Are We Headed for Another Great Depression?
6 Reasons Why Many Americans Think Another Depression Is Likely
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 skyrocket to 25%.
Economic output would plummet by 25%. The gross domestic product would fall from a $20 trillion level to around $14 trillion. Instead of inflation at about 2%, deflation would cause prices to drop. (The Consumer Price Index fell 27% between November 1929 and March 1933, according to the Bureau of Labor Statistics). Trade wars caused international trade to shrink by 65%.
Could it happen again? After the 2007 financial crisis, many people are still worried about a depression reoccurring. Here are a few reasons why that fear persists—as well as some reasons why they may be wrong.
- Structural unemployment, volatile oil prices, and fickle stock markets are some reasons why many believe a second Great Depression is imminent.
- Climate change can pose a substantial threat to the global economy.
Almost 16% of the unemployed have been looking for work for six months or more, as of March 2020. That's significantly below the peak of 45.5% in 2010. Hundreds of thousands of discouraged workers have given up looking for work, and are no longer counted in the unemployed numbers, which drives the labor force participation rate down. Not everyone has returned to the job market. Approximately 5 million people are working part-time because they can't find a full-time job. This is all despite the fact that the unemployment rate is near the 4% natural rate of unemployment.
Stock Market Volatility
Volatility spooks investors when the Dow Jones Industrial Average swings 400 points up or down a day. Stock market losses suffered during the 2008 stock market crash were devastating. The Dow dropped 53% from its high of 14,043 in October 2007 to 6,594.44 in March 2009. It dropped 777 points during intra-day trading on September 29, 2008—at the time, its largest one-day drop ever. Investors who lost money are understandably still spooked by that experience, and more extreme volatility in the market in 2020 have added fuel to the fire.
Two of the top five largest one-day daily percentage losses in the history of the Dow have occurred in 2020. By comparison, the worst percentage drop during the 2007-08 crisis came in 11th on the list. In terms of overall points losses, 2018-20 dominates nearly all of the top spots, but that's primarily because the market's overall size is so much larger than it has been in the past. The Dow plummeted nearly 3,000 points on March 16, 2020, shattering all previous point-loss records.
Oil prices have also been volatile. They rose to $50 a barrel after plummeting to a 13-year low of $26.55 per barrel in January 2016. That was just 18 months after a high of $100.26 per 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. Oil price forecasts have suggested that oil prices could surge to $200 per barrel at some point. Market volatility in 2020 has caused prices to plunge to $20.
The Financial Crisis of 2008
The 2008 subprime mortgage crisis weakened the economy's structure. The housing collapse that caused it was about as bad during the recession as it was during the Great Depression.
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% of all mortgages were guaranteed by 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.
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. Even 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 eventually paid back the $700 billion bailout.
6 Reasons Why the Depression Could Reoccur
Taking into account the factors listed above, there are six main reasons why the United States could see another depression:
- Stock market crashes can cause depressions by wiping out investors' 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. Extreme market volatility in 2020 suggests that this remains an ongoing concern.
- Lower housing prices and resultant foreclosures resulted in many billions of dollars in losses to banks, hedge funds, and other owners of subprime mortgages on the secondary market during the 2007 financial crisis. Banks continue to hoard cash even though housing prices have increased. They are still digesting the losses from millions of 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 near 50% of 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. Low oil and gas prices have had a deflationary impact, and so has a 25% 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 is similar to what happened during the Great Depression. Fortunately, deflationary months have been extremely rare since 2009.
5 Reasons Why the Depression Won't Reoccur
There are also six reasons to believe that we are not in danger of seeing a depression anytime soon.
- 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 continue to rise. After median sales prices dropped to a low of $208,400 in the first quarter of 2009, they reached $324,500 in the fourth quarter of 2019.
- 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. 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.
- Economic output fell 4% from its high of $14.4 trillion in the second quarter of 2008 to its low of $13.9 trillion a year later. It fell a whopping 25% during the Depression. It has recovered to almost $22 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.
What About Climate Change?
There is a long-term threat that could cause another Great Depression, which is the worsening peril from climate change. In 2018, Stanford University scientists calculated how much global warming would cost the world's economy. If the world's nations adhered to the Paris Climate Agreement, and temperatures only rose 2.5%, then the global gross domestic product would fall 15%. However, if nothing is done, temperatures will rise by four degrees Celsius by 2100. Global GDP would decline by more than 30% from 2010 levels, which would be worse than the Great Depression, where global trade fell 25%. The only difference is that it would be permanent.
How to Protect Yourself
When the economy is uncertain, it's a good time to increase your income and reduce your spending. That way, you'll have money to reduce your debt. Make sure you have a cushion, and then build up your savings. The best investment is still a diversified portfolio.
If possible, make sure you have a college degree. Education is the great divide in this society. Although housing is historically cheap, as are interest rates, only buy a house you can easily afford. The smaller the house, the less furniture you'll have to buy to fill it.
The economy is going to experience a lot of uncertainty due to climate change. The best way to prepare is to have enough resources to be flexible.