Mercer Advisors Logo
Search
Close this search box.

Are We on the Cusp of a Second Great Depression?

Donald Calcagni, MBA, MST, CFP®, AIF®

Chief Investment Officer

Summary

  • The Great Depression is an historical precedent against which we tend to compare every economic crisis. But should we?
  • While the U.S. economy isn’t immune to major or prolonged economic disruptions, the issues that caused and exacerbated the Great Depression don’t exist today.
  • Our understanding of economics, the speed and quality of our economic data, and the many tools used to combat economic crises have improved significantly over the past 90+ years.
Are We on the Cusp of a Second Great Depression?

Is Another Depression Likely?

Given the severity of the coronavirus pandemic and its subsequent economic impact, some have argued that the U.S. is on the verge of a “second Great Depression.” Such claims tend to be grounded in drama rather than economics and history. This isn’t to say the U.S. economy won’t experience a severe economic contraction or high unemployment; it most likely will. But it’s important to distinguish between hype and good economic reasoning when evaluating such claims.

 

The Great Depression—What’s in a Name?

Dramatic claims that we’re on the cusp of another Great Depression may elicit an emotional response from readers. The term itself conjures up images of stock market crashes, widespread bank failures, bread lines, Hoovervilles, and dust bowls. These claims typically aren’t analytical or quantitative arguments. For example, an economist’s projections that unemployment will reach 32% is not evidence of a looming second Great Depression; it’s simply one person’s forecast. But even if they’re right, a high unemployment rate isn’t the definition of a depression.

 

What Caused the Great Depression?

Arguments that the current crisis is analogous to the Great Depression are not supported by historical evidence. Economic historians generally agree that the Depression began as a typical recession in the summer of 1929 that was greatly exacerbated by extreme stock market valuations, the imposition of tariffs, the Feds’ decision to raise interest rates, banking crises, tax increases, rigid adherence to the gold standard, and a deeply indebted U.S. farm economy which had its genesis during World War I.

These events acted to reduce consumer spending and remove money and credit from the economy when they were needed most. Subsequently, and perhaps contrary to popular belief, the Great Depression was an era of unprecedented deflation, not inflation. Prices for everything, from crops to labor, fell more than 30% between 1930 and 1933. Why is deflation so much worse than inflation? Imagine taking a 30% pay cut while your mortgage and other debts remain unchanged. To make matters worse, imagine your interest on that debt, as well as your taxes, have also gone up. That’s why deflation, tax increases, and interest rates hikes are a lethal concoction for the economy and why today we fight economic declines with monetary expansion and reductions in taxes and interest rates.

 

Do the Factors That Caused the Great Depression Exist Today?

None of those factors exist today, nor did they exist prior to the onset of the coronavirus pandemic. Stock market valuations are generally in line with their 25-year averages; interest rates remain near historic lows; the Federal Reserve and FDIC protect depositors against bank failures; taxes have been recently cut; and the U.S. monetary system is no longer held hostage by the gold standard. Further, the U.S. economy is significantly less agrarian today than it was in 1930 and, subsequently, farm-related debt is less relevant to the broader economy. In fact, U.S. household debt is at its lowest level since at least 1980. The only remote similarity between the economy of the early 1930s and that of today is that President Trump recently put in place a series of new tariffs against the advice of most economists.

 

Is It Different This Time?

Yes, and in a good way. Today we’re better prepared with real-time data and economic science to guide how we combat economic contractions. For example, rather than remove cash from the economy through tax increases, interest rate hikes, and adherence to the gold standard, today’s policy responses have all sought to inject cash into the economy via various forms of stimulus, tax cuts, expanded social programs, and more.

Consider the evidence: During the Depression, unemployment rose to over 20%, the economy contracted 30%, and over 9,000 banks failed. There were no FDIC or social safety nets for workers. Government removed cash from the economy. Credit froze, and it took nearly four years for the economy to begin to recover; it didn’t fully recover until 1941. The stock market didn’t fully recover until 1944, more than 15 years after the infamous 1929 crash.

Contrast this with the 2007-2009 global financial crisis. The recession that followed was the most severe since the Depression. Unemployment rose to over 10%, the economy contracted 4.6%, and 325 banks failed. Social safety nets were expanded. Depositors were protected by the FDIC, and the Federal Reserve ensured that credit continued to flow throughout the economy. As a result, the recession that began in July 2008 was over by July 2009. The economy fully recovered and went on to post new all-time highs by early 2010. The stock market fully recovered by October 2012, about four years after the crisis began.

Today stands in stark contrast to the Depression. The federal government has been quick to cut interest rates, inject liquidity into the financial system, and expand lending to businesses. None of this would have been possible if we still adhered to the gold standard. The U.S. Congress, rather than increasing taxes and passing new tariffs like it did in the early 1930s, has instead passed a $2.2 trillion plan that provides stimulus, an expanded safety net for the unemployed, and low-cost loans to small businesses (which are analogous to the farmers of the early 1930s). Certain taxes were either temporarily cut or eliminated. While the current economic contraction promises to be painful and steep, economic reasoning and historical evidence suggest it’s unlikely to evolve into something akin to the Great Depression.

Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate, but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control. Mercer Advisors is not a law firm and does not provide legal advice to clients. All estate planning documentation preparation and other legal advice is provided through its affiliation with Advanced Services Law Group, Inc.