Three Steps to Turn a Recession into a Depression
So far, the downturn we are encountering looks like a recession. It may be one of the more severe recessions in the last 50 years or so, but it's still only a recession, and not even close to turning into a genuine "depression," if you define that as a 10 percent or greater decline in GNP.
We should all remember, however, that economic downturns are entirely natural events, and you can't prevent them any more than you can prevent ocean waves, or thunderstorms. The global economic system is a highly complex, path-dependent system of interacting forces. In fact, in the aggregate the economy performs very much like the weather, and will always generate unpredictable results. No one has ever successfully predicted economic cycles consistently, and no one ever will -- ever. This is because the better we get at predicting them, the more opportunities we create for imaginative investors to arbitrage those predictions away with their own investments.
Nevertheless, here are some things our policy-makers in Washington could do today, if they would like to ensure that this economic downturn gets significantly worse, and perhaps really does become severe enough to be classified as a depression:
Implement protectionist trade policies. The days of punitive tariffs and excise taxes are mostly history, thank goodness, due in large part to a network of trade agreements negotiated since World War II. However, protectionism usually gets new life breathed into it by economic downturns, when opportunistic politicians who ought to know better begin buying hometown votes with policies favoring hometown constituents:
• Bailing out particular industries, because these industries employ large numbers of constituents, as our current government is doing.
• Requiring (or even requesting) firms receiving stimulus money to "buy American," as the stimulus plan does.
• Bailing out only US-headquartered automobile companies, and only their operations in the US, as the auto bailout does.
• Requesting banks that have received capital injections from the government to concentrate their lending in the US, as the Treasury Department does (and it should know better!).
Increase taxes on the most productive capital and labor. Not just taxes, but any form of regulatory obstacle or cost imposed on "productive" activities, will impede our economy. Some taxes and some regulations, of course, are necessary. We have a government to run and a society to protect. Nevertheless, higher taxes and regulatory barriers will reduce our economic productivity, period:
• Increasing taxes on investment returns like capital gains and dividends, as the budget bill does.
• Increasing taxes on the highest-earning (and therefore also the most productive) workers, as the budget bill does.
Talk about the dire economic situation. That's right. Simply talking about the downturn as if it is likely to become much worse, or as if a depression is imminent, can in fact cause it to get worse. All those worriers and hand-wringing pundits who are predicting doom and gloom are not just predicting it, they are causing it. Not only that, but because any economy is by definition unpredictable at its most fundamental level, these pundits have no more idea where the economy is headed now than they did 18 months ago, when things began tanking.
But psychology is contagious, and the more people anticipate a depression, the more likely the depression will happen, in exactly the same way that the more people anticipate a rising inflation rate, the faster prices are likely to rise, or the more they anticipate increasing home values, the faster home values are likely to increase. This is true only up to a point, however, because when the expectations of large numbers of people finally get too far out of synch with the reality of the economic system, then this bubble of expectations will collapse, and the quickest investors will gain the most.
So here's my contribution to the globe's effort to overcome this particular downturn:
I have begun buying stocks.
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Emmanuel:
Nice comment, and while I certainly sympathize with your position at ground zero in South Florida, I still don't think you're correct.
Of course, every recession and downturn is unique in some respects. And this one has its own characteristics. But there is just as much evidence that too much regulation caused the current financial meltdown as there is that not enough regulation caused it.
I'm reading a great book on the history of the Great Depression in the 1930's, by Amity Schlaes, called "The Forgotten Man". We'll never know whether the recession in 1930 would have turned into a depression without government intervention, because first Hoover and then Roosevelt applied oodles of government spending, intervention, and new regulatory policies to try to repair the economy, but unemployment was worse going into Roosevelt's second term - a full eight years after the original stock market crash - than it was at the beginning!
A lot of economists think that if Hoover and Roosevelt had taken a "hands off" policy, and simply concentrated on maintaining the money supply and banking liquidity, things would have got better much faster.
But we'll never know for sure, because they didn't do that. What we do know is that government intervention did NOT work well in preventing the last Depression. That is a simple historical fact.
Mr. Don Peppers failed to mention that this recession is a different kind of recession, compared to the natural events he refers to. We're experiencing one that is global and is directly affecting residential and commercial real estate markets in the U.S. Trust me, I live in what they call the "ground zero" of this mess: South Florida.
Because regulatory guidelines were not in place, our financial system (specifically, lending and credit) is falling apart. The government is trying its best to secure it. Almost in the form of CPR. But, is the government doing all of the right things to help recover our economy? We're not sure and that's because this type of recession has never occurred in the past. All we can do is hope that economists carefully dissect the situation to confidently guide our government in the right direction.
Wasn't the whole thing caused by the BBC's reporter Robert Peston? He seems to have made a career out of doom and gloom.
Chris:
Touche!
As it happens, I'm in Spain right now at a big conference of agricultural and food vendors, and the number one question on everyone's mind is NOT "what's next in this downturn?"
Everyone here is too busy trying to do more business...
"Simply talking about the downturn as if it is likely to become much worse, or as if a depression is imminent, can in fact cause it to get worse."
As you did in your first two points? Stop that, you depression-causer, you!