Was 2008 the beginning of another Great Depression?

By Kevin G. Hall / McClatchy Newspapers
Sunday, December 28, 2008



WASHINGTON — It wasn’t 1929, but like that infamous year, 2008 is sure to be remembered by economic historians as one unlike any other.

"We had a much simpler financial system back then. The number of wild and crazy things that happened this year is completely without precedent in world history," said Alan Blinder, a Princeton University economics professor and a former vice chairman of the Federal Reserve.

Where to begin? In March, there was the overnight collapse of Wall Street titan Bear Stearns, in hindsight the first domino to fall in what would become a meltdown of the global financial markets.


Maybe July’s record oil prices of $147 a barrel, which helped spark inflation and send food and commodities prices spiraling upward worldwide? That gave Americans gasoline at more than $4 a gallon, and everyone said that gas would never be cheap again. On Wednesday, however, crude oil prices fell to just more than $37 a barrel, and gasoline was down to a nationwide average of $1.66 a gallon, thanks in part to the global downturn.


Then there was September’s government seizure of mortgage finance giants Fannie Mae and Freddie Mac, which own or back more than half of all U.S. mortgages. Washington, however, let investment giant Lehman Brothers collapse in a shock wave felt around the globe.


Unfortunately, that’s not the half of it. In September, the Federal Reserve also took an ownership stake in insurance behemoth American International Group, followed by the $700 billion Wall Street rescue package that Congress grudgingly passed in October, with little supervision over how the money would be spent.


Then there were the record nationwide home foreclosures and the 13.2 percent year-over-year drop in median home prices nationwide through November, the biggest drop since, yes, the Great Depression.


Capping off the year, December brought the grim-faced chief executive officers of Detroit’s Big Three automakers begging for a lifeline to avoid bankruptcy. Fed Chairman Ben Bernanke and his colleagues dropped a benchmark lending rate almost to zero — the lowest ever — in an attempt to thaw the deepest freeze ever seen in the credit markets.


Investors were so averse to risk late this year that the yield on short-term Treasury bonds briefly went negative twice. Yet investors were opting to lose money on them, perceiving Treasuries as the safest investment to have; better to lose a little than risk losing more elsewhere.


"I have been around awhile, and I have never seen the economy decline more rapidly than it has in the past few months," said Lyle Gramley, a Fed governor from 1980 to 1985 and an economic forecaster since 1964.


At 81, Gramley offers the long view. A child during the Great Depression, he remembers seeing able-bodied men reduced to begging.

"I remember men standing in a soup line that was three or four blocks long just for a bowl of soup," he recalled. "People don’t remember how bad things can get."


Back then, federal cluelessness allowed the U.S. economy to slide into the Great Depression. That’s a mistake that Bernanke, a scholar of the Depression, isn’t repeating: He took unprecedented steps — many of them increasingly at odds with the Bush administration’s laissez-faire economic philosophy — throughout the turbulent year.


In March, the Fed began emergency lending to investment banks that it didn’t regulate, later expanding to a wider range of Wall Street players. In a failed bid to arrest declining home prices, the Fed also began buying the complex mortgage bonds that investors didn’t want. No wonder: The bonds were backed by bundles of mortgages whose risk was impossible to assess.


When the broader credit market froze and banks stopped purchasing commercial paper — short-term promissory notes that major U.S. corporations issue to fund their cash-flow needs, such as payroll — the Fed stepped in and began buying them, too.


By doing all this, the Fed has increased its balance sheet from around $890 billion in assets in August to more than $2.2 trillion. That sum is sure to grow more early next year, when the Fed’s role as the buyer of last resort will expand as it begins buying securities whose underlying collateral is made up of bundled car loans, student loans and credit card debt.


These are called asset-backed securities, and the bundling of loans for sale into a secondary market is called securitization. Securitization allowed for the rapid expansion of credit to Americans during the past 15 years. However, the market for virtually any securitized consumer or commercial debt has evaporated. By stepping in, the Fed hopes to lead institutional investors back into the marketplace.



Bernanke’s aggressive actions are akin to printing money. Once the economy begins to recover, the Fed will face the daunting challenge of shrinking the money supply and raising interest rates — or risking the return of high inflation.


Nevertheless, Bernanke’s Fed also is expected soon to allow GMAC, the finance arm of General Motors, to convert a bank it owns into a bank holding company, making it eligible for Wall Street rescue funds. This would allow carmakers to lend to consumers, since banks aren’t. GM’s November car sales were down 41.3 percent over November 2007.



"It does boggle the mind," Gramley said. "One thing I take a lot of comfort in is, if you were God right now and you could appoint anyone you want to be the Fed chairman to manage us through this crisis, the guy you would pick is Ben S. Bernanke. He is a student of the Depression."



Bernanke declined interview requests.


