Comparing The Coronavirus Recession to the Great Depression

Though most of you know me as the local weather geek, I’ve also a bit of a economics buff and stock market junkie. I got my first taste of Wall Street at a young age, overhearing the market bits between news features on NPR in the back seat as my mom drove me to and from soccer practice. I remember being mesmerized by the perennially-green stock tickers on CNBC at the turn of the millennium, though I had no idea what any of it meant, or that we were in the middle of the dot-com bubble.

Thankfully, as I grew throughout elementary school and middle school, my proclivities shifted from stock tickers to socializing with my classmates, and I didn’t really get back into economics and markets until after I graduated college. But since graduating, I’ve amassed quite a bit of knowledge on financial markets due to independent research, and my knowledge has been bolstered by my employment in the energy sector; first as a wind energy forecaster for Avangrid Renewables and now as a meteorologist for Portland General Electric specializing in renewables and demand forecasting.

The record-breaking sell-off in equities, utter collapse in oil prices, and flight towards bullion we saw in March is unprecedented in American markets. There are been more abrupt market crashes (Black Monday, October 1987) and greater peak-to-trough drops (such as the Great Depression), but this is the quickest the market has fallen into ‘bear market’ territory, which is loosely defined as a 20% drop in equity values from recent highs and, more importantly, a pervasive, persistent, and pessimistic market sentiment.

The graph below shows the value of the S&P 500 (a stock market index consisting of the 500 largest US-traded companies by market capitalization) going back to 1927. I’ve opted for a logarithmic scale to add some granularity. The decline we’ve seen so far looks manageable on a logarithmic scale, but I believe this is only the tip of the iceberg and that the market has much further to fall.

But the carnage on Wall Street is nothing compared to the carnage in crude oil prices, which have fallen to their lowest levels since autumn 1998 in response to a price war between Saudi Arabia and Russia. As two massive net oil-exporters, Saudi Arabia (as part of OPEC) and Russia had previously worked together to curb supply so that they could sustain a price floor, but negotiations on curtailing supply due to reduced demand in Asia from the coronavirus fell through, as Russia is one of the lowest-cost oil producers in the world and actually wants low oil prices so they can take market share from higher-cost US shale, which has gained significant market share over the past decade. Saudi Arabia responded to Russia’s refusals to curtail supply by slashing their export prices by nearly a third on March 8, triggering a price war between these two players

The graph below shows the cost per barrel of WTI (West Texas Intermediate) crude oil since February 1946. This, combined with lowest gas demand since 1993 due to people staying home, is translating to low prices at the pump; gas prices have fallen to their lowest levels since February 2016 and I expect this trend to continue (there is often a lag between oil prices and gas prices). Because the three West Coast states have all seen increasing gas taxes over the past decade, it’s next to impossible for us to return to the $1/gallon baseline that was common throughout the 90s, but I wouldn’t be surprised if we dropped below $2.00/gallon statewide (as of 4/13/2020, the statewide average for Oregon is $2.54/gallon).

Low oil prices are weakly correlated to a weak US economy due to an aggregate drop in consumption, but low oil prices also benefit many consumers and companies (such as airline companies). Oil prices have a more direct correlation to economies that are significant net exporters/importers of oil – for example, India is highly reliant on oil imports, so low oil prices will decrease India’s trade deficit and free up funds for discretionary spending, while Russia and Saudi Arabia are significant net exporters and prefer higher prices.

Comparing the Coronavirus Selloff vs the Great Depression

Due to the panic on Wall Street and surge in unemployment, there have been a lot of comparisons of the Great Depression of 1929-1939 and the Great Recession of 2007-2009 to a potential depression/recession brought by the coronavirus pandemic. But both the Great Depression and Great Recession had fundamentally different causes than the current economic slowdown from the coronavirus. The Great Depression/Recession can be broadly categorized as financial crises caused by speculative bubbles fueled by cheap, easily available credit, while the coronavirus is more of a severe external shock that has simply shut down society, though it has also exposed latent weaknesses in the economy, particularly income inequality and total US debt. Additionally, the government is taking far more aggressive steps to save the economy than it did in the Great Depression or even the Great Recession (such as sending qualifying Americans a check for $1,200), and this should help mitigate the effects of what could otherwise be a cataclysmic economic collapse.

The Roaring Twenties, 1929 Stock Market Crash, and Great Depression: 

In order to understand the Great Depression, we have to first understand the Roaring 20s, and how a deregulated business environment combined with post-war optimism and booms in many economic sectors led to people taking on dangerous amounts of financial leverage, which eventually led to panic in markets, the failure of the nation’s banking system, and a deflationary death spiral that resulted in mass unemployment. The 1920s featured economic booms in a variety of industries, but the one most pertinent to middle-class Americans was the boom in consumer goods. Revolutions in technology and manufacturing processes (notably, the widespread adoption of assembly-line production) allowed new, convenient consumer goods like washing machines, vacuums, and automobiles to be produced at relatively low cost, and the expansion of credit allowed for consumers to easily take out loans so that they could finance these items. Credit is a wonderful tool when used responsibly, as it helps facilitate transactions in the economy by increasing a person’s purchasing power. However, if credit use becomes unsustainable and the economy slows down, debtors risk defaulting on their creditors, which leads to bankruptcies, a drop in aggregate demand, and eventually a recession or depression.

