Summary: In this article, we will compare a recession vs depression. We’ll also explain the key differences, which economic indicators to keep track of and whether or not the next Great Depression is headed our way in 2021.
Introduction
The COVID-19 pandemic has brought unprecedented times. Instead of smiling at each other at the grocery store, we stand six feet away and hide behind masks. All in an effort to protect each other and ourselves. The world has changed massively in the last few months and naturally many of us are afraid…of getting sick, losing our jobs, and about what’s going to happen with the economy.
The big economic questions people are asking: are we headed for a recession? Could it even become a depression? And what does all this really mean?
So I don’t leave you hanging, I’ll tell you the answer to the first question. Yes, there will be a recession. How could there not be after Coronavirus shut down most of our country and the unemployment rate has skyrocketed? But how bad is our economy going to get and for how long? Could we end up in a full blown depression? It’s anyone’s guess at this point.
In this article we’re not going to make any predictions about what’s going to happen to the economy, because it’s not fully clear yet. What we are going to do is explain the differences between a recession and a depression, and give you more insight into what’s currently happening with the economy, so you can come to a conclusion for yourself. We’ll also cover the economic indicators that imply a recession is coming, and how to prepare for a recession or depression if and when it hits.
What is an Economic Recession?
Most of us probably know the answer to this one already, because recessions of varying degrees typically happen every five ish years. The economy enters into a recession when there is more than 6 months (or 2 quarters) of decline. The most notable in our lifetime thus far was the Great Recession of 2008, where homebuyers became overleveraged due to loose lending restrictions, causing the housing bubble burst.
Now, the COVID-19 pandemic is pushing our economy into recessionary unchartered waters. Because the spread of the Coronavirus happened somewhat suddenly, markets dipped fast and sharply as people began to react to these unprecedented times. When more than one economic indicator is in decline (more on that below), chances are high that a recession is on its way.
What is an Economic Depression?
When the economy fails to recover from a recession and the market continues to decline, eventually it will turn into a depression. Depressions happen less often and come with different levels of severity. Generally, a significant decline, with little to no growth in markets for more than two years is considered a depression.
Economic Depression Example
While countries around the world have had depressions over the last several decades, we haven’t seen a global depression since The Great Depression in the 1930s.
The Great Depression of 1929
The Great Depression began in 1929 and lasted 10 years. Even though newly elected President Herbert Hoover attempted to save the economic collapse by cutting rates on income and corporate tax, the dominoes had already begun to fall.
A number of factors caused the stock market to crash in October of 1929. Namely, big declines in the British stock market, media fueled fear and more investors buying stocks “on margin” or borrowing money from brokers to invest. The market became over leveraged and a collapse ensued. Those who had invested their life savings and businesses lost everything as the asset bubble burst and the market came crumbling down. Triggering a global depression for the next decade.
What’s the Difference Between a Recession and Depression?
The difference between a recession and a depression includes both the severity of economic decline and how long it lasts. A recession is defined as a downturn in the economy that lasts for more than six months or two quarters. A recession turns into a depression when the economy stays in decline for several years.
Remember, all recessions and depressions will look a bit differently. Not one is the same as another, so it’s hard to say what the next may look like.
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For example, one of the key economic indicators of a recession is unemployment rate. During a recession, unemployment can reach 10 percent. Whereas unemployment during the Great Depression reached 25 percent.
Since Coronavirus hit and many U.S. cities went on lock down, over 26 million Americans have applied for unemployment. As a result, the unemployment rate is now hovering around 23%, according to Paul Ashworth, chief U.S. economist at Capital Economics.
While this surge in unemployment may lead to a comparison with the Great Depression, Ashworth believes those worries are misplaced. Many of the unemployed have been furloughed and will return to their normal jobs when the stay-at-home orders have been lifted. He expects the unemployment rate to fall quickly once the economy restarts.
That said, it is incredibly rare for unemployment rates to fluctuate to this degree in such a short amount of time. Unless something big happens (like Coronavirus). This is just one economic metric to look at, but it indicates that we are indeed headed toward a recession.
