Historical Recessions and the Current Fiscal Response

A lot of people are trying to figure out how to model the modern market based on recessions of the past.  Is it a sharp V-recovery like the crash of 1987?  Is it a prolonged generational event like the great depression of the 1930’s?  Is it the popping of a financial bubble like Japan post 1989 or the tech crash post 2000?  It’s hard to tell.  No crisis ever repeats exactly – the proximate causes change as do the policy prescriptions, giving each a unique dynamic, and this crisis is certainly unique.

Panic of 1907: https://en.wikipedia.org/wiki/Panic_of_1907

Proximate cause and resolution:

  • An attempt by a consortium of banks to manipulate the stock market by cornering a particular stock and engineering a short squeeze failed, leading to heavy losses from the banks involved.
  • JP Morgan went through the books of the Knickerbocker Trust and decided it was insolvent.  It’s collapse led to a run on a number of other trusts and banks.  Ultimately, JP Morgan and John D Rockefeller put up large amounts of money into a number of New York banks to stop the panic and re-instill public confidence.

Comparisons to modern crises:

  • The LTCM bailout of 1998 seems somewhat similar in that LTCM had a heavy arbitrage scheme which spread a lot of counter-party risk throughout our banking sector.  It’s bailout arguably prevented a major crisis spreading to the US financial system at the time.  International markets had recently come out of the Mexican Peso crisis of 1994 and the Asian Financial Crisis of 1997.
  • In 2008 we had a run on Bear Sterns followed by the failure of Lehman Brothers, which led to a cascade of potential defaults in the US.  Ultimately, the federal reserve bailed out the banking system including cash injections and the nationalization of AIG – which like LTCM before had a lot of counter-party risk.

Stock market response:DowJones1904to1909.jpg

Depression of 1920-21: https://en.wikipedia.org/wiki/Depression_of_1920–21

Proximate cause and resolution: 

  • In 1918, the US armed forces employed 2.9 million people.  This dropped to 1.5 million in 1919 and 380,000 in 1920.  At the same time, the federal reserve was reacting to the high inflation of the war years by raising interest rates sharply from 4.75% in December 1919 to 7% in June 2020.  Massive unemployment and deflation followed.
  • Woodrow Wilson’s slow response led to a landslide victory for Warren Harding who, along with commerce secretary Herbert Hoover, pushed to support the economy and labor force through income tax cuts and tariffs.  A recovery swiftly followed.

Comparisons to modern crises:

  • 2008 certainly had high inflation and high commodity prices, followed by a deflationary crash with high unemployment.  The initial prescriptions were quite a bit different, involving huge bailouts of the banking sector and massive quantitative easing which resulted in increasing asset prices while labor still struggled.  Then the policy prescriptions of President Trump in 2016 of combined tariffs and tax breaks lead to a sharp recovery which certainly has parallels to the response of Harding.

Stock Market Response:


Great depression of the 1930’s: https://en.wikipedia.org/wiki/Great_Depression

Proximate cause and resolution:

