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I&WM Julaug09 Topress.Indd FEATURE Compare/Contrast The Great Depression and Current Financial Markets By Nick Paterakos, CIMA® he fi nancial panics of October Th is current contraction will How will the reduction of this debt 2008 and March 2009 have be labeled defi nitively only after it play out? It could take place all at once T subsided and world markets has passed. But for now, comparing but more likely it will take place over an have rebounded. Some of the global historical events and data may help us extended period of increased savings. economy’s fundamentals have contin- understand what is happening in the In any case, savings will rise to meet ued to deteriorate while some leading interim and provide timely advice and debt. Th e nation has gone from negative indicators are turning up. Th ough the reassurance for our clients. savings to a 5-percent savings rate in short-term picture has brightened, the a matter of months, and this response possibility of a worldwide depression Debt Collapse and Economic Shock likely will continue. lingers. Does our future hold additional Many recessions are the result of inven- Th e downturn also may make and severe, long-lasting, life-changing tory correction or some other economic consumers less amenable to taking on fi nancial conditions? dislocation. Th e Great Depression and future debt. Harry Dent, Jr., in his latest To examine that question, I’ve looked the current decline, however, were set book, Th e Great Depression Ahead, to the 1930s and other recognized off by a sudden collapse in asset prices believes this shakeout or depression depressions for clues. In this paper I against a backdrop of high debt levels. largely will revolve around restructuring consider data as well as intangibles that Indeed, this is perhaps the strongest simi- the debt of the banking system, compa- may help in a comparative analysis of the larity between our current situation and nies, and the U.S. government.3 Great Depression and current events. the Great Depression. In both the Great Indeed, maybe the U.S. consumer is A depression is a contraction in Depression and today’s decline, sudden fi nancially unable to take on additional economic activity of 20–25 percent loss of wealth reversed a long period of debt to sustain spending levels. If this is that lasts several years. Th e Great rapidly increasing prosperity and trig- the case, the question of whether banks Depression was the most severe in gered a cycle of asset destruction. are willing to lend becomes moot. our nation’s history. It started after the Th e shock that began the Great Regardless, with asset prices down, a market crash in late 1929 and lasted Depression was the stock market crash, lack of collateral and income should until 1938. In depressions of the 1870s which resulted from overborrowing; mean a period of slower, lower growth. and 1890s, gross domestic product during the 1920s leverage rates of up to (GDP) returned to its original level 90 percent debt were not uncommon.1 Impacts on World Trade in fi ve years; recovery from the Great Th e recent dramatic leveraging of Noteworthy declines in world trade as Depression took almost 10 years. housing was similar to the leveraging of economies shrink are a trademark of But economic depressions are so stocks in the late 1920s. Th e latest asset depressions, and some of today’s picture rare that data describing their pre-con- boom, especially in real estate, was con- seems to mimic the Great Depression. ditions are scarce. Today’s economy and spicuous because it didn’t result from World trade is collapsing, wealth is overall accumulated wealth—individual greater incomes or demand; it resulted evaporating, the banking system is and national—are dramatically diff erent from credit-induced excess liquidity. broken, defl ation is a growing threat as from the 1930s, possibly muting the We’re now experiencing the deleverag- companies close plants and cut pay and validity of comparing the situation we’re ing of the infl ation in housing prices prices, and leaders worldwide are strug- living i n to the Great Depression. that grew over 20 years or more. gling to halt the decline. Th is comparison, however, still has Figure 1 shows that today’s debt Furthermore, the International value, even if it only illuminates the level as a percentage of income is above Monetary Fund reports that for the fi rst similarities and the diff erences between that of the 1930s.2 Debt as a percent- time since World War II the United States now and then. So what follows is a com- age of GDP reached almost three times and other industrial nations are suff er- parison, categorized by the characteris- disposable