What kind of depression will it be?

That it will be a depression is yesterday’s news. What kind then? Greg Jericho kicks us off with some useful musing:

Through my lifetime there have been three “worst since the Great Depression” times for the economy – the early 1980s, the early 90s and the global financial crisis. In each case we never really got close to experiencing dramatic declines in production and income that happened during the 30s.

Out of those three cases the worst our GDP per capita ever fell in a year was 2.2%. By contrast, during the Depression, there were three consecutive years where it fell by more than 3.5% and one where it fell by more than 10%.

Most of us have lived in a time of moderation.

Consider that from 1920 to 1946, Australia’s annual GDP per capita either rose or fell by more than 4% 14 times; over the past 50 years it has happened just once.

Right now it would not be a shock if such a fall occurs in the June quarter alone.

In the US things have ground to a halt such that the total number of unemployed has increased by more than 50% in a week.

When such things occur, even comparison with the Great Depression fails.

Here in Australia the numbers are going to be just as bad. The numbers of people this week applying for Newstart this week are unprecedented (though not unanticipated) and Westpac economists now predict our unemployment rate will hit 11% by June.

Were that to happen the unemployment rate would have risen 6%pts in four months. The previous biggest four-month jump was in 1982 when unemployment rose 2.4%pts, from 7% to 9.4%.

The Great Depression was as bad as it was because economies around the world went backwards for three to four years. Australia’s GDP per capita in 1931 was 20% below what it was in 1928; in the US it fell 31% from 1929 to 1933.

Were our GDP per capita to fall by 20% that would take us back to 2001 levels – 20 years of growth wiped away.

Fortunately, things are a bit different now from the 30s.

Firstly, the world is not on the gold standard as it was in the 20s and 30s, so central banks have been able to engage in an extremely strong monetary policy response.

And secondly, John Maynard Keynes has already written his General Theory, so we know that fiscal expansion, not austerity, is the best response.

This, of course, is a different economic crisis – people are unemployed because the government has in effect mandated that their workplaces close. And so the hope is that when the crisis is over everything snaps back into place.

But generally it takes longer to recover than it does to fall.

It took two years of the Great Depression to lose 20% of GDP per capita and five years to make it back. During the 90s recession it took three years for the level of employment to fall from 59.6% to 55.5% and more than seven years to get back to the pre-recession level.

The monetary and fiscal supports are significent positives.  Shane Oliver runs with those:

But while the slump in economic activity may be deeper than anything seen in the post war period, depression may not be the best description. Most definitions of depression focus on it being over several years and seeing a very deep fall in GDP compared to a recession which is shorter and shallower. The current hit to economic activity may be very deep but it won’t necessarily be longer than past recessions. And there is good reason to believe that if the virus comes under control in the next 2-6 months and we minimize the collateral damage from the shutdowns that the hit to activity may be shorter. There are big differences between the current situation and that of past recessions and Great Depression of the 1930s:

  • First, recessions and The Great Depression (which saw GDP contract by 36% over 4 years and unemployment rise to 25% in the US and GDP fall by 9.4% in Australia with a rise in unemployment to 20%) were preceded by a period of excess in terms of investment, consumer discretionary spending, private debt growth and inflation that had to be unwound. This time around there has been no generalised period of excess and there has been no large-scale monetary tightening to bring on a downturn.
  • Second, monetary policy was tightened in the lead up to past recessions and in the early phase of the Great Depression whereas global monetary policy was eased last year and that easing has accelerated this month with rate cuts, a renewed ramp up of quantitative easing (QE) and central banks around the world establishing various ways to ensure credit flows to the economy. In the 1930s banks were simply allowed to fail. Now they are being supported by ultra-cheap funding. Much of this owes to the GFC experience which has made it easier for central banks to now ramp up QE and introduce support mechanisms.
  • Third, going into the Great Depression fiscal policy was tightened to balance budgets whereas in the last month we have seen massive and still growing global fiscal policy stimulus swamping that of the GFC. The latest US fiscal stimulus package alone is around 9% of US GDP.
Source: IMF, AMP Capital
Source: IMF, AMP Capital
  • Fourth, there has been no trade war such as the Smoot-Hawley 20% tariffs on US imports that were met by global retaliation and saw global trade collapse in the 1930s.

The bottom line is that while we may see the biggest hit to global and Australian GDP since the 1930s thanks to the shutdowns, there are big differences compared to the Depression suggesting that a long drawn out global downturn is not inevitable. Basically, it’s a disruption to normal activity caused by the need to stay at home. In fact, growth could rebound quickly once the virus is under control and policy stimulus impacts. Which in turn should benefit share markets and could see this latest bear market turn into a gummy bear market rather than a grizzly bear market. Of course, at this point we are still waiting for convincing evidence that markets have bottomed. And the key is that the number of new cases of coronavirus starts to slow and that collateral damage from the shutdowns are kept to a minimum.

Actually, it’s now much more. Goldman sees fiscal supports at nearly 4% of global GDP for this calendar year:

If we see a 20% drawdown in global GDP for one quarter and 10% for a second then that amounts to roughly $7tr in global GDP so governments are doing a pretty good job of catching up.

The issue as I see it is captured by Chanticleer:

The global financial crisis was marked by excessive corporate debt. About $98 billion in capital raisings were conducted in Australia to rebuild balance sheets. Many of these cap raisings, especially in the property sector, were at the behest of banks.

Now, Australia has one of the highest levels of household debt in the world and that could pose a problem for the pace of recovery.

David Plank, head of Australian economics at ANZ Bank, says high household debt is likely to amplify the hit to the Australian economy from the virus.

He says the shock to household incomes is likely to force households to reassess their appetite for borrowings over the medium term and extend the period of recovery as they boost savings to pay off loans.

The world is massively leveraged. In the US it is corporate debt. In Europe it is weak banks. In China it is everything debt. In Australia it is household debt.

Such a large shock to growth is odds-on to shake this out in a second round of financial crisis. Central banks will try but they cannot fix solvency or counterparty risk. Thus I see the crisis playing out further as:

  • a major US coporate debt restructuring;
  • a major European debt crisis that will make or break the EUR;
  • a major acceleration of the Chinese ex-growth trajectory into the middle income trap, and
  • a major Australian household debt crisis as the housing bubble pops.

Authorities are very adept at hiding crises these days through both fiscal and monetary supports. And they will go all-in on extend and pretend. Let’s not forget that we have already been in a income depression for the best part of a decade on this basis.

But expecting a v-shaped recovery from this is all too hopeful. Yes, we’ll get a snap back with pent-up demand but it looks U-shaped at best, probably L-shaped, with all kinds of bumps and drops along the way as stimulus mounts and fades, plus political crises rise and fall.

My best guess then is it is a rerun of the last decade, beginning with a very severe global growth shock followed by a materially worse “secular stagnation” recovery.

Let’s call it The Long Depression, then, that began in 2008 and is now taking its second leg down.

David Llewellyn-Smith
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