If 2008 was an ice age for banking and finance, millions of ordinary Americans will remember it for its utter destruction of their personal wealth, their hopes for retirement and even their children’s college plans.


Home prices nationwide sank 7.5 percent on a year-over-year basis through October, and 8.8 percent since they peaked in April 2007, according to the Federal Housing Finance Agency. Through the third quarter, the annualized declines were much steeper in former boom states such as Florida, where they were down 16 percent, and California and Nevada, where they were down almost 21 percent.


Apart from seeing the equity in their homes evaporate, many Americans have seen their 401(k) retirement plans shrink by 30 percent or more as the stock market plunged. Many economists say that amounts to more than $2 trillion in lost retirement savings.


Through Christmas week, the 30 blue chip companies that constitute the Dow Jones Industrial Average had collectively lost 47 percent of their stock value during the past 12 months and 39 percent since the Dow’s all-time peak close on Oct. 9, 2007.


In a Dec. 15 report, the Investment Company Institute, a trade group for the mutual fund industry, estimated that 47 percent of U.S. households have some exposure to stocks or bonds, down 10 percent since 2001. Both younger and older Americans are now less prone to take risks, the group said, following the bear market of 2000-02 and this year’s nosedive.

It may be a hard sell to get ordinary investors back into the stock market anytime soon.

"We’ve just thrown people through two bear markets in eight years. They’re going to decide, ’I can’t risk the rest of my life on this,’" said Howard Simons, the president of Rosewood Trading, an economic research firm in Glenview, Ill.

The new Democratic-led Congress and President-elect Barack Obama have identified a regulatory crackdown on Wall Street as a top priority.

"We need to put rules into place that will give people some assurances," said Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, which will be drafting new Wall Street regulations.


To restore confidence in the broader economy, Obama and Congress must find a way to halt massive job losses. Employers had shed more than 2.5 million jobs through the end of November, and on Wednesday the Labor Department reported 586,000 new requests for jobless benefits in the week that ended Dec. 20, the highest level since 1982. Many economists think that the unemployment rate may peak as high as 9 percent next year, which would be the worst jobless rate since the 10.8 percent peak of 1981-82.


When the 111th Congress convenes on Jan. 6, lawmakers will quickly begin work on an economic stimulus plan that will be so large that its only parallel is the New Deal. The spending and state-aid plan is expected to range from $650 billion to $850 billion over two years, and could grow larger as lawmakers begin horse-trading.


Stimulus efforts can do only so much, however. For the economy to recover, many economists say, bolder steps are needed to reverse the slide in home prices and the epidemic of foreclosures.


The Obama team has signaled a more interventionist approach to finding ways to purchase distressed mortgages and perhaps refinance them with the taxpayer and lender sharing the loss.





"The public sector has to provide some response," Frank said.

(c) 2008, McClatchy-Tribune Information Services. Visit the McClatchy Washington Bureau on the World Wide Web at McClatchy Washington Bureau | Homepage.

Depression, PMI and China


by: Edward Hugh January 02, 2009 | about stocks




The second Great Depression wends its way forward in December ... and lands in China.

Well, China isn't quite in Great Depression mode yet, but manufacturing activity - which forms the core of the Chinese economy and accounts for 43% of all activity - is already very close to a technical recession, and phew, it wasn't very long ago that the Chinese economy was registering double digit growth. So the turnaround is gigantic. The "close to technical recession in manufacturing industry" call comes from the people over at CLSA Asia-Pacific Markets, who compile the China purchasing managers index, and they base their judgment on the fact that their Chinese manufacturing index has now been registering contraction for five consecutive months.




Now for those of you who are new to the world of Purchasing Manager's Indexes (PMIs), welcome. Basically these indexes are very useful, since they give you a "just in time" point of reference to tell you what is actually happening. These are composite indexes - measuring things like current output, new orders (both domestic and export), employment and input prices. They are not perfect, but they are reasonably accurate - the fit which you can get between composite PMIs (manufacturing and services combined) and GDP is often attractively good. And in a country like China where the main data we get is year-on-year (which in a critical moment of rapid change like this one is virtually useless) it is very hard to see what is happening.

The Shanghai-based Industrial Bank estimates, for example, that GDP growth in China will be 5.6% in Q4 2008. But what does that data point - if accurate - tell us? That the economy is slowing fast - well, we already knew that. But just how fast? Well, GDP was 9% in Q3 - down from 10.1% in Q2. So the deceleration is very rapid, but did the Chinese economy actually manage to contract in Q4? I doubt it, but it may do in Q1 2009, although the only way we would really know would be if the National Statistics Office published quarter-on-quarter seasonally adjusted numbers, which as far as I can see they don't. Indeed only a small group of highly developed economies actually take the trouble to do this, and you don't even find all EU member countries doing it yet, although Eurostat (thank god for Eurostat) does require such data from members (but those of you who ever get round to checking will see there are still blanks for some countries in the Eurostat quarterly releases).