And in the 1920s, credit eventually grew to unsustainable levels. This was particularly true when banks began the practice of “margin lending,” which is allowing people to buy stocks on credit. By 1929, approximately 80-90% of the entire stock market was owned on credit, and banks were lending more for stock and real-estate investments than they did for commercial ventures (something that would be repeated in the 2007-2008 financial crisis).

The stock market remained relatively flat through 1924, but rose dramatically from 1925-1927 and surged to exorbitant levels through autumn 1929 in what Herbert Hoover called an “orgy of mad speculation” in the stock market. But by 1929, there were clear signs that the economy was weakening, with slowing steel production and sales of expensive consumer goods, such as automobiles. Agricultural commodity prices, which had been in the toilet for much of the 1920s due to oversupply following the government-incentivized boom in production during World War I, continued to fall due to large harvests in Europe in Australia, bringing more hardship to American farmers and more fear and uncertainty to financial markets. The market reached a peak on September 3rd and began declining through mid-October, and panic selling set in on the week of October 21 and persisted through 10/29 as people faced “margin calls” and were forced to liquidate their holdings to pay their creditors they had bought stocks on margin from. 

However, the Great Depression was not caused by the 1929 stock market crash. Only 3% of Americans owned stock, and while the stock market crash was devastating for stockbrokers, it had little effect on most Americans. And besides, the market had pared a lot of its losses by early 1930. However, this crash did signal that the markets would not go on forever and created distrust and fear in the markets. This distrust and fear eventually led to people taking mass withdrawals from banks, causing widespread bank failures. And it was the failure of America’s financial system that caused the Great Depression.

Bank Runs, The Decline in Money Supply, and Deflation

The biggest policy difference so far between the economic decline now and in the Great Depression is that the Federal Reserve continues to take unprecedented steps to ensure the health of the US banking system now, while it basically sat idly by and watched it fail in the early 1930s. The Federal Reserve is the United States’ central bank and was established in 1913 in response to a string of banking panics that took place over the previous decades, most notably the Panic of 1907. It was not the first US central bank – the US had a central banking system from 1791-1836, but Andrew Jackson, who was adamantly opposed to the idea of a central bank, refused to renew its charter, and the idea of a central bank fell by the wayside for the remainder of the 19th century.

Up to and including the 1930s, most banks were small, local banks, and could be easily be sunk in the event of a ‘bank run,’ where depositors would rush to the bank to withdraw their money and collectively would withdraw more cash than the bank had on hand. Banks are leveraged by design and invest the money you deposit into their accounts and keep a relatively small amount of cash on hand, so a flood of withdrawals forces a bank to sell assets, liquidate loans, and can often result in a bank failure. Bank runs began in the Upper South in November 1930 and spread to other parts of the nation over the next several years, such that by 1933, over a third of the nation’s banks had gone bankrupt.

The “broad money supply” (physical currency + checking and savings accounts) fell from $47 billion in 1929 to $32 billion in 1933 as a result of these bank runs – in other words, the US population as a whole lost a third of its cash over the span of four years. The decrease in cash led to deflation, where the purchasing power of currency rises over time. Having your money become more valuable may seem like a good thing, but it is awful for the economy as a whole. This is because a deflationary environment encourages saving; it becomes more profitable to simply hold on to money instead of investing it in stocks, bonds, or business ventures, and people will delay their purchases because they know their money will be able to buy more things at a future date. This leads to reduced demand for products and services, and businesses respond by laying off workers to cut costs. And because these workers who have been laid off now do not have any income, demand for products and services continues to fall, more people get laid off, and the economy gradually grinds to a halt. This leads to an ostensibly paradoxical state of equilibrium, with massive underemployment despite under-utilized factories and facilities, simply because it is more profitable to hold on to money than to invest it.

Franklin D. Roosevelt was inaugurated in March 4, 1933, and his administration and Congress passed a series monetary and fiscal stimulus programs that we collectively call the “New Deal” to mobilize us out of this deflationary death spiral. Roosevelt immediately declared a “bank holiday” from March 6-13, 1933, that temporarily prohibited withdrawals from banks as a temporary fix to stabilize the financial system, and in April 1933, he passed an executive order that required Americans to turn in their gold for cash. The US and much of Europe still adhered to the Gold Standard at the time, so the government wanted to gain gold so that they could expand their monetary supply. After collecting all this gold, they devalued the dollar from approximately 1/20th an ounce of gold to 1/35th of an ounce and printed a bunch of money, reducing deflation in the process (by making cash less valuable). The government also sent relief checks to the severely impoverished, and it invested heavily in public works projects to create new jobs. The Grand Coulee Dam in Washington and Hoover Dam in Nevada are two of the most famous public works projects, but there were over 34,000 projects that either received supplemental funding from the newly-created Public Works Administration or were created from scratch.

