“It looks like the unemployment rate is headed to 15 percent,” said Chris Rupkey, chief financial economist at MUFG Bank, in a note to clients. “This isn’t a recession, it’s the Great Depression II.”And yet you may have noticed a sustained rally in the stock market over the past two weeks. If you had bought at the bottom on March 23 you would have made a 30% return by now.
All this might lead you to experience some cognitive dissonance. If we're headed for another Great Depression, why is the stock market rallying? Wasn't the great crash of October 1929 and subsequent bear market one of the hallmarks of the original Great Depression? Might it be that this time the market knows something that Chris Rupkey and the Washington Post don't? Well, it's possible, but I doubt it.
There is one enormous difference between what is happening today and what happened in 1929, namely, that in 1929 the Fed didn't intervene to try to fix the problem and today it is staging the biggest intervention by a central bank ever in human history. In a nutshell, it is offering essentially free money in the hopes that people will take it and use it to keep the economy from collapsing during the pandemic. As the same time, Congress is also pumping vast amounts of cash into the economy through what appears likely to become a series of stimulus programs. At the moment all this appears to be working. Supermarket shelves are still reasonably well stocked (except for toilet paper). There is no widespread civil unrest. The churches and the gun stores are still open, at least they are if you lucky enough to live in a red state (and yes, that was intended to be ironic).
So maybe it's working this time. It is certainly working as a temporary stop-gap. Things would certainly be much worse right now if not for these measures. But there is a very, very big danger for the medium-to-long term.
The problem is that the stock market is being propped up by cheap credit which is exactly what led to the crash of 1929. Banks are borrowing money from the Fed and using that money to buy stocks, which are cheap by historical standards. If the economy were functioning normally they would be a bargain, having dropped 37% from their peak. (And note that percentage drops don't combine intuitively with percentage gains. A 37% drop followed by a 30% gain is not the same as a 7% drop, it's a net 18% drop.) But the economy is not functioning normally. Vast sectors of it -- travel, entertainment, restaurants, pretty much the entire hospitality industry -- have been completely shut down overnight, with ripple effects into other sectors that supply the hospitality sector. So the actual value of the U.S. economy is dropping like a stone at the same time that cheap credit is pumping up the price of stocks.
This is not the same as October of 1929. This is much, much worse. In 1929 the U.S. economy was basically sound. There was just as much productive capacity after the October crash as before. What amplified the crash into the Great Depression was the Fed's failure to relax credit which in turn led to a cascade of bank failures. A similar thing happened in 2008, except that lessons were apparently learned and we kinda sorta dodged a bullet.
Today there is not as much productive capacity as there was a month ago. There is a lot less. So there are only three ways that this can play itself out:
1. We find a way to end the lockdowns and return to work before too much time goes by. The only way this could be done safely is through the discovery of an effective treatment for covid-19, or more widespread testing so we can be more selective about who we isolate. The other possibility is to just throw in the towel and let a million people die.
2. The Fed continues to prop up the market for as long as the crisis continues.
3. The banks who borrowed the money realize that they now hold overpriced stocks and begin to sell in order to lock in their profits. Once prices start to drop, panic selling sets in.
At the moment the Fed has indicated a willingness to do #2 but whether they are really willing to stick with this in the long run is unclear. Artificially propping up prices by pumping money into the economy is no panacea. Germany tried that during the Great Depression and it did not end well.
We dodged Great Depression 2 in 2008 by the skin of our teeth. We did that in an era when the crisis was driven entirely by policy and not by any underlying physical factors, and when the people in charge were mostly competent and honest. Today none of those things are the case. We have an actual significant drag on the economy, and the country's leadership is both corrupt (really really corrupt) and incompetent (really really incompetent).
We Americans are a resilient and resourceful people and maybe we'll figure out a way to make this all work out somehow despite the headwinds. But I wouldn't bet my life savings on it.
[UPDATE] If you were pinning your hopes on the prospect that the Trump administration is not rampantly incompetent but rather perhaps just a little slow on the uptake, and that now that reality has set in they will finally do the Right Thing and deal effectively with the crisis, well, I wouldn't count on that either.