  • The Roaring 20’s were characterized by increasing asset prices along with debt levels, and relatively easy financial conditions.  This changed as the 1929 stock market crash led to the popping of the asset bubble followed by a banking crisis in which 1/3 of the banks vanished and the money supply contracted heavily.  The federal reserve did not react to this contraction, particularly because they were concerned about a reduction in interest rates causing a run on gold at a time when they only had enough gold to cover about 40% of the outstanding federal reserve notes.
  • This economic crises was made significantly worse by the dust bowl in 1930, in which severe dust storms killed crops and livestock throughout the region from Texas to Nebraska
  • Note that many also like to mention the Smoot-Hawley tariffs leading to a collapse in international trade.  This is a false narrative using the cherry-picking of data  simply to promote free trade policies.  The collapse in international trade was primarily caused by the deflationary aftermath following the popping of a world-wide asset bubble.  Trade collapsed in 2009 despite the lack of a tariff response:
  • Policy responses from the central banking side included a 1933 bill making the private ownership of gold illegal, followed by a sharp devaluation in the conversion of US Dollars to gold.  This was a major turning point in the great depression leading to a slow recovery.
  • From the labor side, the response was very muted as the Roosevelt administration was primarily concerned with keeping a balanced budget up through 1937.  New deal plans helped some get through the period while heavier taxes made it difficult for the private sector to recover.
    • This was exacerbated by the way that the “wealth effect” as financial and asset bubbles tend to concentrate wealth into a small number of hands – leading to an enormous concentration of wealth in 1929.  With the government concern in balancing the budget, there was limited labor demand from the government plus private sector and a demand collapse from an impoverished population.  The philanthropy of the wealthy included some large projects such as Rockefeller Center, but simply isn’t enough to keep the labor pool busy.
    • World War 2 finally brought labor out of the crises, as the country suddenly had need of the massive numbers of people who were essentially deemed unnecessary during the great depression.  Budget deficits went out the window as the US military ramped up along with massive production for the war effort.

Comparisons to modern crises:

  • The 1989 peak of the Japanese asset bubble with the aftermath has interesting parallels including the popping of a large asset bubble, the de-population of rural areas, and the anemic recovery of the labor market.  It wasn’t world-wide though, and the policy response was also different in that it involved a lot more central bank easing and large-scale bailouts of large corporations and banks.
  • The 2007-2009 “Great Recession” has some obvious parallels including the worldwide nature, the concentration of wealth and popping of an asset bubble, the deflationary aftermath, and the anemic recovery of the labor market.  Like the response in Japan, there was a wide-scale bailout of large corporations and banks.  The federal reserve response was ultimately larger than that of Japan’s, however, as it successfully led to the re-inflation of the asset bubble and an even greater concentration of wealth.

Stock market response:



The 2020 Lockdown Crisis also has some interesting parallels with a number of these crises.  Like the great depression, the lockdown of much of the world in response to a pandemic hit at a time where asset prices, debt levels and inequality are at all-time highs.  World-wide trade and tourism collapsed overnight, and unemployment quickly shot up to levels last seen at the bottom of the great depression.

The government response has been swift and enormous in comparison to previous crises however:

  • The Federal Reserve Response: https://wolfstreet.com/2020/04/02/helicopter-money-for-wall-street-1-5-trillion-in-3-weeks-of-fed-bailouts/
    • Large direct purchases of assets expanding the balance sheet by 1.5 trillion in 3 weeks to a total of $5.81 trillion including the following
      • Treasury purchases
      • Liquidity swaps with foreign central banks (most volume to Yen and Euros)
      • Mortgage-backed securities purchases
      • Loans to “Special Purpose Vehicles” in conjunction with the US Treasury to support the corporate bond market and money market funds
  • The US Fiscal Response: https://en.wikipedia.org/wiki/Coronavirus_Aid,_Relief,_and_Economic_Security_Act
    • $130 billion grants to medical and hospital industries
    • $500 billion loans to eligible businesses, states & municipalities
    • $349 billion loans to small businesses, which are forgiven if certain conditions are met such as spending 75% to support payroll expenses
    • Corporate tax credits, deferrals & deductions
      • Payroll tax deferment of 2 years
      • Employee retention tax credit for qualified wages
      • Increased deduction of net operating losses from 2018-2020 resulting in retroactive tax refunds
      • Increased limit of deductions for charitable contributions for corporations
    • Individual relief programs
      • One-time payments to individuals, married couples and dependents
      • $600/mo additional payments for unemployment benefits
      • Expansion of unemployment benefits for qualifying gig-economy workers
      •  Increases in deductions for charitable contributions for itemized filers plus a charitable $300 contribution credit for those using a standard deduction
    • $14 billion in cash grants for college students and work-study programs
    • Retirement accounts suspend distribution limits, waive early distribution penalty under certain circumstances, and allow more borrowing against these accounts
    • Allows defense contractors to use their contracts to pay employees and subcontractors up to 40 hours a week if they can neither work on-site nor remotely until 9/30/2020.