The Coronavirus Recession: A Severe External Shock, But a Proactive Federal Reserve

While the Great Depression was purely the result of human errors – speculation by consumers/capitalists and the failure of the Federal Reserve – the coronavirus recession was necessitated by the onset of a severe, biological shock – the most severe global pandemic since the Spanish Flu of 1918. This is best illustrated by the “US initial weekly jobless claims” from the Department of Labor.

The mammoth US unemployment claims in their historical context. pic.twitter.com/UNDwhBMpZt

— Ben Riley-Smith (@benrileysmith) April 2, 2020

Many economists – including Federal Reserve chairman Jerome Powell – claim that the economy was perfectly healthy before the coronavirus shock, citing the absence of any major speculative bubbles, such as the housing bubble that led to the 2007-2008 financial crisis, as well as low inflation and low unemployment. I don’t claim to know more about the US economy than the Federal Reserve chairman, but nevertheless, I’d still contend that the US economy has some serious issues, and most of these issues revolve in some form or another around income inequality. Wage growth has been more or less in line with inflation over the last 40 years and has been significantly outpaced by productivity growth, and most of the wage growth has gone to the upper class. And to make matters worse, the cost of health care and education have both significantly outpaced inflation for the past several decades. In other words, having the lowest unemployment in 50 years is a moot point if people have to hold multiple jobs just to make ends meet.

If the Fed sat idly by and watched the economy deflate like cold balloon during the Great Depression, it is desperately heaving gasoline onto a disappearing fire this time around, taking unprecedented action to keep the economy afloat. The Federal Reserve has begun the process of “quantitative easing,” which is a form of monetary policy where the Federal Reserve purchases various government or private-sector financial assets, and by doing so injects cash directly into the economy. In the case of quantitative easing, the Federal Reserve doesn’t require any “funds” to purchase these assets; this is what the media means when they say the government is “printing money.”

The above graph shows the Federal Reserve’s balance sheet, which is the total amount of assets they have on their books. As you can see, the last time they expanded their balance sheet so rapidly was during the Great Recession, with gradual quantitative easing through late 2014. The Fed actually began “quantitative tightening” in 2016 and reduced their balance sheet by selling back some of the bonds and financial products they had purchased, but their balance sheet has already expanded to record levels and they are now buying pretty much all publicly available financial products except stocks. The Fed has pledged to buy unlimited amounts of these assets in order to keep the markets functioning – with a public health crisis forcing such a severe economic shutdown, they really have no choice.

The CARES Act

In addition to the monetary stimulus measures taken by the Federal Reserve, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act is a staggering 2.1 trillion dollar economic stimulus package – far larger than the $831 billion for the American Recovery and Reinvestment Act of 2009, which was the analogous economic stimulus package for the Great Recession. Keep in mind however that the 2008 Financial Crisis also had the 700 billion dollar “Emergency Economic Stabilization Act of 2008” (better known as the ‘bank bailout’), which is probably the most effective, least popular piece of legislation in American history.

One thing that the CARES Act does not call for are large public works projects like those undertaken during the Great Depression, as doing so would defeat the whole purpose of the social distancing measures we’ve undertaken. But when the dust has settled from this virus, such projects may be worth considering. I’ve always been in favor of private entrepreneurship paving the way towards a green energy economy instead of a taxpayer-subsidized “Green New Deal,” as we are now at the point where the environmentally friendly and economically prudent options are often one and the same, particularly when thoughtful policies like carbon cap & trade or a carbon tax & dividend are put in place, but having a Green New Deal may make more sense if we need the government to help employ us out of a deep recession.

Summary:

To summarize, the Great Depression originated as the large-scale failure of the nation’s banking system, not only bankrupting many individuals and businesses but destroying a significant portion of the nation’s money supply, leading to a vicious cycle of deflation that froze up credit and caused massive unemployment. The coronavirus recession (which hopefully will not develop into a full-blown depression) was caused by a severe external shock forcing governments to enact social distancing measures, which will inevitably result in a severe contraction in GDP and a recession. However, the government has been much quicker to enact fiscal stimulus programs that guarantee some sort of economic security for individuals and corporations, and a proactive Federal Reserve has gone to extraordinary measures to keep credit markets from freezing up. Though the government actions will add to our debt and the quantitative easing from the Federal Reserve will increase inflation by increasing the money supply and devaluing the dollar, not intervening in markets would result in a much more severe outcome.