Bad Recession, 'Zippy' Recovery? History Says 'Yes'

While many are predicting that the depth of the economy’s troubles will mean a “slow-burn” or muted recovery, James Grant writes in The Wall Street Journal that he’s expecting something much different.

“Not famously a glass half-full kind of fellow, I am about to propose that the recovery will be a bit of a barn burner,” writes Grant, the editor of Grant’s Interest Rate Observer and author of The Trouble with Prosperity.

“Americans are blessedly out of practice at bearing up under economic adversity,” Grant says. “Individuals take their knocks, always, as do companies and communities. But it has been a generation since a business cycle downturn exacted the collective pain that this one has done. Knocked for a loop, we forget a truism. With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery.”

Grant says that growth surged following the depressions of of 1893-94, 1907-08, 1920-21 and even 1929-33. He quotes Michael T. Darda, chief economist of MKM Partners:”At the business trough in 1933,” Mr. Darda points out, “the unemployment rate stood at 25% (if there had been a ‘U6’ version of labor underutilization then, it likely would have been about 44% vs. 16.8% today. . . ). At the same time, the consumption share of GDP was above 80% in 1933 and the household savings rate was negative. Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate while the unemployment rate dropped 10.6 percentage points.”

Grant notes that this occurred after Franklin D. Roosevelt, in some of his first acts in office, “closed the banks … excoriated the bankers, devalued the dollar, called in the people’s gold and instituted, through the National Industrial Recovery Act, a program of coerced reflation.” So while that surging growth that followed didn’t recapture the 27% of GDP lost during the depression, Grant says the “economy’s lurch to the upside in the politically inhospitable mid-1930s should serve to blunt the force of the line of argument that the 2009-10 recovery is doomed because private enterprise is no longer practiced in the 50 states.”

Grant also offers some interesting observations about the 1920-21 depression and the government’s response to it, which included higher interest rates and budget surpluses. And he warns about the Federal Reserve’s recent quantitative easing: “[The Fed] maintains this stance of radical ease lest it get the blame for a relapse. However, by driving money market interest rates to zero and by setting all-time American records in money-printing ($1.2 trillion conjured in the past 12 months), the Fed is putting the value of the dollar at risk. Its wide-open policy all but begs our foreign creditors to ask the fatal question, What is the dollar, anyway? Why, the dollar is a scrap of paper, or an electronic impulse, the value of which is anchored by the analytical acuity of the monetary bureaucracy that failed to predict the greatest financial crackup since the 1930s.”

Grant’s overall prediction of a more robust recovery is also based on observations about human behavior. He quotes English economist Arthur C. Pigou in framing the issue: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism,” Pigou said. “This new error is born not an infant, but a giant.” Adds Grant, whose view runs counter to those of most economists: “The ‘error of pessimism’ is born the size of a full-grown man — the size of the average adult economist, for example.”

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