Another Great Depression?

As this coronavirus crisis has progressed, the tenor of the news has progressed too – in many cases taking on an ominous tone. These are anxious times, to say the least. Many of the opinion pieces out there address a common central question: how bad will things get? Some people openly fear the worst. From an economic perspective, in my view the worst we’ve had it as a nation was during the 1930s when we were at our hardest of hard times.

Okay, let’s go there. Are we at imminent risk of falling into another Great Depression? I think the answer is an emphatic no. Anything of course is possible. If a new calamity struck us right now while we are reeling, it could change the calculus about everything. But with this particular crisis, no, I don’t think a depression is a plausible outcome. Let’s consider.

Definition of Terms
First some definitions. A recession is when economic activity in a country contracts for several months, such as one to three quarters. This means that most of the organizations and businesses in the economy stop thriving and growing, and instead contract, which can lead to layoffs, business closings, high unemployment, and a range of other problems. Recessions are painful, but they are a normal occurrence and they don’t last long.

A depression is a very long and deep recession. Economic activity contracts for an extended period. There isn’t an obvious delineation between a recession and depression. Recessions are more of a cyclical occurrence whereas depressions can be intractable. The Great Depression lasted for twelve years. That is really something.

It can be hard for an economy to break out of a depression because the solutions are likely to be very complex and the tools needed are likely greatly weakened. But the causes of a depression can be quite simple: incorrect government policy action on top of terrible timing. The Great Depression in the United States was a beast of our own making. And the good news is, we learned from those mistakes.

Wrong Moves in the 1930s
From an economic perspective, today’s situation is very different from the Great Depression. When the market began to crack in 1929, the Fed, White House, and the fiscal policymakers made all the wrong moves. The actions they took then were the exact opposite actions of what we now know to be the correct response to an economic crisis. They gave us a playbook of what not to do. Here are the highlights:

Bad Monetary Response – Monetary policy, mostly from the Fed (which was then in its infancy) was contractionary, not stimulative:

• Trying to slow the speculative fervor of the Roaring Twenties, they raised interest rates in 1928, but then they continued to raise rates in 1929 and 1930. This had a calamitous effect on the market.
• The Fed did not act as a lender of last resort and let many banks fail, just when they were most needed. Policymakers were concerned about the moral hazard of bailouts. While this may be a legitimate concern, their actions caused a run on banks. People lost faith in the banking system and rushed to withdraw their money.
• Policymakers thought they should conserve cash to protect the banks, so they made banks close or take forced holidays. This only made the panic worse. No faith in banks = panic withdrawals = no bank deposits = no lending = no bank earnings = banks fail = further panic. And so on. Thousands of banks failed during the 1930s.
• Finally, the Fed was limited in its ability to increase money supply because of restrictions placed on it by the gold standard. They could only increase money supply at a certain percent relative to gold reserves. The money supply contracted. This, on top of the above missteps, caused the whole financial system to seize up, like an engine being run without oil. Disaster.

Bad Fiscal Policy Response – On the fiscal side, they made some blunders too:

• Hoover believed in a balanced budget at that time (ah, the good old days). He in fact proposed cuts to government spending and increases to taxes in 1931. Contractionary policies to be sure.
• When they began to increase fiscal spending to provide stimulus, they also increased taxes. So the stimulus was essentially offset, and the collapse got worse.
• Also, in 1930 Congress passed the Smoot-Hawley Tariff act which was basically aimed at blocking international trade. The thinking was, I assume, that we if don’t trade with the foreigners, we’ll just buy American. But this policy in fact raised prices because of retaliatory tariffs from international trading partners, and it cut down on potential markets for American producers. The effect was to worsen the contraction and speed our decline into the Depression. (Sound familiar? When oh when will we ever learn?)

We Learn from Our Mistakes
In disciplines such as science, technology, and medicine, we are generally aware of progression in a body of knowledge. We understand that doctors of 200 years ago were working with a different knowledge base than those of today. The same is true for economists. They learn. Economists can’t experiment in a laboratory, but they can learn from history. They build upon prior actions in formulating policy for today. I love this quote below from former Fed Chairman Ben Bernanke addressing a dinner in honor of Milton Friedman and Anna Schwartz, famous monetarists (tbh Friedman is my nerd hero).
“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”

Policy Responses Today
It’s true, they haven’t done it again. Look at the response during the most recent crises of 2008 and today. Fed Chairmen Bernanke in 2008 and Powell today have, in my view, made the moves required to sustain the financial infrastructure and stimulate recovery. Fiscal policymakers for their part managed work across party lines just enough to put stimulus packages in place. Now, to be sure there is an Austrian economics rise-from-the-ashes type of argument to be made about all of this. But the cold purist perspective is not on really on the table and perhaps shouldn’t be.

The policies being enacted today in the US, Europe, and Asia are massive and will have mostly positive impact on the economy (beware the unintended consequence). The highlights of today’s policies:

Monetary Policy – designed to provide support, liquidity, and stimulus.

• Fed lowered interest rates quickly and decisively. This makes borrowing cheaper and supports the economy and stock market.
• Fed taking action to expand money supply dramatically. The economy needs enough money to function. In financial markets, the level of trading right now is gigantic and would not be possible if there wasn’t enough cash to settle trades. For example, if you sell and go to cash, what if there were not enough cash?
• Fed has been working since 2008 crisis to develop and support the banking system. The stress-tested too-big-to-fail banks have been much maligned in recent years. But now, when it really matters, we find that the banking system is sound. That is a huge relief.
• The Fed has been creative, accommodative, and decisive in its support of other aspects of the financial markets: money market funds, overnight corporates, discount window.
• Finally, the Fed has made it clear that it is going all in and will continue to do so, no matter how long it takes. This is greatly reassuring to the markets and investors.

Fiscal Policy – Everyone’s a Keynesian when the economy collapses. Or in other words, you don’t hear much about limits on taxpayer bailouts or big government spending in times like these.
The federal spending policies being enacted now as I write this are too numerous to list here. But make no mistake, this is a big effort. It’s mind-blowing how far we’ve come in just one month. Over $2T in a unanimous spending package funded by deficit spending? Sending checks to ordinary Americans? Marshall Plan for the US healthcare system? Big increases to the social safety net? Bailouts to multiple industries? And all of this happening under a GOP controlled White House and Senate? What in heaven’s name is going on.

What Happens Now?
From here, we go through the sure to be crazy experience of watching the government try to cram two trillion dollars into the economy, fast. Now that should be interesting. Some very big questions remain. With the fiscal and monetary pieces coming into place, the market will turn its attention to the next set of worries.

Bottom line is that monetary and fiscal responses have been very big. They will have impact. Whether or not it is enough, only time will tell. And the unintended consequences will be many.

The biggest question of all takes us back to the beginning of all of this. How long will it take the coronavirus be contained? There are so many unknowns about prevention, treatment, and vaccination. There is a lot of writing in financial papers about the prospects of V-shaped recovery. And some writers are trying to out-clever each other by suggesting it will instead look more like a U, or a W, or the provocative L. We cannot know. It seems impossible that all of this resolves quickly. So stay tuned for the ups and downs.

But for now, maybe we can breathe a brief sigh of relief that some sort of foundation is being put into place. Eventually, we’ll grow upon that base.

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