I know I try to keep most of my posts on here at an easily digestible level, but whenever you start delving into deep economic theory, it isn’t always easy. Today I want to discuss the current state of the U.S. economy, and how close we are to a ‘depression’…or not.
First, for most people, when people think of an economic depression, they are thinking about ‘The Great Depression’, which occurred throughout the 1930s and into the 1940s in the United States. And now, it’s hard to find an economist who will claim the U.S. is headed for a depression, because mentioning a depression conjures up images of the dust bowl, widespread tent cities and massive unemployment.
Most economists like to use the term ‘recession’, partly because it doesn’t have the unpleasant connection for Americans and also because a recession is much easier to define. A recession is simply a falling or ‘pulling back’ of the economy. So it’s easy to see if the economy is falling, and when Alan Greenspan came out this week and said the U.S. was in a ‘deep recession’, you have to wonder if he thought that was a shocking announcement to anyone. The U.S. unemployment rate hit 6.5%, and 10 million people are out of work. Pretty obvious to everyone that it’s a ‘deep recession’.
However, defining a depression is a little different. A depression doesn’t have to hit the levels of the Great Depression to actually be a depression. And you can have a severe recession but not have an actual depression. Let me try to explain.
First, let’s get a level set about the Great Depression. First, the Great Depression did not happen overnight, and lasted for more than a decade. During it’s worst year, 1933, unemployment hit a whopping 24.9%, and most of the families were single income families. A lot of economists will claim that today we’d be less effected because most families are two-income families, but I put it to them that two-income families are working under much higher inflation and cost of living.
But, I digress.
When you compare the current U.S. unemployment rate of 6.5%, it doesn’t seem even close to the lowest year of the Depression (8.9%). But, a depression isn’t defined by how close it is to the Great Depression at all. It’s defined by whether the economy is growing than a lower rate than it should. And that is very tough to define.
Let’s try and create a real-world example. Let’s say that some company creates a new bean bag toy and suddenly there’s a huge market for the toy, which people are paying incredibly high prices for. Even though the company sells the toys for $10, the secondary market pays upwards of $200 per toy.
Well, the reality is, it’s a bean bag toy. It’s only worth what a bean bag toy is worth, which is some plastic beads, cloth and a few stitches. Sure, it’s cute, but it’s still a bean bag toy. Eventually, people stop paying exorbitant prices for the toy and the secondary market collapses.
Is this a depression for the bean bag toy secondary market? No. It’s a correction. The bean bag toys were never worth $200, so eventually the prices dropped back to acceptable levels. But let’s say that the toys really are cute and well made, and well worth the retail price of $10, but fewer people are buying. If all market conditions indicate that the toy should be selling and it isn’t, that’s a bean bag toy depression. Just to reiterate, the period where the toy prices fell from $200 back down to $10 was a recession.
I hope I didn’t make light of this. The reality is that we don’t know if we’re in a depression or not. I suspect that the overuse of credit from the Bush administration has artificially inflated the housing market, the oil companies and the stock market and we’re in the midst of a major correction. Thus, for now, today, I think major correction and recession. Hard to say if we’ll actually end up a depression. One thing that will help stave it off is the programs put in place because of the Great Depression which help cushion the blow. So we’ll see.
