The global economic news is not good these days:
Companies are cutting jobs, or worse, going out of business.
Cash can be hard to find for healthy companies that want to expand.
Car sales keep dropping and both General Motors Corp. and Chrysler LLC are planning to cut car lines to stay in business.
It's easy to imagine that we're entering another Great Depression. But that's not really an accurate assumption, said Jim Gillette, director of financial services with auto industry consulting group CSM Worldwide. He is based in Grand Rapids and is a finance instructor at Grand Valley State University's Seidman School of Business in Allendale, Mich.
“Although the current recession promises to be severe, perhaps the worst since World War II, there is little chance of it falling into another Great Depression. The statistics from the 1930s overwhelm any we have seen since,” Gillette said in a recent interview.
During the first 10 months of 1930, 744 banks failed; they were among 9,000 that went under during the next decade, he said. Currently, only 34 banks have failed and the Federal Deposit Insurance Corp., which was created during the Depression, has protected individual accounts and savings.
“There is no need for panic or 'bank holidays,'” Gillette said. “Unemployment insurance and, in many cases, multiple wage earner households have cushioned the blow today. Rapid deployment of government funds to support the banking system has prevented the type of collapse we saw during the Depression. A combination of public works spending and tax cuts will at the very least prevent the economy from sinking deeper.”
In addition, today's financial leaders have learned from the Depression and other recessions and have a better understanding about what action to take. The following is a Q&A interview with Gillette:
Q: What are the biggest similarities between the current economic conditions and those at the start of the Depression?
Gillette: The period from 1929-39 that is commonly referred to as the Great Depression was actually comprised of two recessions. The first, lasting 43 months, that began in August of 1929 — yes, prior to the stock market crash on Black Thursday, Oct. 24, 1929 — was the most severe. The second, milder recession began in May of 1937 and lasted a more typical 13 months.
The difference between an “average” U.S. recession and the Great Depression is a matter of degree of decline in economic activity and the pain felt by an average household.
The most striking similarity between 1929-32 and today is that both periods were preceded by excessive and careless use of credit.
A word of caution: While all recessions have similarities, no two are sufficiently alike to prompt identical policy prescriptions for recovery. History does not repeat itself precisely.
Q: What are the biggest differences?
Gillette: The economic pain felt during the '30s was, in order of magnitude, many times greater than we can expect today, even in a worst-case scenario.
Typically, an average post-World War II recession experiences about a 3 percent decline in real gross domestic product, peak-to-trough.
Unemployment during the worst [postwar] episode, the 1981-82 recession, spiked to 10.8 percent. In contrast from 1929-32, real GDP fell about 30 percent while unemployment peaked at 25 percent. [These are approximate figures, as economic statistics were not gathered as diligently during the Depression.]
Keep in mind, the safety net of unemployment benefits was not available at the beginning of the 1930s, and most households depended upon a single wage earner. An equivalent percentage point of unemployment during the '30s had much more dire consequences for the average household.
Q: What are some of the biggest lessons today's economic leaders can learn from those decisions made 70 years ago that can aid us today?
Gillette: Had it not been for serious government policy mistakes during the 1930s, many speculate that the severity of the economic downturn may never have reached such disastrous proportions. There were five errors most economic historians agree upon:
* The Federal Reserve, [which was still in its] infancy relative to its policy-making role, misread economic indicators and actually tightened the money supply. Today, we know that the appropriate response would have been to flood the economy with liquidity.
* Both the Hoover and Roosevelt administrations raised taxes, a sure way to discourage households from spending and businesses from investing.
* Foreign trade was severely constrained by the passage of the Smoot-Hawley Tariff Act in 1930. Retaliation by U.S. trading partners was especially damaging to manufacturing businesses.
* Allowing The Bank of United States to fail [in 1930] caused irreparable damage to the psyche of all bank depositors. While a fairly large bank for the time with an impressive name, the bank was state-chartered with no affiliation to the government. Recall that the Federal Deposit Insurance Corp. had yet to be formed.
* Roosevelt's National Recovery Administration, formed under the National Industrial Recovery Act [of 1933], actually prevented market forces from self-correcting.
Roosevelt ... thought that fixing prices above the prevailing market level would end deflation. Instead, the policy distorted the market, enabling less-efficient businesses to dominate and slow rather than stimulate commerce. The Supreme Court found the law unconstitutional in 1935.
Most historians will also agree that policy attempts to end the Depression failed to stimulate the economy and prosperity only returned to the U.S. as a result of the enormous industrial-military buildup required during World War II.
That being said, some regulatory reforms and government programs born during the era have made a contribution to our quality of life, including Social Security, unemployment insurance, rural electrification, and yes, the Securities and Exchange Commission, although the last is long overdue for an overhaul.
Ironically, the 1999 repeal of the Glass-Steagall Act of 1933 may have contributed to the credit bubble of this decade.
Glass-Stegeall [which created the FDIC] was originally passed in response to speculative behavior by banks and served to separate commercial banking activities ... from investment banking and property trading.
Innovation in financial markets for the past three decades has far outpaced the ability of existing regulatory agencies to track and evaluate new products, especially trading in derivative securities. Clearly, the regulatory environment will be rethought over the next several months.
Q: What kinds of manufacturing companies survived the Great Depression? What sorts of companies failed? And what can we learn from them today?