So what causes an economy to go into a recessionary period to begin with? There are five key indicators to watch that signify the overall health of the economy.
5 Economic Indicators a Recession is Coming
We’ve touched on unemployment as one of five key indicators of economic health. The other four include, GDP (Gross Domestic Product), income, manufacturing and retail sales.
Keep in mind that just because one indicator drops, doesn’t mean a recession is coming. Because each indicator tends to impact the other, there must be multiple indicators that decline at the same time in order to trigger a recession.
Decline in Gross Domestic Product (GDP)
GDP tops the list as most important to economic health and refers to everything produced in the U.S. by individuals and businesses (not including inflation). Because GDP impacts all the other indicators, when it begins to decline it usually results in the economy declining as a whole, and eventually to a recession.
The BEA estimates a 4.8 percent contraction in GDP during quarter one of 2020. Here’s what is contributing to to the sudden decrease in overall GDP:
- There was a quick drop in consumer spending with -5.4 percent. Consumer spending makes up 68 percent of total GDP.
- The service sector went down -5.0 percent with sharp drops in:
- Household spending on healthcare services: -18 percent
- Transportation: -29 percent
- Recreation: -31.9 percent
- Food services and accommodations: -29.7 percent
On the bright side, because COVID-19 has forced all of us to stay at home, the loss in durable goods was somewhat offset by the increase in nondurable goods, i.e. food. At-home food and beverages saw a 25 percent spike in Q1.
The U.S. government has put together relief options in the form of the CARES Act for individuals and businesses affected by the Coronavirus pandemic. Because consumer spending has gone down, the Trump administration is trying to avoid a more severe and lengthy recession.
That’s one reason qualifying American’s received a stimulus check for at least $1,200. Workers that have been furloughed and businesses that are unable to open have even more relief options. However, so far the government and banks haven’t been able to keep up with demand and people aren’t getting their checks.
The BEA says, “Federal policies that support workers and job creators should help limit negative effects on the economy in the second quarter as States restart their economies and let their residents return safely to work.”
Loss of Personal Income
When the economy is bad, companies tend to layoff workers in order to cut expenses. Which inevitably leads to loss of income and increased levels of unemployment.
As of April 27th, a report by Statistica showed that 37 percent of Americans had lost income due to COVID-19. And 11 percent of those surveyed reported that they had lost all of their income. The pandemic has impacted 30 percent of jobs or finances due to furloughs, layoffs, decreased hours and pay cuts.
Rise in Unemployment
With a hit to consumer and business spending comes job losses. A rise in unemployment is another signifier a recession is looming.
Since mid-March unemployment has gone from 701,000 new claims up to over 26 million.
The Congressional Budget Office (CBO) released its economic projections for the rest of this year through the end of 2021. Unemployment is expected to peak at 16 percent (maybe as soon as this summer) and then stay at around 10 percent until 2021.
Manufacturing Declines
Manufacturing in the United States produces 18 percent of goods around the globe. These products add a huge amount of money to our economy.
Between 40 to 50 percent of manufacturing workers must perform their duties on-site. Because most of America is having to stay home due to COVID-19, supply, demand and available workforce are all impacting the manufacturing industry simultaneously.
The companies that supply essential goods are having trouble keeping up with a surge in demand, while others are experiencing huge drops in demand and income.
For instance, the pandemic has forced people to stay home, resulting in less driving. Because the demand for oil has dropped massively, so has its value. Oil companies don’t have room to store the surplus oil so they’re practically giving it away for nothing!
The long-term effects of COVID-19 on manufacturing is unclear, but as long as it’s declining so does GDP and retail sales.
Retail Sales Suffer
When the world is suffering from poor economic times, most of us are looking for ways to cut back our spending, especially on non-essential items. Retail sales take a hit when consumers decide to tighten their belts and spend less.
