We are heading into a new depression. It is not coming. It is already here but we are only in the beginning so it may not be easy for many people to see just yet. Once it is easy to see it will be too late for any meaningful actions to mitigate the effects. Just as you must prepare for a tornado ahead of time, you must prepare for economic conditions early.
If the United States had an economic downturn on the scale of the Great Depression of 1929, your life would change dramatically. One out of every four people you know would lose their job. The unemployment rate would quintuple from its current rate of 5 percent to 25 percent.
Economic output would plummet 25 percent. The gross domestic product would fall from its current $19 trillion level to $14.25 trillion. Instead of inflation at about 2 percent, deflation would cause prices to drop. The Consumer Price Index fell 27 percent between November 1929 to March 1933, according to the Bureau of Labor Statistics. Trade wars caused international trade to shrink 65 percent. That’s how bad the Great Depression was.
Could it happen again? In a 2011 CNN poll, almost 50 percent of Americans believed it could. They thought it would happen within a year. Fortunately, they were wrong. But many people are still worried about a depression reoccurring. Others are convinced we are already in a depression. They can’t see where the drive for growth will come from. What makes these Americans so worried?
First, almost 25 percent of the unemployed have been looking for work for six months or more. 355,000 discouraged workers have given up looking for work, and are no longer counted in the unemployed numbers.
That has driven the labor force participation rate down to 62.7 percent. Not everyone has returned to the job market. Another 5.2 million are working part-time because they can’t find a full-time job. This is all despite the fact that unemployment rates are near the 4 percent natural rate of unemployment.
Stock Market Volatility
Second, volatility spooks investors when the Dow swings 400 points up or down a day. Stock market losses suffered during the 2008 stock market crash were devastating. The Dow dropped 53 percent from its high of 14,043 in October 2007 to 6,594.44 on March 5, 2009. It dropped 800 points during intra-day trading on October 6, 2008, its largest one-day drop ever. Investors who lost money are understandably still spooked by that experience. The Dow closing history shows the behavior of the stock market since the Great Depression.Its fluctuations follow the phases of the business cycle.
In early 2016, stock prices plummeted. Investors lost trillions, and some countries went into recession. That followed losses in 2015 when almost 70 percent of all U.S. investors lost money. According to some, it was the worst year for stocks since 2008. Almost 1,000 hedge funds shut down, and junk bonds were crashing.
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Oil prices have also been volatile. They rose to $50 a barrel after plummeting to a 13-year low of $26.55/barrel in January 2016. That was just 18 months after a high of $100.26/barrel in June 2014. Oil prices were pushed down by an increase in supply from U.S. shale oil producers and the strength of the U.S. dollar. Volatility makes people want to save, in case prices skyrocket again. The oil price forecast for the next 30 years reveals that oil prices could increase to over $200/barrel to meet demands from China and emerging markets.
The Financial Crisis of 2008
Third, the 2008 financial crisis weakened the economy’s structure. It faces future global stresses without its normal resilience.
The housing collapse was worse in the recession than the Great Depression. Prices fell 31.8 percent from their peak of $229,000 in June 2007 to $156,100 in February 2011. They fell 24 percent during the Depression. In the early stages of the recovery, foreclosures made up 30 percent of all home sales.
Many homeowners were upside down in their mortgages. They couldn’t sell their homes or refinance to take advantage of record-low interest rates. The housing collapse was caused by mortgage financing reliant upon mortgage-backed securities.
After 2008, banks stopped purchasing them on the secondary market. As a result, 90 percent of all mortgages were guaranteed, Fannie Mae or Freddie Mac. The government took ownership, but banks still aren’t lending without Fannie or Freddie guarantees. In effect, the Federal government is still supporting the U.S. housing market. A primer on the subprime mortgage crisis clarifies how rising interest rates triggered the crisis.
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Business credit froze up. Demand for any asset-backed commercial paper disappeared. The panic over the value of these commercialized debt obligations led to the financial sector’s crisis, causing the intervention of the Federal Reserve and the Treasury. The governments of the world stepped in to provide all the liquidity for frozen credit markets. The U.S. debt was downgraded. Europe wasn’t much better. Worse, all that addition to the money supply didn’t find its way into the regular economy. Banks sat on cash, unwilling to lend.
