There are many powerful misconceptions that need to be addressed about our past in order for us to gain a better understanding of the present. Looking back at the roots of "conservative" and "liberal" ideology would be one. Addressing the people and motives that were behind the creation of our current monetary system is another. But appreciating what the Great Depression was, what it meant and what it looked like is something that seems to be shrouded in hyperbole and sensationalism, giving the word "depression" such a mythological undertone as to almost make it meaningless.
When I suggest that we are in a "depression" now - or heading toward one - most dismiss the notion as "out of touch." "If we're in a depression, where's the dirty people riding on top of trains? Where's the people lining up for a day's work? How come when I go to Walmart, it's packed full of shoppers? Why does everyone still have a car?"
The above questions show an ungraceful ignorance of basic economic realities involving wealth, money, debt, productivity, education and many other components of an economy that naturally fluctuate - but even more so in times like now.
The mythology of the Great Depression likely started for most in school. I remember being taught about all of the daily necessities that people had to do without, the unemployment lines, food stamps, the dust bowl and the desperation it caused in eagerly joining up for the ensuing war. To get an idea of what children learn about the Great Depression today, one can take a look at Mrs. Winfield's Grade 6 Website.
I remember the same picture of Florence Owens Thompson being shown to me as representative of daily life in the 30's - as well as ones of bread lines and soup kitchens.
While not factually incorrect, summaries like Mrs. Winfield's are terribly misleading. Leaving out major causes leading up to the '29 crash and painting pictures of total destitution for nearly everybody.
It seems that today, the word "depression" is more representative of what happened in the 30's, rather than being representative of a general economic phenomenon. So when it is attempted to be applied to today's world it is dismissed as impossible. While the 30's repeating themselves verbatim is impossible. An economic depression is not.
I suppose another way of describing this misconception is through the mainstream lack of differentiation between money, credit and wealth in general. I've outlined my position as to credit being more important than the money supply in terms of the inflation/deflation question. So I will not dwell on that here. But another powerful misunderstanding seems to revolve around definitions of money and wealth.
It is assumed that if we were to have a depression, all of our wealth would disappear. Hyperbolic statements are made in the media that, "the doomsayers think we're going back to the stoneage." Being a stock market bear would probably qualify me as a "doomsayer," but to imply that a major correction in the stock market is equal to the loss of our technological advancement is just plain silly. Let's explore this further.
Wealth is cumulative in nature. Another word for it is capital. Essentially, it is something that is used to produce something else. In contrast consumer goods are things that capital can produce with various amounts of labour providing assistance. What is capital to some people may be consumer goods to others. For example, raw materials are capital goods for the toolmaker. Whereas the tools are capital goods for the homebuilder. And the home is a capital good for the landlord. The renter of the home consumes what it can produce - shelter.
So if a depression were to ensue thereafter, bankrupting all of the above, it does not follow that all of the capital goods disappear and become completely unproductive. They remain. And although their value may fall relative to whatever metric is commonly used, and while their ownership may be transfered, they are sill capital goods.
This may seem self-evident to many. But if arguments about the impossibility of depression are broken down, they violate these basic economic principles. Depression is a relative term. It is used to describe a dramatic drop in economic activity, a transfer of capital goods from the incompetent to the competent and typically a reduction in debt levels via bankruptcies.
People have become progressively wealthier over the last century. Those who nowadays are considered to be impoverished, have access to luxuries that only the wealthy elite did decades ago. This can be illustrated by the chart below which plots US GDP per person, adjusted for inflation since 1929. (courtesy Econompic Data)
It does not matter how bearish one is. Even a substantial decline in the above metric would only make people feel as "poor" as they felt in the 90s. Of course, the problem with dealing in aggregates is that some people are hit harder than others. But because the nature of a depression is to depress the values of capital goods and force liquidations of those who have made malinvestments, it is typically the already wealthy who are hit the hardest in relative terms. This happened in the 30's and will likely happen again - no matter how much it is resisted by central banks and politicians. Evidence of that can be seen below:
(note: the above chart only goes to 2006)
The wealth of all has a tendency to grow over time. But the wealth of the elite tends to grow even faster during highly inflationary periods - and decline during periods of deflation (remember: inflation/deflation are changes in the supply of money and credit, not prices).
