Depression dynamic ensues in US as markets revisit 1930s

Bloomberg

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The U.S. economy’s vital signs may not confirm a diagnosis of depression. The symptoms increasingly point to one.

As in the Great Depression, world trade is collapsing, wealth is evaporating and the banking system is broken. Deflation is a growing threat as companies slash production, pay and prices. And leaders worldwide are having difficulty making headway in halting the self-perpetuating decline.

"We are tracking 1929-1930," says Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley.

In the wake of the devastation of the 1930s, Americans swore off stocks, husbanded their own resources and looked to the government for help. Now, another generation might draw some of the same lessons from the deepest economic collapse of their lifetime.

"This is going to scar the collective psyche," says Mark Zandi, chief economist at Moody’s Economy.com. "People will become much more conservative in borrowing, lending and investing." There’s no official definition of what qualifies as a depression. In the 1930s, the unemployment rate rose to 25 percent and the economy shrank by more than a quarter. No economist forecasts a return to the breadlines and shantytowns of that era, even as the economy gets closer to some of the metrics academics cite as constituting a depression, if not a "great" one.

Technical definition

Nobel Prize-winning economist Robert Barro defines a depression as a 10 percent fall in per-capita gross domestic product and consumption. The Harvard University professor sees roughly a 30 percent chance of that occurring now.

The economy contracted at a 6.2 percent annual rate in the last quarter of 2008 and will shrink at a 7 percent rate in the first three months of 2009, projects Jan Hatzius, chief U.S. economist at Goldman Sachs Group.

Bradford DeLong, a former Treasury official, says a depression is a two-year period with unemployment at 10 percent or above. He says that’s possible, though not likely. The jobless rate rose to 8.1 percent in February, a 25-year high. Some industries are already in a depression, led by housing, where the decline accelerated in recent months as the credit crisis intensified. During the last four years, residential investment is down by 37 percent. That compares with an 80 percent drop in spending on home building from 1929 to 1932.

"The past five months have been among the most difficult in U.S. economic history," Robert Toll, chief executive of Toll Brothers, said Feb. 11, after the largest U.S. luxury homebuilder reported a 51 percent sales drop.



Auto industry woes

In the auto industry, U.S. sales have fallen 55 percent from their July 2005 peak. Production of cars and trucks plunged in January to an annual rate of 3.9 million, the lowest since the Federal Reserve began keeping records in 1967, and 67 percent below the January 2005 level. Things are so bad that auditors have questioned the ability of General Motors, the biggest U.S. automaker, to continue as a going concern.

U.S. motor vehicle output slumped 75 percent from 1929 to 1932.

"We are in an automotive depression," said Efraim Levy, an equity analyst for Standard & Poor’s.

The financial-services industry has also been decimated. Since the crisis began in the middle of 2007, institutions worldwide have racked up $1.2 trillion in credit losses and writedowns. Announced job cuts have topped 280,000.

"You’ve had a major disruption of the financial system, just like the 1930s," says Mark Gertler, a New York University professor. In the 30s, more than 10,000 banks went bust.

That disruption is making it hard for Bernanke and his fellow policy makers to get much traction in their efforts to stop the economic decline. Strapped with losses, banks are hoarding capital rather than lending.

This type of breakdown happens only two or three times a century and can lead to a "downward vortex" in which weaknesses in the economy and the financial industry feed on each other and are difficult to break, Lawrence Summers, director of the White House’s National Economic Council, said Feb. 26. "It’s the kind of vicious cycle Franklin Roosevelt talked about," he said.

Mass unemployment

Particularly worrying, says Stanford University professor Robert Hall, is the collapse of the jobs market. Over the past four months, payrolls have plunged 2.6 million. Summers has also voiced concern about a return of deflation, which wreaked havoc on the economy during the Great Depression. As wages fell back then, workers had a harder time paying their debts, aggravating the banking industry’s woes.

In an echo of those troubles, GM, FedEx Corp. and casino company Wynn Resorts are among businesses slashing pay for more than 100,000 workers as they cut costs.

There are other echoes. Since hitting a peak in October 2007, the Dow Jones Industrial Average has fallen 54 percent. Over a similar length of time - from 1929 to 1931 - the average fell 55 percent. It ultimately dropped 89 percent from its 1929 high before beginning to recover in mid-1932.

Combined with collapsing house prices, the free-fall in the stock market will destroy $23 trillion worth of U.S. wealth, reckons Lawrence Lindsey, a former senior White House official.