income at the onset of the ing simultaneous economic decline.4 tics and impacts of, as well as responses Great Depression, and surpassed that in Th e credit crunch has curbed fi nancing to, depressions. the past few years. for exporters and importers and led to a 36 Investments&Wealth MONITOR © 2009 Investment Management Consultants Association. Reprint with permission only. FEATURE FIGURE 1: TOTAL U.S. DEBT AS A PERCENTAGE OF GDP low interest rates are leading to forecasts of slow growth for 2010. Jan Hatzius, ANNUAL 360% 20088 Q2 = 356.756 chief U.S. economist at Goldman Sachs 340% Group Inc. in New York, predicted a GDP decline of 7 percent in the fi rst 320% three months of 2009;9 the number 300% 19339 = 299.82 9. 20033 = 306.22 came in closer to a 6-percent decline.10 280% During the Great Depression, 260% GDP declined 8.6 percent in 1930, 6.4 240% percent in 1931, and 13 percent in 1932. 220% Th ese numbers bode well for the cur- 200% Averageve age = 194.94 rent decline, given the extent of wealth destruction that has taken place of late. 180% Wealth destruction, however, is a major 160% determinant of decreased spending. 140% But it’s unlikely that the economy will 120% continue to decline at the rate of the 4th 1916 1924 1932 1940 1948 1956 1964 1972 1980 1988 1996 2004 quarter 2008 and 1st quarter 2009. Such Sources: Bureau of Economic Analysis Federal Reserve, Census Bureau: Historical Statistics of the United States a period of stability reduces the chance Colonial Times to 1970. Through Quarter 2 2008. (Figure 1 is from Michael Hodges, “American Total Debt,” a that we will be reprising the GDP chapter of The Grandfather Economic Report, available at http://mwhodges.home.att.net.) declines of the Great Depression. tumble in world trade. Trading volume to 89 percent below its 1929 high before Curtailed Lending plunged at an annual rate of 22 percent in beginning to recover in mid-1932. Th e pullback in lending as banks hoard- the fourth quarter from the third in 2008, Relatively speaking, overall economic ed capital was crippling in the Great according to the CPB Netherlands Bureau and balance-sheet losses for the recent Depression, and it has been disabling for Economic Policy Analysis.5 decline have been signifi cant and in the in the latest downturn. Indeed, the Th e peak-to-trough decline from ball park of the initial Great Depression contraction in bank lending is making it 1929 to 1932 was 35 percent as coun- declines. Combined with collapsing hard for Federal Reserve Chairman Ben tries slapped giant tariff s on imports. house prices, the free fall in the stock Bernanke and his fellow policy makers Today’s global trading partners are market will destroy $23 trillion worth to get much traction with their eff orts to acutely aware of the nearly two-thirds of U.S. wealth, according to Lawrence stop the economic decline. Th is type of drop in global trade after Smoot- Lindsey, a former senior White House breakdown happens only two or three Hawley tariff s were imposed in 1930.6 offi cial who now heads his own consult- times a century, and weaknesses in the Hopefully the General Agreement on ing company in Arlington, VA.7 economy and the fi nancial industry feed Tariff s and Trade won’t make the same on each other and can lead to a “down- mistakes by erecting new trade barri- Decline in the Gross ward vortex,” said Treasury Secretary ers, because the result might be a free Domestic Product Lawrence Summers. Summers also has fall in trade as was experienced in the Declines in the GDP are one of the voiced concern about a return of defl a- Great Depression. defi ning characteristics of recessions tion, which wreaked havoc during the and depressions. Great Depression. As wages fell back Market Declines In March 2009, Harvard economist then, workers had a harder time paying Market declines are another depression Robert Barro said he believed that the debts, thus aggravating banking woes.11 characteristic. Like the Great Depres- near term holds roughly a 30-percent Levels of U.S. public debt now are at sion, the current economic decline is chance of a 10-percent decline in GDP levels seen in the United States in the global. Domestically and internation- and consumption—his defi nition of 1930s and in Japan in the 1990s. Th e ally, all markets have crashed from their a depression.8 In fact, the economy collapsed lending market is forecasting highs. Since peaking in October 2007, contracted at a 6.2-percent annual rate rising defaults through 2009. Th e global the Dow Jones Industrial Average (DJIA) in the last quarter of 2008—the worst default rate on speculative-grade debt has fallen more than 50 percent.
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