Again, the point of this is to paint a realistic picture of what a deflationary depression would do to our wealth. We would still have all the technological advancements of the 20th century. We would still have all of the productive capacity used to provide it. We would still have an able workforce, etc, etc. It is true that there is a depreciative factor in all of these things, which is the basis for the immediate liquidationist argument - the faster this happens, the less depreciation is experienced while under incompetent management. But it is clear that the hyperbole of "living in caves" is baseless fear mongering. (Ironically, it is people like myself accused of doing the fear mongering). But I digress.
The final argument I would like to touch on that dispels the depression impossibility argument has to do with debt and its impact on economic activity. Because we live in a credit based monetary system, the influence that credit expansion has on GDP is sometimes quite substantial. It has the effect of pulling forward future demand to the present. That is, people who would normally need to save prior to consuming something can borrow money and instead do it sooner. Karl Denninger of the Market Ticker Blog had some good comments along these lines that I will more or less echo here, starting with the chart below of total private debt outstanding.
As the chart above shows, there was very little growth in credit relative to the size of the economy prior to 1981. For all intents and purposes, we can consider that most post war economic growth was legitimate. Since then, private debt outstanding has gone parabolic. In 1981, with the GDP around $3 Trillion, total private debt outstanding was around $4.5 Trillion. After Q1 of 2009, with GDP around $14 Trillion, total private debt outstanding sits around $50 Trillion - an increase of about $45 Trillion. The total cumulative GDP since '81 is $218 Trillion. 45/218 = ~20%.
20% of US economic growth since 1981 has been based on credit expansion. More of this occurred in the latter part than did earlier. Unfortunately, none of this includes the many trillions more of government debt - but that is unnecessary for this analysis. It is enough to consider just private debt (besides, it is spurious at best to conclude that government contributes any growth at all). Of course, it could be argued that we have made technological advancements that allow for a more efficient expansion of credit. To an extent I can see the validity of this. Having computers that are able to keep track of payment, credit records, collateral values and such is definitely less cost prohibitive than attempting to do so with paper record keeping. Lower costs in the provision of credit should enable confidence in a lower rate of interest to persist. But in the inverse it can be said that 2008 made that argument a pile of crap. The truth probably lies somewhere in between.
The implications of this should not be underestimated. If this credit is on the verge of collapse, a significant portion of economic activity, say between 15-25%, could go along with it. To most, this is apocalyptic. Hellfire and brimstone kind of stuff. But to anyone who read the above part of this article, it can be seen in a more realistic light. A drop in 15-25% of US GDP would bring the country back to it's level of activity around (gasp!) 2002-2005.
How much poorer would the average person feel if they were to be relegated to their standard of life 5 years ago? As mentioned before, "the average person" is a bit of a misnomer. There is no such thing. It would mean immediate poverty for people involved in some industries - and no change at all for others. Many would see their standard of living rise as many of their basic necessities would fall in price.
It seems to have been a bit romanticized among many bearish commentators about how a collapse in credit will force a return to frugality and away from conspicuous consumption. But it should be made clear that this frugality is a relative phenomenon. Regular people will not have to do without basic necessities like they did in the 30's. The massive productivity advancements since then have made these goods much more affordable while the accumulated capital we have makes them more plentiful. People will trade down in brands and therefore spend less overall. They will do without the unessentials that were previously only consumed because of easy credit. People will choose smaller dwellings and squeeze more into existing large ones. They will accept lower wages in exchange for fewer hours.
None of this will have an extreme depreciative effect on people's quality of life. We will not lose our existing infrastructure. Life goes on. For some easier than others. A depression in the 21st century is real and probable - if not inevitable.
It would just be nice if we could address our problems rationally without the fear campaign that seems to go along with it.
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