In recent days, some prominent economists have pondered the idea that the current economic shock brought on by shutdown of large swaths of the U.S. could trigger not just a recession — an outcome deemed all but inevitable — but a longer, deeper and more damaging event along the lines of the Great Depression.
Some hallmarks of the current economic catastrophe bear an uncomfortable resemblance to those of nearly a century ago, while the sheer velocity of the economic collapse has rattled investors. The International Monetary Fund characterized it as the “worst economic downturn since the Great Depression” in a recent blog post.
“The magnitude and speed of collapse in activity that has followed is unlike anything experienced in our lifetimes,” IMF chief economist Gita Gopinath wrote.
“It took three and a half years, from August of 1929 to March of 1933, to go from robust full employment to the depths of the Great Depression. It looks like we’re going to get there in less than three and a half months,” said Lawrence White, an economics professor at New York University. “The speed of the descent is unprecedented.”
The unpredictable epidemiological trajectory of the coronavirus leaves a wide array of outcomes still in the cards. Economists think this could herald a sea change in how Americans spend, save and invest their money — changes that will reverberate potentially decades into the future.
Mohamed El-Erian, chief economic adviser at Allianz and a prominent economist, said the pandemic will be the worst thing to happen to the economy since the Great Depression, in an interview with Financial News. “What we don’t know is how long it will be and whether it can stumble into being a depression,” he said.
Experts say there are a host of policies in place designed to prevent the economy from sinking into a years-long slump like the Depression, when one in four workers were jobless, many households lost their savings when banks collapsed and the stock market lost nearly 90 percent of its value.
Recessions — traditionally defined as two consecutive quarters of GDP contraction — are fairly regular occurrences, with 11 taking place between 1945 and 2009, with an average of roughly 11 months between peak and trough. The Great Depression was remarkable both for its depth as well as its duration, with nearly four consecutive years of contraction followed by an economic malaise that lingered until the start of World War II.
But there are some important distinctions between then and now. Both the Great Depression and the Great Recession were kicked off by asset deflation. “Those burst bubbles tend to create a longer recovery period,” said Dan North, chief economist for North America at Euler Hermes. Similarly, the events that led up to the near-collapse of the Greek economy in 2012 had roots in the financial sector, whereas the coronavirus pandemic is not a banking crisis.
“Here, you’re dealing with something that in some ways has elements of a natural disaster, which creates a different dynamic,” said Mason B. Williams, a political science professor at Williams College.
To the extent that lenders will face hardship when homeowners, credit card customers and highly leveraged businesses default on their debts, the Federal Reserve and its counterparts in other countries today have the tools to contain the fallout.
“Banks have strengthened their positions substantially since 2009 and although there will be a rise in non-performing loans, central banks and governments have been swift to ensure that liquidity and solvency of the system is maintained,” said Sarah Hewin, chief economist, Europe and Americas, at Standard Chartered Bank in the U.K.
Many of today’s monetary policies were created in response to events that exacerbated the Depression: Unemployment insurance, for instance, sustains at least some of the demand that vanishes when joblessness spikes and people have no income to spend.
Stimulus plans and sophisticated monetary policy are all legacies of the Depression that will be very useful to us in the current crisis.
“We’ve entered this crisis with a set of policy tools that came out of the crisis of the 30s and 40s,” Williams said. “The idea of stimulus, of macroeconomic management, more sophisticated monetary policy — all those are legacies of the Depression that will be very useful to us in the current crisis.”
This is not to say a recovery necessarily will be quick. Although former Federal Reserve Chair Janet Yellen expressed hope that the rebound could be rapid or “V-shaped” in a recent CNBC appearance, she acknowledged the severity of the plummeting of economic activity and skyrocketing unemployment, calling the shock “a huge, unprecedented, devastating hit.”
In a prolonged downturn, the relationships between worker and employer, creditor and borrower, and landlord and tenant all break down, and reestablishing those commercial relationships takes time.
“All of those things need to be rebuilt, and it doesn’t happen overnight,” White said. “I don’t think it’s going to take six or seven years,” he said, but he added that a rebound could take more than a couple of quarters to emerge.
And this could fundamentally change the way Americans relate to money for decades to come. “After the Depression, we had a whole generation of people who were more likely to save for a rainy day,” said Joseph Mason, professor of finance at Louisiana State University. Especially with the threat of viral recurrences and subsequent outbreaks, “I can certainly believe people are going to want a little bit more of a nest egg socked away,” he said.
Economists speculate that a flight to caution on a scale not seen since the World War II era could alter how Americans approach everything from home buying to saving for retirement — potentially threatening the rebound in consumer spending that drives domestic economic activity. “I think it’s a fairly long-term reduction, which is going to drag on growth,” Mason said.
“We have had a very lucky 80 years in the sense that we have had no war on our soil and we have had uneven, but growing, living standards for many decades,” said Constance Hunter, chief economist and principal at KPMG. “COVID-19 changes things in terms of risk… something humans had to deal with in much greater quantities before World War II. This will impact spending and savings patterns and it will impact investment decisions,” she said.
“The wealth effect is a major thing in the U.S., especially after a huge run in equity prices,” said Alon Ozer, chief investment officer at Omnia Family Wealth. “The biggest risk — and we saw it in March — is that the fixed income markets, corporate debt mostly, and equities are going to start to move together. All these 60/40 portfolios you hear about, if they move together, you’re going to get decimated,” he said. Investors who don’t have several years to wait for a recovery could be driven to eschew even so-called safe haven investments, curbing companies’ ability to raise cash or issue debt.
“The stuff we see is just staggering,” Ozer said. “What the Fed has to do is basically continue what they’re doing, but on a larger scale. They have to make sure that credit growth continues. If credit growth in the U.S. contracts, we’re going to have serious problems.”
Nobel-prize winning economist Robert Shiller warns that an out-of-proportion fear factor could drive the U.S. into the very depression policymakers are scrambling to avoid.
“It may mean people won’t go to restaurants or sporting events in good numbers for years,” he said in a CNBC interview. “It puts a whole psychological framework onto this that may be a self-fulfilling prophecy.”