There’s a long list of short-term challenges that many retailers are experiencing from closing up shop, thanks to the Coronavirus. Businesses are losing money everyday, workers are getting laid off, with unemployment rates soaring, and the last thing people are looking to do is spend money on non-essential items.
It’s hard to say how long it will take for the retail industry to bounce back. What we do know is that the way consumers shop will probably never look the same again. E-commerce should continue to do well because “stay-at-home” orders are still in place.
As you can see, when one economic indicator declines (especially for several months) the others are usually triggered, creating a domino effect.
Will the Next Stock Market Crash Cause a Recession?
During a recession or economic decline, investors tend to either pull their stocks and/or stop investing. How well the stock market does has a lot to do with the confidence investors have in future growth. If stocks are declining, especially rapidly, panic can set in and investors may get out of the market because they’re afraid of losing more money.
If enough investor confidence is lost and the economy continues to decline, the stock market may crash and trigger a recession. However, how well the stock market is doing does not indicate a recession.
Because we are already floating in recessionary waters due to the pandemic, if the stock market crashes it will likely prolong the length of time it takes our economy to recover. Worst case scenario, it throws us into the next Great Depression.
When the COVID-19 pandemic ended normal life as we knew it, consumer confidence plummeted and so did the stock market. All major stock indexes have since declined (Dow Jones, S&P 500, and Nasdaq) due to the Coronavirus (as you can see from the charts below).
Dow Jones went down 32 points.
S&P 500 went down 15 points.
Nasdaw went down 122 points.
Predictions for What’s Next for the Stock Market?
With April almost over, the major stock indexes are actually trending back up. In April, Dow is up over 10 percent and the S&P is up 11 percent, both with their best finish in three months. Fingers crossed that this is a sign of a Coronavirus comeback!
Bear Markets vs Bull Markets
A bear market occurs during a recession when the financial market declines 20 percent. A bull market occurs when the market is trending upward. Often bear and bull markets are referred to regarding the stock market, but these markets can apply to real estate, bonds, commodities, etc.
Bear and bull markets usually mirror the economic cycle. This cycle is made up of four phases and looks like a never ending wave:
- Expansion
- Peak
- Contraction
- Trough
Are We Headed for the Next Great Depression?
The United States has enjoyed a Bull Market for the last 11 years. Now we’re sliding fast into recessionary waters. There has been plenty of talk about if the COVID-19 pandemic will cause the next Great Depression. The bottom dropped out of the economy in 1929 and now in 2020. Does this mean a depression is inevitable? Not necessarily…Let’s compare the two economic climates:
Great Depression
- Unemployment rates peaked at 25%. Just four years before, unemployment was at 3.2 percent.
- GDP contracted by nearly 28%
- Stocks dropped over 30% in one month and took three years for it to recover (according to Morningstar Direct)
2020 Recession
- Unemployment rates expected to reach 14-16% next quarter.
- GDP declined 4.8 percent in Q1 and is expected to decline by 12 percent in Q2.
- Since the pandemic, the S&P 500 declined over 34%, which is the steepest drop in that period of time since 1931. However, the major stock indexes are showing positive growth in April–a good sign.
While these numbers are somewhat similar it’s easy to understand why many are worried about this recession turning into a depression. Having said that, the world looks a lot differently in 2020 than they did even back in 2008 and especially 90 years ago. Policies have changed for the better, unemployment insurance is available for those that lose their jobs. And banks are more secure than ever.
Only time will tell how far the economy will drop and how long it will last. The best thing we can do is avoid panic and ride out the wave.
Wondering how to prepare for a recession? Check out this article and podcast for updated tips and helpful information.
Conclusion
Understanding a recession vs a depression won’t keep us out of either of them. Financial markets are cyclical. While we can expect good times, we know that downtimes are around the corner. The better we can understand the causes and effects of both recessions and depressions, the more prepared we should be for the next one. Even if the economic climate looks dark and stormy, the clouds will clear and the sun will shine on us (and our money) again.
Interested in learning where to invest your money during a recession? Check out these 11 tips for smart investing.
