kevin O’Rourke, make me feel less of perma bear and more of an objective observer who happens to have been commenting when there was little reason to be of good cheer, as far as my skepticism of the “green shoots-recovery in 3Q-4Q 2008” theory is concerned. This is a follow up to an April post by the two economists,

No country (at least based on reports I have seen) has ever recovered from a severe financial crisis as quickly as a 3Q-4Q timetable would suggest. And the speedy recoveries generally featured having banks take writedowns and restructuring/writing off the underlying bad debt, plus seriously devaluing the currency at a time of better (as in not awful) global growth. In other words, being able to pull the economy up via much stronger exports played a big role. And those countries still had nasty downturns, but also solid rebounds.

Our policy responses may not be as bad as those of the Great Depression, but they are a long way away from best practices. So I have had trouble seeing why we should expect better outcomes. Both the Depression and the Japan bust featured a period after the initial shock where things seemed to be stabilizing, and then the decay resumed.

Even by my sometimes dystopian standards, this post is sobering. It has a ton of charts, most of which show world performance indicators on an even steeper trajectory downward than in the Depression. Welcome to a tightly coupled world.

From VoxEU (hat tip DoctoRx):

This is an update of the authors’ 6 April 2009 column comparing today’s global crisis to the Great Depression. World industrial production, trade, and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better. The update shows that trade and stock markets have shown some improvement without reversing the overall conclusion — today’s crisis is at least as bad as the Great Depression.

New findings:

World industrial production continues to track closely the 1930s fall, with no clear signs of ‘green shoots’.

World stock markets have rebounded a bit since March, and world trade has stabilised, but these are still following paths far below the ones they followed in the Great Depression.

There are new charts for individual nations’ industrial output. The big-4 EU nations divide north-south; today’s German and British industrial output are closely tracking their rate of fall in the 1930s, while Italy and France are doing much worse.

The North Americans (US & Canada) continue to see their industrial output fall approximately in line with what happened in the 1929 crisis, with no clear signs of a turn around.

Japan’s industrial output in February was 25 percentage points lower than at the equivalent stage in the Great Depression. There was however a sharp rebound in March.

….To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimise this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline. We therefore turn to the policy response….

This is a must read. The post continues here.

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  1. Richard Kline

    I found three things of notable interest in this illuminating article by Eichengren and O'Rourke beyond their fundamental and important demonstration: it's bad alright.

    First, they assess the beginning of 'the crisis' as July 08. From the standpoint of the real economy, that is a reasonable judgment. The crisis started in July 07, but it was in the financial industry and the construction industry. Stocks still advanced, and didn't really hit the skids until Sprin 08. We had the commodities dislocation, which is fundamentally a second order effect of the financial crisis as I'm condident will be historically evidenced. But even so, employment in the US didn't really hit the skids until after the authors' starting mark. And world trade didn't _really_ tank, despite the evaporation of short-term financing, until our major exporter partners dumped Agencies and pushed the flight to Treasuries big time. So yes, from the standpoint of tracking the economic impact of the financial crisis, it is no bad match to use July 08.

    Second, in the Great Depression, as demonstrated in the authors' charts, there were a few countries which sustained economic output, and others whose descent was both erratic and less than the US. Presently, ALL countries are going down fast together big time. Welcome to globalization, friends. We have no cushion, unless or to the extent to which China provides one domestically, and that is debatable and problematic in the impact it will have on the rest of the international economy. What is understated in this outcome, perhaps, is that all countries are coming down hard now because ALL benefited from the excess credit creation of the preceeding ten years: everybody was pumped up, even if indirectly. All of that 'world growth' became dislocated by the mega-gush of credit so great in volume was the latter. This has real implications for policy changes going forward, but we need credible specialists to dissect and advocate here, which are scarcely to be found in the economics profession nominally charged with the responsibility. (But Joey da Stig, are you on this one?)

