April - Benefits and Pensions Monitor

The two words that you really don’t want
to hear together – ‘depression’ and ‘crash’
– are getting a renewed emphasis from
academics these days. They are reviewing
history to ask the question ‘Does experiencing one
necessarily bring the other?’
This isn’t as obvious a question as you might
think. While the great depression and the stock market
crash of 1929 are often spoken of as one event,
there have been other more recent market crashes
that didn’t result in depressions.
Limited Examples
To answer this question with any certainty, you
have to look at countries outside of North America.
The U.S. and Canadian macro economies have
been so strong (or at least so stable) for so long that
there have only been limited examples of economic
depressions in either of these countries.
Robert Barro and Jose Ursua, of the National
Bureau of Economic Research, have addressed this
topic in a paper released this year titled ‘Stock-Market
Crashes and Depressions.’ Their data looks at
25 countries and reveals 195 stock market crashes
(defined as multi-year real returns of -25 per cent
events. From this listing of cases, the importance of
wars, either local or world-wide, is apparent.
So what does all this data say? Here is some of
what we can learn:
◆ If there is a stock market crash, the probability of
having a minor depression (a GDP decline of at
least 10 per cent) is 30 per cent. The probability
of a major depression (a decline of at least 25 per
cent) is 11 per cent.
◆ In a non-war environment, the probabilities
drop a bit, but are still substantial – 20 per cent
for a minor depression, and three per cent for a
major depression.
◆ The reverse trend is even stronger. If you are experiencing
a minor depression, the probability of having
a stock market crash as well is 69 per cent. If
you are in a major depression, then the probability
jumps to 91 per cent. In times when there is no war,
the probability falls to 64 per cent and 83 per cent.
Thus, the largest depressions are almost certainly to
be accompanied by stock market crashes, whether
or not there is an accompanying war as well.
Cause For Concern
So, as Samuelson noted, stock market crashes are
The Dreaded ‘D’ Word
THE BACK
PAGE
By: Jim Helik
Jim Helik is co-author
of ‘Strategic Wealth
Conversion,’ a
textbook published
by the Canadian
Securities Institute.
He also teaches at
the School of
Business, Ryerson
University in Toronto.
or less) and 84 depressions (defined as real multiyear
declines in per capita consumer expenditure or
declines of GDP by 10 per cent or more).
Unlike most other countries, the United States from
1869 to 2006 had no depressions that were not associated
with stock market crashes. However, the United
States experienced plenty of stock market crashes during
this period that did not result in depressions.
Of the 58 cases that the authors could find of
stock market crashes paired with depressions, more
than half were associated with world-wide events.
For example, about one-quarter of all these cases are
associated with World War II (even affecting the neutral
countries of Sweden and Switzerland); another
17 per cent with the Great Depression of the early
1930s; and a further 15 per cent with World War I.
The rest of the pairings came from more localized
more frequent than depressions. However, he was
wrong in concluding that crashes have no predictive
power at all. A market crash is a cause for concern
since there is a 30 per cent chance of having at least
a minor depression and an 11 per cent chance of having
a major one.
This talk of wars, crashes, and depressions masks
some signs for optimism. For the future, we can
remember that most periods in history are very stable
since in the absence of a stock market crash, a depression
is highly unlikely to occur. And in the near term,
while we are certainly suffering from the effects of a
stock market crash, a 20 per cent probability of also
having a minor depression still means that there is an
80 per cent probability of avoiding one.
More on crashes, and how we can recover from
them, next month.
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46 Benefits and Pensions Monitor – April 2009