They paid back the $700 billion bailout. That’s about it. That situation is improving only now.
Expansionary Monetary Policy and the Federal Reserve
Fourth, the Federal Reserve used up its usual expansionary monetary policy tools to fight the financial crisis. It ended quantitative easing, but that only means it isn’t adding to its bloated balance sheet. It keeps rolling over the $4 trillion in U.S. debt that it purchased for that program. The fed funds rate is 1.75 percent. The Federal Open Market Committee will raise it again in 2018 and 2019. It wants to reach the normal rate of 2 percent. Until then, the Fed has less firepower for the next financial crisis.
Fifth, the federal government is unlikely to come to the rescue with stimulus spending as it did in 2009. The $21 trillion debt means that Congress could prefer to cut spending instead.
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Six Reasons Why the Depression Could Reoccur
Stock market crashes can cause depressions by wiping out investor’s life savings. If people have borrowed money to invest, then they will be forced to sell all they have to pay back the loans. Derivatives make any crash even worse through this leveraging. Crashes also make it difficult for companies to raise the needed funds to grow. Finally, a stock market crash can destroy the confidence required to get the economy going again.
.Lower housing prices and resultant foreclosures totaled at least $1 trillion in losses to banks, hedge funds, and other owners of subprime mortgages on the secondary market. Banks continue to hoard cash even though housing prices have increased. They are still digesting the losses from one million foreclosures.
Business credit is needed for businesses so they can continue to run on a daily basis. Without credit, small businesses can’t grow, stifling the 65 percent of all new jobs that they provide.
Bank near-failures frightened depositors into taking out their cash. Although the Federal Deposit Insurance Corporation insures these deposits, some became concerned that this agency would also run out of money. Commercial banks depend on consumer deposits to fund their day-to-day business, as well as make loans.
High oil prices could return once U.S. shale producers are forced out of business. Millions of jobs were lost when oil prices plummeted. At the same time, many consumers bought new cars and SUVs when gas prices were low. They will be pinched when prices rise again.
Deflation is an even bigger threat. One reason the Fed doesn’t want to raise rates is that inflation has yet to reach its goal of 2 percent annual price increase. Low oil and gas prices have had a deflationary impact. So has a 25 percent increase in the U.S. dollar. That depresses import prices. These deflationary pressures seem like a boon to consumers. But they make it difficult for businesses to raise wages. The result could be a downward spiral. That’s similar to what happened during the Great Depression.
Seven Reasons Why the Depression Won’t Reoccur
Stock price declines haven’t exceeded 11 percent in one day or 30 percent in a year. The kick-off to the Depression was the Stock Market Crash of 1929. By the stock market’s close on Black Tuesday, the Dow had fallen 25 percent in just four days.
Housing prices and foreclosures have recovered. Rental rates are relatively high, which has brought investors back to the housing market. Now that confidence has been restored, housing prices will continue to rise. The foreclosure pipeline, which once seemed endless, has disappeared.
Business credit has been affected the most. The world’s central banks have pumped in much of the liquidity needed. In effect, they have replaced the financial system itself.
Monetary policy is expansionary, unlike the contractionary monetary policies that caused the Great Depression. During the recession in the summer of 1929, the Fed decreased the money supply by 30 percent. It raised the fed funds rate to defend the value of the dollar. Without liquidity, banks collapsed, forcing people to remove all funds and stuff them under the mattress, causing economic collapse. The FDIC helps prevent bank runs by insuring deposits. The Fed has said it will keep the fed funds rate at almost zero through 2012. That certainty calms markets and provides needed liquidity.
Oil prices are rising. But even at $85 per barrel, they translate into gas prices that are still less than half of what Europeans pay, thanks to high gas taxes. The Organization of the Petroleum Exporting Countries would prefer to return the price of oil to its sweet spot of $70 per barrel once it has bankrupted U.S. shale producers. That will reduce oil price volatility. OPEC wants to keep its enemy, Iran, and others from exploring their oil reserves and developing alternative fuels.
Economic output fell 4 percent from its high of $14.4 trillion in the 2nd quarter of 2008 to its low of $13.9 trillion a year later. It fell a whopping 25 percent during the Depression. It has recovered to $18 trillion.
There is a big difference between a recession and a depression. Even if another Great Recession does occur, it is unlikely to turn in a global depression.