Is the Second Great Depression approaching? Part two: the case against
While it is true that there are similarities between the present day and the pre-Depression period
- Surplus countries unwilling to stimulate (Germany today)
- Overproduction and the lack of a global engine
the question is whether it adds up to another Great Depression or a slow period of growth?
Weak growth rather than collapse
A more likely outcome to my mind is that rather than a collapse, we just get weak growth punctuated by bursts of policy easing, which ultimately may only be resolved through inflation or debt write-offs.
I am brought to this conclusion by the differences between today and the 1920s, which combine to produce a more benign economic environment and a greatly reduced risk of crisis.
Money supply eases stress
Firstly, we should bear in mind that the US money supply contracted and the economy went into serious deflation during the Great Depression.
By contrast, though the US is experiencing low inflation at present, its money supply continues to expand (see chart).
In addition, other major central banks are also busily expanding the money supply, with quantitative easing underway in the eurozone and Japan, while China is also easing monetary policy.
This widespread monetary accommodation does much to ease financial stresses of the sort that helped trigger the Great Depression.
In a related vein, the US banking system is stronger today than in the 1920s and 30s, as the recent crisis helped to demonstrate.
Though there were high profile casualties, depositors were protected and we did not see a string of bank failures.
In part this was due to the provision of liquidity by the US and other authorities, but also to the structural reforms imposed upon the banking system in the intervening decades.
Secondly, while it is true that a number of economies still maintain some form of dollar peg, the fact remains that the links today between the US and the rest of the world are far weaker than under the Gold Standard system.
The Gold Standard provided a link between major developed markets and the US, as well as the emerging markets who dominate the “pegged currency” list today.
The clearest demonstration of the difference this makes for monetary policy lies in the diverging stances of the Federal Reserve (Fed) and European Central Bank (ECB), with the latter all but actively cheering the euro’s depreciation against its transatlantic cousin.
Consequently, an economy almost the equal of the US, in terms of GDP, will be easing as the Fed tightens, providing a welcome counterweight to the contractionary effect on global liquidity.
We are not about to enter a second Great Depression, but growth will remain sluggish.
Of course, dollar and euro liquidity are not perfectly mutually interchangeable, but you will not have the eurozone constricting demand in tandem with the US.
It is also likely that other major economies would feel comfortable to allow currency depreciation given their lack of US dollar debt.
The main pain here will be felt by the emerging markets. This is not to be discounted – there could be serious casualties – but it will not be on the scale of a global depression.
A third point is that, while it is true that overall global trade is struggling, the degree of weakness is but a mere echo of that seen in the 1930s.
The chart below depicts trade behaviour around the 1929 Great Depression and the 2008 Global Financial Crisis, and we have simply not seen anything like as significant a contraction in trade this time around.
Trade is certainly weak, perhaps in part as a result of trade restrictive measures, but neither the measures nor the contraction seem comparable to the Great Depression era.
Finally, while we have seen significant falls in some commodity prices, commodities are a smaller share of global GDP today than they were in the 1920s, as Craig acknowledges in his case for.
The price declines have also been of a lesser magnitude – the most pessimistic reading of current data sees a 45% decline across commodities in the last five years, while declines of up to 70% in a similar time period were witnessed in the run up to the Great Depression. Consequently, the effect here is again more muted.
To sum up
I can see a number of parallels and similarities between the 1920s and today, but in each case they are in a more attenuated form today.
This alone would lead me to conclude that the implications for growth are less severe as a result.
I agree that the world lacks a locomotive at present and do not see the US being in a position to repeat the credit driven expansion which characterised the twenty years before the financial crisis.
China is going through a major structural adjustment.
But the world today is different as the factors which turned a downturn into a depression are far more constrained. This time around the policy response has been far more significant.
There was no QE in the 1920s/30s, and this ameliorates many of the problems economic historians identified – whether the Friedman view of mistakenly tight policy, or the Eichengreen view of the Gold Standard generating global tightening.
Finally, banking systems are more stable today. We saw this in the lack of mass failures in the US during the 2008 crisis, for example.
This policy response owes much to the experience of the Great Depression, a period on which Ben Bernanke, at the helm of the Fed as the financial crisis unfolded, is an expert.
Yet as with all medicine there are side effects.
In this case by driving interest rates to zero to support the economy, the authorities prevented some of the creative destruction which would have cleared out unproductive sectors and provided a better base for recovery.
Much of the recovery we have seen has been accompanied by an increase in government debt which will drag on future growth. Meanwhile, productivity struggles as resources are misallocated.
We are not about to enter a second Great Depression, but growth will remain sluggish by past standards. In avoiding the fall we have hampered the recovery.
In case you missed it, part one of the debate: The case for... is available here.
The full article containing both Keith Wade and Craig Botham's sides of the argument is available as a PDF below.