As the current global economy continues to maintain its positive growth, with neither major developed nor emerging economies experiencing a recession, let alone a depression. However, the sustainability of global economic growth is facing challenges. The expansion and deterioration of the global trade war have aggravated the slowdown of international economic growth. As the U.S. economy is beginning to show signs of slowing, several investment banks are beginning to raise the odds of an impending recession. A similar sight can be seen on the other side of the Atlantic, with the recovery of the European economy being relatively fragile. The economic growth of Germany and France has been slowing down, and economic losses caused by Brexit have further weakened the European economy. The worsening trade war has also increased downward pressure on China's economy. If the trade war further extends its reach to the field of science and technology and finance, it may also trigger domestic economic contradictions and structural economic problems in China, which will introduce greater troubles to the Chinese economy.
Over the past 100 years, the United States has twice gone through long term debt cycles, which led to the great prosperity of the 1920s and the Great Depression of the 1930s, as well as the prosperity of the early 21st century and the global financial crisis that began in 2008 respectively. After 11 years since the 2008 financial crisis, will there be another Great Depression? That remains to be seen. But in the current situation where a worsening global trade war is influencing the world, the structural problems of overproduction and excess capital are still difficult to change, and it is still difficult for the global economy to get rid of the "crisis triangle" of capital surplus-urbanization-economic crisis (Chan Kung, 2015). Thus, it is imperative that we plan ahead and consider the possibility of a recession or even a depression.
How should we respond with policies when the economic depression comes? In other words, how are we going to manage an economic depression through policy adjustments? Bridgewater Associates Founder Ray Dalio provided several policy options from the perspective of dealing with the debt crisis in the face of depression: fiscal austerity, debt defaults/restructuring, monetization or printing money, and redistribution of wealth (the transfer of wealth from the rich to the poor). Each of these policies has a different impact on the economy, and the key is that policymakers should find the right combination between these policies.
When the economic and capital market bubbles burst, it is practically a knee-jerk reaction for management to tighten the purse strings and promote deleveraging, hoping that these actions will be able to reduce the extent of the bubble. But in many cases, management often make the wrong choice. Dario believes that in a depression, a good management move is for the central bank to provide enough liquidity, and to promote ample amounts of liquidity, for example rapidly reducing short-term interest rates to 0%. Poor management can be seen in providing limited liquidity, slowly reduce liquidity or even implementing austerity policies prematurely. If the government is reluctant to take action at the beginning, it will lead to a more serious economic depression down the road. In both the Great Depression of the 1930s and Japan's lost decade of the 1980s, the governments' slow responses has led both nations to a long period of depression. On the other hand, when the financial crisis broke out in 2008, the U.S. government drew on the lessons of the 1930s and quickly stepped in to pump liquidity back into the market, which resulted in the period of the depression being shortened.
Inevitably, one of the most important tasks in dealing with an economic depression is debt restructuring. There are several approaches to this issue: The first is to provide liquidity, including bank liquidity and emergency lending. The second is to solve the debt problem of lenders. This includes debt restructuring, recapitalization and debt nationalization. The third is to offload debts, including the establishment of asset management companies to absorb these debts. For instance, China had established four asset management companies to absorb bad debt from banks in the late 1990s. The fourth is sovereign default and restructuring. For instance, the U.S. nationalized some banks after the 2008 financial crisis, which is a common practice. In the short term, debt restructuring is meant to reduce the impact of the debt crisis so that short-term debt will not be unbearable. In the long run however, policymakers must be aware of the need to carry out institutional reforms in order to address the root causes of the debt problem.
During the economic depression, lending institutions, especially those that are not protected by the policy, often suffer "runs". The central bank and the central government must quickly determine which institutions possess high systemic importance and which ones need to be rescued first. Above all, the central government needs to do its utmost best to ensure the stability of the financial/economic system remains intact and minimize the cost to government/taxpayers. Any potential rescues or bailouts will be financed partly by the government (through budget allocations) and partly by the central bank (through printing money). In the process of alleviating a credit crisis and stimulating the economy, if the government is unable to raise enough funds through taxation and borrowing, the central bank will be forced to print more money to buy government bonds. The central bank and central government's response should capture several key points: 1) Provide debt guarantees to reduce panic in the market; 2) Provide liquidity; 3) Support the solvency of systemically important financial institutions; 4) Recapitalize/nationalize/cover losses of systemically important financial institutions.
In the economic depression, the gap between the rich and the poor will become wider than it already is and might even cause serious social problems. From historical experience, if the rich and poor share similar social resources, economic downturns will lead to economic and political conflicts, resulting in a swing to both left and right-wing populism. In this context, how the people and the country respond to populism will determine whether the economy and society can successfully survive an economic depression. Raising taxes on the rich is often a politically attractive policy option, as the rich tend to make more money using assets and wealth. Purchases of financial assets by the central bank also make more money for the rich, who in turn hold more financial assets. At this time, the left-leaning political trend will accelerate the process of a social wealth redistribution. If any taxes are increased, it will usually be in the form of an increase in income tax, real estate tax and consumption tax, which will drive the rich to transfer their money to more secure places, resulting in policies to raise taxes on the rich becoming largely inefficient.
The above four policy ideas that deal with economic depression provide a brief policy framework for decision-making during the time of economic depression. It should be pointed out that although this framework has a certain degree of universality, it is mainly based on relatively sound market economic system. Moreover, the suggestions are mainly derived from the perspective of investment and of dealing with the debt crisis. In the real world, economic depression is often a systemic collapse of the national or global economy and financial system. To deal with such extreme and complex systemic crises, more complicated policy responses, as well as economic and financial resources are often required. In any case, thinking about the extreme risk scenarios and the ways to cope with them in advance can help us find possible policy solutions in a more rational and effective way, thereby enhancing any risk management initiatives.
Final analysis conclusion:
The downward pressure on both the global and China's economy has increased. Although any hints of a recession or depression are currently still far away, policymakers need to think ahead and prepare for the occurrence of an economic depression in the face of an increasingly uncertain world.