Gillette: Some might be surprised to learn that GM made an accounting profit during every year of the Great Depression. While the auto industry went through its first major consolidation, GM was on the forefront of product innovation. The company took the market share crown from Ford during the 1920s and never looked back, while such venerable names as Cord, Auburn, Duisenberg, Stutz, and Pierce-Arrow fell into bankruptcy.
Growth in other industries resulted from recognizing opportunities in the business environment and taking advantage of innovative technologies.
One striking example was the growth in packaged foods. According to economic historian Michael Bernstein, new canning and bottling techniques led to the food industry introducing 39 new products between 1929-39, including fresh-pack pickles, prepackaged ice cream, and margarine. In 1935, there were only 300 supermarkets in the country; in 1939, there were 4,982.
Rural electrification projects like the [Tennessee Valley Authority] and Hoover Dam expanded markets for home appliances. The number of homes with refrigerators, electric vacuum cleaners, and radios soared as a result.
Q: So while we can't predict the future, history tells us that there will be opportunities even in times of recession. Is there any way for molders to find where those opportunities will come from?
Gillette: Many molders have successfully diversified over the years into non-auto business. Most will tell you [that] the biggest drawback is the lack of the huge annual volumes offered by the auto business [that] are not readily available elsewhere.
That being said, opportunities do pop up for an agile molder willing to be innovative and explore alternative markets. Some examples from the past that I have seen include things like cell phone cases, copier toner cartridge cases, and Jane Fonda- brand exercise steps.
The three areas I would watch most diligently are:
* Medical: With the aging of the Baby Boomers, the market for medical equipment and devices to assist seniors will continue to grow. Delphi Corp. is developing a credible presence in this industry.
* Energy: I've noted a number of opportunities for plastic components in alternative energy-generation equipment.
* Agriculture: While commodity prices have retreated temporarily, the global outlook is strong.
I wouldn't ignore automotive, though. There will obviously be an accelerating wave of consolidation over the next several months, providing an opportunity for companies with strong balance sheets to acquire or take over business and assets on the cheap.
Once fuel prices resume an upward trend, the push for material substitution in autos will intensify. Suppliers should not let up their quest to reduce component weight and improve the materials' aesthetics, durability, and recyclability.
A final note: Suppliers who continued to support Chrysler through its many rough periods in the past were often rewarded with increased profitable business during the boom of the '90s. Do your best to take care of your customers, even though it may seem they are going under.
Q: How closely do you think today's leaders are studying the Great Depression?
Gillette: Federal Reserve Chairman Ben Bernanke is one of the foremost scholars of the economics of the Great Depression. This makes it all the more curious that he was late to recognize the severity of the [current] subprime mortgage problem and the related financial meltdown. He clearly underestimated the damage to the public psyche of allowing major banks to fail.
Many politicians seem to have short memories, especially when it comes to issues affecting their constituencies. We hear many cries ... for “Buy American” clauses connected to bailout funds.
It is appealing to believe that jobs will be saved at home if we can either exclude foreign-made goods or make them more expensive through tariffs. The fact is, however, that the loss of foreign trade will be even more damaging to our economy.
Fortunately, mistakes provide a learning opportunity. While the academic debate continues among the various schools of economic thought as to how to jump-start the economy today, lessons from the '30s have been deeply ingrained. Any mistakes made by policy makers are unlikely to be as near-fatal as those made in the early '30s.
Q: The global economy is highly intertwined. How will that make a difference in dealing with a recession now, compared to the 1930s?
Gillette: Again, the differences are more a matter of degree than substance. The Great Depression was a global economic downturn much as is the current episode. One of the significant differences between today and the '30s has been the broad cooperation among the world's economic powers to launch a coordinated and massive attack against the downturn.
With respect to the auto industry, we have long passed the point where strictly “American” auto production can be segmented from foreign.
GM and Ford have been leading the charge to buy overseas “cheaper” components since the 1990s. It would be impossible in any reasonable amount of time to re-source components to “American” suppliers.
There is also the question, setting NAFTA aside, if “Canadian” and “Mexican” also equate to “American.” Requirements to “Buy American” auto components are, therefore, not only a bad idea — they simply will not work. We must be even more careful to prevent protectionist policies from gaining strength.
Q: Is there any way to know whether the manufacturing sector has bottomed out yet? Or is a recovery only clearly seen months after it's already happened?
Gillette: There is no perfect leading economic indicator. Four that I would watch over the coming months are:
* The Institute for Supply Management's [monthly industry] index: Consistent readings above 50 percent indicate orders at the manufacturing level are stronger. January's reading, at 35.6 percent, was slightly better than December's 32.9 percent report.
* The private sector average hourly workweek reading of 33.3 in January is a record low: Look for any solid upturn.
* Factory orders: both for capital goods and consumer goods, [those] fell for five consecutive months as of December [2008].
* The Federal Reserve Board's Senior Loan Officer Opinion Survey: January's report showed that banks remained very tight in their lending criteria and that the demand for both business and consumer loans was weak.
It is important to remember than the unemployment rate is a lagging vs. a leading indicator of the economy. Businesses will have their employees work more hours rather than add workers until there is confirmation that future orders will turn up. The unemployment rate is likely to continue to rise after the economy has begun to recover.
The housing market is a key [indicator], both from repairing bank balance sheets, but more importantly, repairing consumer balance sheets. It is unlikely that we will see a return to real strength in auto sales until housing prices stabilize and begin to recover.