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A Brief History of U.S. Economic Crises JULY 2019

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A Brief History of U.S. Economic Crises JULY 2019 A Brief History of U.S. Economic Crises JULY 2019 Snapshot U.S. economic and financial crises have been a recurring reality throughout ›› While no two financial and economic history, pervading the U.S. economy since it was formed nearly 250 years ago. crises have been exactly alike, most Each new crisis tends to invite comparisons to past recessions—especially the share certain characteristics: Political and Great Depression that began in 1929, but also the malaise of the 1970s and monetary policy errors, loss of investor early 1980s and the global financial crisis of 2008 to 2009. confidence, and rising risk aversion. While no two periods of severe turbulence have been exactly alike, varying But past crises also ultimately ushered widely in size, scope, cause and length, they do tend to share common in a new age of economic growth and characteristics: prosperity of varying length—hopefully with many lessons learned. ›› Political and monetary policy errors ›› Loss of confidence in the banking and financial sector ›› Even in the absence of a severe crisis, ›› Rising investor risk aversion uncertainties are ever-present. Investor moods regularly vacillate between fear They also ultimately ushered in new ages of economic growth and prosperity and greed, and financial markets can of varying lengths, offering lessons to be learned. exhibit heightened volatility for extended periods of time. The Great Depression: 1929 to 1939 ›› No matter the economic or market The Great Depression is the ultimate benchmark for financial and environment, it’s important that investors economic crises, primarily because of its depth and duration. Officially focus on their personal investment goals— beginning in 1929 following the infamously devastating stock-market in the context of a time horizon that’s crash, it spanned a total of nine years and involved two deep recessions most appropriate to their circumstances— adhering to a well-designed asset (one from 1929 to 1933 and another from 1937 to 1938). As economist allocation strategy, and employing a Robert Margo has put it, “The Great Depression is to economics what the rebalancing discipline to capitalize on Big Bang is to physics…and it continues to haunt successive generations market volatility. of economists.”1 While its causes are still hotly debated, there’s fairly widespread agreement that an initially mild recession prior to the 1929 stock-market crash was exacerbated by subsequent policy errors, including a global tariff and trade war as well as tightening measures by the Federal Reserve (Fed) and Bank of France (BoF). Exhibit 1 on the next page depicts the sharp downturn and long recovery in U.S. trade. The policy moves of the Fed and BoF threatened to push worldwide prices of goods and services to a level not seen since before the start of World 1 “Employment and Unemployment in the 1930s.” Margo, Robert A. Journal of Economic Perspectivse, Vol. 7, Num. 2, Spring 1993, Pgs. 41-59. War I in 1914, causing massive deflation. History offered a warning against taking such actions: The Bank of England enacted similar measures around 1920, then changed course as they threatened to throw the world into depression. But new generations of leadership at the Fed and BoF overlooked that lesson. By the mid-1930s most countries abandoned the so-called gold standard (which established an international benchmark for the value of gold and other currencies) in order to provide their economies with some relief from deflation. Exhibit 1: A Long Drought for International Trade ■ U.S. Imports ■ U.S. Exports 20 18 16 14 12 10 8 6 4 2 Trade in Goods and Services, Index 2012=100 0 1941 1931 1937 1944 1943 1934 1942 1940 1933 1938 1932 1939 1935 1936 1929 1930 Source: U.S. Bureau of Economic Analysis As the Depression era unfolded, unemployment soared well into double digits across much of the world, productive capacity was idled, and deflation (which causes nominal revenues and income to fall while debt-servicing costs typically remain fixed) triggered recurrent financial and banking crises. As a result, creditors eventually became insolvent, banks’ assets (loans) started to go bad, and depositors all at once tried to pull their money out of failing banks. The number of bank failures that occurred during the Great Depression remains a staggering figure to this day. The situation became so dire that people largely abandoned check writing, and most transactions were executed with cash or via bartering. All three catalysts typically responsible for financial and economic turbulence were clearly at work: ›› Political and monetary policy errors: The hands-off approach of President Herbert Hoover’s administration at the Great Depression’s onset in 1929 is perhaps the most