Barry Eichengreen and Kevin H. O’Rourke have been updating us on the progress of this depression by comparing it to the big one, The Great Depression. Their original post, in April 6, 2009, captivated their audience.
One thing that struck me was that we might compare the two events to the totally overlooked depression of the 1970s – The Great Stagflation. The reason why this one is missing and, perhaps, lost from official economic history is that it did not look anything like how we expect a depression to look – at least by the accepted, albeit vague, standard of what constitutes a depression. For instance, as shown in the graph below, year over year Gross Domestic Product enjoyed an unbroken expansion during the entire period.
Chart 1 (Source: Bureau of Economic Analysis)
Compare this performance to the contraction of GDP during the Great Depression
Chart 2 (Source: Bureau of Economic Analysis)
However, when The Great Stagflation is subjected to the critical observation of an ounce of gold, the contraction of the economy easily exceeds both the present contraction of economic activity in intensity, and its more infamous companion of the 1930s in both intensity and duration, as shown below.
Chart 3 (Source: Bureau of Economic Analysis)
Moreover, in this snapshot of the decade we can see evidence of the 1973-1975 recession, which bottoms in 1974, yet shows no evidence of its existence on chart 1 above. It appears as a dead cat bounce – a momentary recovery before the final leg of the depression unfolds.
Be that as it may, the Great Stagflation presents a bit of a problem: Although gold tells us it occurred, Gross Domestic Product, as measured by dollars, actually ended higher than it began in the 1970s contraction. Peak unemployment, though higher also, was nowhere near the peak of the Great Depression. U.S. trade volume positively exploded, whereas it viciously contracted during the Great Depression. Here is a comparison between these two depressions, with the current Great Recession thrown in for good measure.
Chart 4 (Source: Bureau of Economic Analysis)
When we use the price of an ounce of gold to measure the progress of the current depression an altogether striking contrast emerges with the official portrait. Not only are we in a depression-like event, but that depression has been clearly evident since 2000.
Chart 5 (Source: Bureau of Economic Analysis)
Again, between 2004 and 2005 we see evidence of some slight flattening in economic activity, as the housing bubble reaches its crescendo. The bounce, however, is nowhere near that of the 1973-1975 period.
The real similarity here is to the steady progressive decline of economic activity during the Great Depression as shown in chart 2 above. There are two possible explanations for why these three depressions appear so different: Either gold is wrong, and what happened in the 1970s wasn’t a depression. Or, gold is right and the accepted definition of a depression is wrong.
In the former case, what is happening now is not a depression. In the latter case, what is happening now is a depression at least approaching the duration of the 1970s and the intensity of the 1930s.
So, how do we break this analytic impasse?
The important thing to remember here is that until 1933 there was only one measure of GDP. As the Great Depression unfolded it was expressed in the single footprint of a dollar pegged to a definite amount of gold. When the economy crashed in terms of an ounce of gold, it also had to crash in "dollar" terms, since the dollar was backed by gold.
By 1971, the United States defaulted on the Bretton Woods agreement and no longer honored its commitment to settle its international obligations in gold. The dollar was allowed to float against gold, and thus emerged a discrepancy between two measures of economic activity. Gold continued to reflect the true value of economic activity through the inverse action of its dollar price. Whenever economic activity contracts, the dollar price of gold rises. During expansions the dollar price of gold falls.
It follows from this that gold can be telling us that we are in a depression, even though the dollar measure of the economy shows no evidence of this depression. Using the dollar to measure whether we are in a depression or not is, therefore, is not only useless, it is absolutely misleading to anyone trying to understand what is taking place in our economy.