Hence you can see why, in the case of somewhere like China, the PMIs are very, very useful, for those of us who would like to try and follow what is happening as it actually happens.

As for the PMI itself, China’s composite manufacturing index contracted for the fifth consecutive month in December as recessions in the U.S., Europe and Japan bit deep into demand for exports - indeed China's exports fell year on year for the first time in seven years in November. The CLSA China Purchasing Managers’ Index registered a seasonally adjusted 41.2, compared with a record low of 40.9 in November. On such indexes any reading below 50 reflects a contraction.

Despite the apparent small improvement in December, the current output index actually fell sharply, and was down to a record low of 38.6 from 39.2 in November, so production was falling, and the index was basically nudged up slightly by other factors, such as the measure of new orders which rebounded to 37 from 36.1, driven by a rise in export orders to 33.6 from a horrific 28.2 in November. However, according to the report, Chinese manufacturers reduced the size of their workforces at a series record in December, and the employment index has now contracted for five consecutive months, to hit 45.2 in December.



So where exactly are we? Well, we aren't (quite) in the Second Great Depression yet, but the situation is deteriorating, and rapidly. Manufacturing output is now contracting at quite a sharp pace, while it was rising in the first half of the year at something like a 15% year on year rate. In a useful summary of the Chinese situation back in November, Nouriel Roubini defined a hard landing in China - which he felt was coming - as follows:




There is thus now a growing risk of a hard landing in China. Let us be clear what we mean by hard landing. In a country with the potential growth of China, a hard landing would occur if the growth rate of the economy were to slow down to 5-6% as China needs a growth rate of 9-10% to absorb about 24 million folks joining the labor force every year; it needs a growth rate of 9-10% to move every year about 12-14 million poor rural farmers to the modern industrial/manufacturing urban sector.



This is more or less the consensus view of what we used to think a hard landing would mean in China, but I think the latest data already take us beyond that. I think there is now a real risk of a technical recession in the more or less classic sense of two consecutive quarters of negative growth (let's say that the risk is 50-50 at this point), and of serious economic and financial dislocation following in the train of this (btw, just how quickly can you burn your way through $1.7 trillion in reserves? It will be an interesting experiment, I think).

Brad Setser (further down the same link) has long been more cautious on China, being sceptical about the impact of a dramatic slowdown in exports (and even more importantly in export oriented investment) on an export driven economy, but those of us who have been closely watching other export dependent economies like Germany and Japan over the last decade and a half were surely not quite so sceptical. However even Brad himself is clear that the possibility of an export downturn feeding its way back into the domestic economy - via some sort of negative feedback process - is real enough:

But the real key to forecasting China’s future growth consequently is determining whether domestic consumption and above all investment will continue to grow strongly in the absence of strong export demand. Remember, over the past few years both domestic investment and exports increased rapidly. If they fall together as well, Chinese growth will slow quite significantly. And unfortunately the latest indicators seem to suggest that they are correlated; consequently domestic demand may fall along with exports.

The $1.7 trillion question is, then, just why China is so export dependent? Doubtless there are many factors at work, but one of these is, I am almost sure, China's very special demographics (30 years of one child per familiy policy), and the special problems that these present in the context of building a sustainable national pensions system at the same time as the population pyramid inverts. Obviously the absence of a credible pension system has to be one of the factors influencing the strong desire to save which we are seeing in China. Economics Nobel Franco Modigliani also thought this, and specifically addressed the Chinese saving puzzle in his last published paper:



China's per capita income ranks below 100th in the world. Its saving rate, however, has been one of the highest worldwide in recent decades. In this paper, we attempt to explain the seeming paradox within the framework of the Life-Cycle Hypothesis developed by Franco Modigliani. The key LCH variables are income and population growth. Our results based on data we put together from official sources show that income growth has been the dominant factor behind the dramatic increase in China's saving rate, as predicted by the LCH. Demographic structure and inflation also had significant impact on the fluctuations of the saving rate.
The Chinese Saving Puzzle and the Life-Cycle Hypothesis - Franco Modigliani and Shi Larry Cao



By Way Of Brief Conclusion


Well basically, the conclusion here is that there is no conclusion, at this point at least. But I would draw attention to two potential points of interest for all you "economy watchers".



Well basically, the conclusion here is that there is no conclusion, at this point at least. But I would draw attention to two potential points of interest for all you "economy watchers".

Firstly, a couple of months back my fellow blogger Doug Muir

drew our attention

to a very interesting point being made

by US economic historian Scott Reynolds Nelson


As a historian who works on the 19th century, I have been reading my newspaper with a considerable sense of dread. While many commentators on the recent mortgage and banking crisis have drawn parallels to the Great Depression of 1929, that comparison is not particularly apt. Two years ago, I began research on the Panic of 1873, an event of some interest to my colleagues in American business and labor history but probably unknown to everyone else. But as I turn the crank on the microfilm reader, I have been hearing weird echoes of recent events.