    Third, of all those countries coming down presently, the descent of the US is the least and slowest. The question is why? The next question is, whill that 'why' continue in effect? One potential why is that the decline rates are strongly linked to industrial output and exporting, so that those who have seen exports collapse have had the biggest losses in profits and employment, and thus lead the way down. This was true in The Great One, also, and one reason for the more rapid output decline of the US at the time: we were much more an industrial nation then than we are now. Our down trend is slower because we export less.

    But the real reason for the slower relative decline in the US presently compared to other nations in the international economy was, I strongly suspect, that the global deleveragin drove money into the dollar, and specifically into US Treasuries, and that this monetary inflow has cushioned our output decline. _Initially_ cushioned our output decline. Once that prop ends, our actual interest rates go up, our faux 'profits' disappear, and unemployment can be expected to keep on increasing. We are slower down because the world pays off in American dollars. The sweet spot in that effect for this crisis has been passed, methinks, and our decline will come closer to world trends than to recent US ones. That is my view.

    A splendid paper, with the real data. And can we dismiss that ridiculous 'green shoots' phrase as the marketing slogan it always was? It sets my teeth on edge, and is materially false. Uncle Ben only had 'green shits' in prospect to opine upon, but this is family media he was appearing on, so we got a namby-pamby diphthong instead. Somebody (anybody) coin another one.

  2. Brick

    Quite rightly the article points out that if you look at global manufacturing and equities rather than US only then things are much more sobering, however I think they fail to pick up on the recent inventory bounce. What should be noticed in the disparity between US and global markets with global markets tending to be more stationary while US markets are on the up. This suggests to me investment policy in the US has somewhat gone awry, with investors failing to learn lessons from the previous episode.

    While it is OK to look at the great depression in comparison to now, you need to identify the specifics of why the current turn around will run out of steam. What is it that will stop the apparent inventory bounce which ought to bring some stability and an eventual up turn, as crop failure which triggered the further fall in the great depression seems unlikely this time round. It is becoming clear that not all authorities are pulling in the same direction and there are some recent differences in the tone of announcements from the FED and Treasury, while state finances are forcing things in the opposite direction. My worries would be that unemployment will not abate during 2009 and the cost of the safety net will produce a reinforcing cycle for state finances. This could be handled with bailouts which could be monetized but whereas the FED may have some room to manoeuvre at the moment, you could be staring at inflation or default if the bailouts become too big.

  3. Richard Kline

    Brick: "What is it that will stop the apparent inventory bounce which ought to bring some stability and an eventual up turn . . . [?]" A lack of profits from a paucity of sales. An inventory bounce restocks after flushing out inventory excess. Show me that consumer spending is even leveling off let alone on the uptick it we're to speak of more than a 'bounce' off a downslope ledge before a continued fall. A bounce is contextual; a turnaround needs buyers. Find 'em and we have our answer. Where are they?

    There is no possibility that unemployment will 'abate' in 2009, as I think you know. There is every reason to believe that it will continue rising _throughout 2010_, though likely at a much lower pace than that through Q2 2009.

  4. Brick

    The bounce is linked to a rise in manufacturing orders as retailers restock. It is a one off occurance that should see a levelling off afterwards. Linked to this we should see unemployment begining to level, but I expect worsening state finances
    will begin to push it higher sometime during the summer.
    I am convinced that a trigger much like the crop failure in 1930 is required to turn the current rosy view of the economy around. It could be eastern european default, semi default of california, Chysler and GM not coming out of bankruptcy quickly, Treaury yields or dollar currency problems.
    It is important to seperate the real economy from the markets, yet it is clear that markets can affect the economy if not the other way around. Take mortgage rates which have significantly risen over the last month as an example how a false market view can impact the economy.

  5. Andrew Bissell

    The assertion that "today's policy responses are much better than those of the Great Depression" is the kind of arrogant self-congratulation you come to expect from modern economists … especially given that our policy responses are so *similar* to those of the 1930s.

    Aside from that quibble, though, it's a good post.

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