Friday, July 10, 2009

The Greater Depression

What new research is showing us
This week I received an interesting e-mail from Chris Botha of Stanlib Asset Managers. It was an astonishing chart that compare the World Industrial Output between the Great Depression of 1929 and our current state of affairs that started in April 2008.

I simply could not believe the similarities and set out to search for the source.

The authors of this chart turns out to be Barry Eichengreen, Professor of Economics and Political Science at the University of California (also a senior policy adviser at the IMF) and Kevin H. O'Rourke, Professor of Economics at the Trinity College in Dublin.

They argue that this global phenomenon cannot be measured with US data only. (see The other side of the coin). International trade, capital flow between continents and global commodity prices play a big part to interlink this crises all over the earth.

In other words, what they are doing is comparing world data that was available in 1929 with world data today.

The conclusion is contrary to other measurements. Many economists still believe that this crises is not as severe as the 1929 one. The authors of the above mentioned chart, disagree.

Since April '08, things have been pretty similar to 1929. They have calculated that globally, stock markets are falling even faster than in 1929.

The response however by treasuries the world over, has been very different to those of the governments of 1929, so it is still reasonable to expect a different outcome. The thing is, we don't know whether it's going to help but look at how the available tools are put to work:

Rates has been cut more aggressively than in the 1930's. This chart shows the average of 7 countries' rates that the central bank charge the institution who borrow from them. (Similar to the South African Repo Rate).

The supply of money is introduced much earlier in the cycle. This is those stimulus packages that Obama keeps talking about. The difference however, between now and then is the fact that the US economy at the moment stands at a deficit of -5,5% of GDP vs Zero in 1929. This means that the US is loaded with debt and should things not work out they should - it might cause an event greater disaster.

The other side of the coin.
Some analysts believe that this crises is not yet as bad as in 1929. Paul Krugman, author of The Great Recession versus the Great Depression argues that (to date) this has been slightly milder than in 1929. He uses this graph to compare the four biggest losses in modern history to substantiate his point.

The Bottom Line

I believe that one should not spend too much time trying to forecast the future. How severe it will be or how deep the cut? - We will all only find out afterwards.

What I do believe is this: We have become exceptionally self satisfied. Even in the midst of a great crisis, newly bought cars still line up at KFC for take-aways, people continue to fork out R1 000 per seat for rugby tickets and not to go on holiday is totally unheard of.

But one cannot be realistic about the future without the reasonable expectation that some day, maybe not even in our life time but some day, people will again line up at soup kitchens all over the world for something to eat. Again they will walk to get where they want to go, and again, they will grow up in such extreme poverty that they will save and invest every little dime they earn and by doing so, enabling the following generation to harvest the fruits of their hardship.

Eichengree, B and K.H. O’Rouke. 2009. “A Tale of Two Depressions”. April ‘09
Paul Krugman, “The Great Recession versus the Great Depression”. Conscience of a liberal. March ‘09
Doug Short, “Four Bad Bears” Dshort: Financial Lifecycle Planning. March ‘09