distinguishing feature of the historic crisis. Since then, the U.S. government and Fed have taken much more active roles in mitigating periods of turbulence. ›› Loss of confidence in the banking and financial sector: More than 9,800 banks failed from 1929 through 1934 because of so-called bank runs, which is when bank customers try to withdraw more money than the bank can provide. For comparison: Less than 500 banks failed during a comparable six-year period that began in 2008 and included the most acute phase of the global financial crisis, according to the Federal Deposit Insurance Corp (FDIC). Banks runs, common during the Depression, are all but a thing of the past—primarily due to the backstop provided by the FDIC, which was created at depths of the Great Depression in 1933. ›› Rising investor risk aversion: The Dow Jones Industrial Average (DJIA), the price- weighted average of 30 large U.S.-based stocks, plummeted by 91% from 1929 to 1932—reflecting plunging investor confidence and rising risk aversion. (It’s worth noting, however, that this followed an incredible eight-year surge in stock prices, during which the Dow rose nearly 500%). The Great Inflation: 1965 to early 1980s Between the Great Depression and the Global Financial Crisis of 2007-2009, the two longest U.S. recessions each lasted 16 months—the first from November 1973 through March 1975 and the second spanning July 1981 through November 1982. In both periods, high inflation accompanied steep and volatile unemployment and interest- rate levels—contributing to uncertainty among policymakers and a general malaise in financial markets. Before entering recession in the 1970s, the stock market had already exhibited significant volatility for nearly a decade (since 1965); it remained range-bound for almost 10 more years until finally springing back to life after the early-1980s recession. This macroeconomic era is known as the Great Inflation. The early 1970s were arguably one of the bleakest periods for Americans during the second half of the 20th century. Mired in the Vietnam War, which had already spanned more than 10 years, the nation endured a confluence of several crises. In 1973, the Bretton Woods international monetary system that was forged in the wake of World War II collapsed. In 1974, the Watergate scandal ultimately brought down U.S. President Richard Nixon. Meanwhile, a full-scale energy crisis began to grip our nation in 1973. Not only did oil prices quadruple in the wake of Saudi Arabia’s emergence as the world’s swing producer and marginal price setter of crude oil in its role as the effective leader of the Organization of the Petroleum Exporting Countries (OPEC), but there was also a shortage in oil supply. Long lines were common at gas stations, gasoline was rationed, and the U.S. government made matters worse by putting price controls in place. During this period, Baby Boomers across many developed economies began entering their household formation years en masse, propelling household and consumer credit into a four-decade expansion. ›› Markets: During the bear market of 1973 to 1974, the DJIA lost 45% of its value in less than 23 months. ›› Inflation:Inflation began to soar in 1973; after averaging about 3.3% annually for 10 years, it hit 6.2% in 1973, 11% in 1974, and 9.1% in 1975. This was a somewhat new and frightening concept to many Americans. The U.S. had not experienced rising inflation to this extent since the post-war years of 1946 to 1948 (Exhibit 2 on the following page). ›› Labor market: In November of 1973, the unemployment rate stood at a rather benign 4.8%. One year later, in November 1974, unemployment increased to 6.6%. The rate continued to rise until hitting 9% in May 1975 (two months following the end of that recession), before slowly falling below 8% by January 1976. All of these factors presented a quadruple whammy to 1970s America: High unemployment, rising prices, an energy crisis, and turmoil at the highest levels of our government. Exhibit 2: Extraordinary Inflation 1948–1958 1958–1968 1968–1978 1978–1988 1988–1998 1998–2008 2008–2018 16 14 12 10 8 6 4 2 Consumer Price Index, 0 Percent Change from Year Ago -2 -4 Source: U.S. Bureau of Labor Statistics By late 1979, unemployment had fallen below 6% once again—but then crept back upward during a short recession that began in January and ended in July of 1980. Inflation hit a 33-year high, having jumped from 7.6% in 1978 to 11.3% in 1979, before ultimately reaching 13.5% in 1980. But this was not a typical case of inflation. This was “stagflation,” when high inflation and economic stagnation occur simultaneously, and it began in the wake of the energy crisis of 1979. Although not as severe as the 1973 energy crisis, the 1979 version came amid major tensions in the Middle East, including a revolution in Iran, a war between Iran and Iraq, and the taking of American hostages in Iran.
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