At the time of reading this I thought to myself hmmmm! This isn't that simple, but he is on to something. Basically I think no two (or does that make it now three) Great Depressions are ever really exactly alike. I certainly think the resemblence between what is going on now and what happened between 1929 and 1933 is more than passing (especially for the sequencing, of which more in another post), but evidently there are elements of the 1873 one too, and Scott Reynolds puts his finger on some of them, especially in the context of surplus to requirement investment and large capacity overhangs. So my best guess is that what we have is a hybrid, and that what is now happening in China is the best example of the underlying dynamics behind that other great depression that hit our grand- (or great grand) parents and that may well be now about to come back to hit us, boomerang style.

Which brings me to my second point, the Smoot-Hawley Tariff Act, which,


as wikipedia explain


, was signed into law on June 17, 1930, and raised U.S. tariffs on over 20,000 imported goods to record levels. After the act was passed, many other countries retaliated with their own increased tariffs on U.S. goods, and American exports and imports plunged by more than half. Many economists now regard the Smoot-Hawley Act as having been the principal feedback catalyst for the severe reduction in U.S.-European trade, and which took it from the 1929 high down to the depressed levels of 1932 and which thus accompanied the start of the Great Depression. And here, in the spectre of a repeat performance comes just the danger we face in the wake of the dramatic contraction which is now underway in China.

It is my personal guess that the first major issue to face Barack Obama as President of the United States may well be what to do about China, and especially what to do about a China which lets - as I now suspect they may well do - the yuan float, in order to see it

float DOWN

as the economy unwinds. If this does indeed happen then Obama will really have to struggle to hold back the protectionist pressure I think.

LA RECESIÓN PODRÍA "DURAR AÑOS"
Obama admite que EEUU corre el riesgo de sufrir una II Gran Depresión

Tras reconocer que el déficit público de EEUU superará el billón de dólares "durante años", el presidente electo, Barack Obama, acaba de admitir la posibilidad de que la primera potencia mundial sufra la segunda depresión económica de su historia. La recesión podría "durar años", indica.







LD (Agencias) El presidente electo de EEUU, Barack Obama, advierte de que la recesión económica podría "durar años" y el desempleo podría alcanzar dobles dígitos si no se adoptan fuertes medidas, incluyendo un paquete de estímulos cuyo coste será "considerable, aunque necesario" para detener el círculo vicioso en el que se encuentra la economía. Es decir, una recesión en forma de L, que se podría prolongar en el tiempo, tal y como aconteció durante la Gran Depresión, tras el crack de 1929.

Obama, que tomará posesión como nuevo presidente de EEUU el próximo 20 de enero, pronunció este jjueves un discurso en la Universidad George Mason, en Fairfax (Virginia).

"No creo que sea demasiado tarde para cambiar el curso de los acontecimientos, pero lo será si no adoptamos acciones drásticas tan pronto como sea posible. Si no se toman medidas, la recesión podría durar años y la tasa de paro podría alcanzar dobles dígitos", indicó Obama.

En una entrevista concedida ayer a la CNBC, Obama no descartó que su propuesta de medidas de estímulo económico y fiscal pueda llegar a superar los 800.000 millones de dólares (589.245 millones de euros).

En este sentido, el presidente electo de EEUU reconoce en su discurso que su plan de estímulo añadirá más presión al déficit del país, que la Oficina Presupuestaria del Congreso cifró ayer en 1,2 billones de dólares para el ejercicio fiscal 2009 (que concluye el próximo 30 de septiembre), aunque defendió la necesidad de asumir este "coste considerable" para detener el "círculo vicioso" en el que se encuentra la economía.


"Sólo el Gobierno" puede estimular la economía


"Es cierto que no podemos depender sólo del Gobierno para crear empleo y crecimiento a largo plazo", señala Obama en el discurso que pronunciará esta tarde. "Sin embargo, en este momento sólo el Gobierno puede proporcionar el impulso necesario a corto plazo para salir de esta profunda y severa recesión".

Asimismo, el discurso de Obama apunta que la próxima Administración está dispuesta a utilizar "todo el arsenal de herramientas" a su disposición para estimular el crédito y restaurar la confianza en el sistema financiero.

A este respecto, el presidente electo planea hacer hincapié en la necesidad de reformar el sistema regulatorio de EEUU, que califica como "débil y anticuado", para proteger a los consumidores e inversores.

Además, el discurso apunta la preocupación de Obama respecto a la necesidad de prevenir la caída de aquellas instituciones que puedan poner en riesgo al conjunto de la economía.