The swiftness of the current lockdown crisis is as unprecedented as it’s enormous government response.  The results remain to be seen, but forecasts run rampant of how it will turn out – from a mild recession with a sharp V-recovery similar to 2018 to a deflationary depression as asset prices from stocks to commercial and residential real estate reset lower as commodities bounce along the floor, to a wild hyperinflation driven by unconventional monetary policy.  Will we all be flying again by August?  Will growing international tensions lead to war?  Will growing political angst over record wealth inequality lead to a drastic re-structuring of the economy?  Only time will tell.

My personal predictions include the following:

  • We have not seen the bottom of the stock markets yet.  While the speed of the crash was large, it was not unprecedented.  Most crises have a large initial pullback followed by a large retracement rally, and I do not think this time will be different.  However, bear market rallies can be large and persist for months.
    • The response from the federal reserve should make this rally larger and longer than previous bear markets saw.
    • Despite the enormous size increase in dollars from the federal reserve, there will continue to be a deflationary squeeze toward the US dollar as much of world debt and trade is denominated in that currency.  Many dollars lost in writedowns from oil wealth, to business shutterings and commercial real estate writedowns, to residential writedowns as a tough economy stresses mortgage and rent payments while much of the foreign demand for housing will be cut off and air bnb properties come under stress… you get the picture
  • The economic recovery will be slow.  Things will reopen gradually and with restrictions.  The relentless drive toward automation and reduction of labor costs will accelerate during the recovery.
  • The large response including easy money for and bailouts for corporations will increase the forces of corporate consolidation as large companies hold an enormous advantage over startups.  Concentration of market power and economic wealth will increase, as will political angst from the population.  Responses once considered dangerously socialist like universal health care and universal basic income will become more likely – particularly as a way to avert the need for a breakup of large corporations.
  • The deglobalization trend will continue further into an American sphere, European sphere, and Chinese sphere, along with more fragmentation within those spheres.
    • Global tensions will be higher as will the chance of war.  However, I believe that the enormous costs of large-scale war will have a similar dampening affect as during the cold war.  We are more likely to have a proxy war with China than an outright war for example – just like we faced in the Korean War and the Vietnam War.
    • Economic war will be much more likely than physical war.  Our economic warfare against Iran, North Korea, and Russia using sanctions will be a template used by other countries going forward, driving the fragmentation of the world into regional spheres.

Please don’t think I’m a perma-bear or I’m predicting outright collapse or anything.  I’m really optimistic about a number of things from the future of technology and health care, to a potential increase of our social safety nets finally pushing the trends of homelessness and poverty in the right direction.

Policy makers will finally start to understand that blaming people for their own economic hardship to avoid dealing with the problem is no longer an option.  Over the past 20 years many crises facing individuals were encouraged by public policy including the affordable housing crisis, student loan crisis, healthcare crisis, and inequality crisis.  Business consolidation was encouraged driving the development of vast oligopolies and the systematic destruction of small business.  Private sector labor unions all but died while the gig economy took over leading to minimal wages, benefits, and job security for an ever-growing percentage of the workforce.  Hopelessness and desperation ensued throughout much of the population leading to the growing populist movements in the US, Europe, and elsewhere.

The political status quo has long been deriding today’s millennial workforce as socialists while pushing for ever more centralization of power, wealth, and decision making.  Now we finally have a chance to address these problems.  Hopefully we will begin to consider ways to not only include ordinary people economically, but also to encourage opportunities toward personal and career growth.  Everyone should be given access to real economic opportunity and growth whether they graduated in a depression or not – and personal fulfillment through small business creation should be encouraged by public policy and not hopelessly hampered by it.  We have a real chance to fix things here, and my hopes that we will are higher than ever.

Stay safe, stay sane, and stay positive.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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1 Response to Historical Recessions and the Current Fiscal Response

  1. phusg says:

    Thanks for the interesting article!

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