Americas

Are we on the verge of the Second ‘Great Depression’?

The great depression in the 1920’s and the 1930’s is one of the most researched subjects in economics. The current financial crisis engulfing the world which shows no signs of ending any time soon has the characteristics of being the 21st century’s great depression.

The great depression holds great significance because it was the first time the market crashed. The Great Depression bewildered economists and politicians alike as the Capitalist Economic System began to break down – it took over a decade for Western economies to recover. The liberal economists at the time continued to hold, against mounting evidence to the contrary, that time and nature would restore prosperity if governments refrained from manipulating the economy. In the US, Franklin D. Roosevelt’s 1932 landslide presidential victory over Herbert Hoover attested to the political bankruptcy of laissez-faire economics.

Until the great depression classical economists assumed that full employment was the normal state of affairs. Changes in taste or technology, or the opening up of markets at home or abroad, might mean that jobs were lost in some industries, but would also mean that new jobs were created in others. Any unemployment that emerged would be temporary, soon being eliminated by the operation of market forces. As more and more people lost jobs and were left homeless, such economists argued that the market would sort itself out.

It was not until John Maynard Keynes in the 1930’s argued that the economy did not automatically tend to a state of full employment, and that market forces could not be relied upon to pull the world out of the great depression.

Some of the facts from the great depression include:

– 25% of the US workers were unemployed
– 40% of German workforce was unemployed
– Inflation reached 3.2 million percent in Germany with a loaf of bread costing 200 Billion Marks
– 5000 banks collapsed in US
– 50% of the children in the United States did not have adequate food, shelter, clothing or medical care
– In the US Soup kitchens were created for starving citizens
– Britain the worlds largest exporter at the time saw a reduction of 50% in its exports
– In 1932 the US economy shrunk by a record 13.4%

A comparison of the great depression with the current global financial crisis highlight that both crises share more or less the same characteristics:

1. The great depression began in the US and then spread to the rest of the world. The Western world was recovering from WW1 and a period of cooperation to kick start the economies of the West meant they were became more and more interlinked. The current global financial crisis was a direct result of the US attempting to stop the US economy from drifting into recession after the dot.com bubble burst, interest rates were lowered to 1%, leading to a surge in mortgage debt. Much of the world’s investment banking wealth found itself onto the US housing market.

2. Both crashes were the direct result of artificial booms. The 1920’s appeared on the surface to be a prosperous time, however as the US moved from an economy producing for WW1 to a peacetime economy; the economy subsequently grew rapidly with the introduction of a wide array of new consumer goods. The US increased its standing as the richest country in the world, as its industry aligned to mass production and its society turned towards consumerism. The roaring twenties was the period where the US turned more and more inward, away from international issues and social concerns and towards greater individualism. The emphasis was on getting rich and enjoying new fads, new inventions, and new ideas. The self-centred attitudes of the 1920s positioned nicely with the needs of the economy. Modern industry had the capacity to produce vast quantities of consumer goods which would kick start the economy. The current global financial crisis has its roots in the dot.com crash when US policy makers were convinced that the US would go into recession – especially after the events of 9/11. Interest rates were lowered and restrictions on credit were removed so Americans could spend their way out of recession.

3. Both crashes have at their core the frenzy that the boom could only continue which led to much irrational behaviour that only added to the bubble surging towards its inevitable crash. The rising incomes of the wealthiest Americans fuelled rapid growth in the stock market in the 1920’s. The price of stocks was rising far beyond the worth of the shares of the companies they represented. People were willing to pay inflated prices because they believed the stock prices would continue to rise and they could soon sell their stocks at a profit. The widespread belief that anyone could get rich led many less affluent Americans into the market. Investors bought millions of shares of stock “on margin,” a risky practice similar to buying products on credit. They paid only a small part of the price and borrowed the rest, gambling that they could sell the stock at a high enough price to repay the loan and make a profit. The Dow Jones industrial average – the index that tracks the stock prices of key industrial companies doubled in value in less than two years. The current global financial crisis was driven by the frenzy to buy up the securitised products which could apparently only rise. Most of them were based upon the boom in the housing market – Both Collateralised debt obligations and mortgage debt obligations were based upon breaking down and re-engineering them alongside other products. Banks brought these products with debt and protected themselves by taking out credit default swaps, which was an apparent insurance policy if these products didn’t come through with the forecasted profit.

4. Both booms were artificial and not based upon real wealth, but on borrowed money. The stock market boom of the 1920’s draw people from all walks of life to place their money, even if it meant borrowing on to the financial markets in the hope of reaping rewards from a buoyant market. People were allowed to “buy now, pay later.” But this only put off the day when consumers accumulated so much debt that they could not keep buying up all the products coming off assembly lines. That day came in 1929. Today US citizens hold over $11 trillion in debt, US households are in far greater debt today with much less savings..

5. Both crashes have led to massive spending in the hope that nations can spend their way out of the crisis. In the 1930’s alongside leaving the Gold standard Roosevelt initiated a programme of increasing the money supply, when this eventually failed he introduced the ‘new deal’ which was a massive public works programme building the US highway and the construction of buildings to take the US populace out of unemployment. Today governments have resorted to only two types of actions to solve the crisis – which fundamentally are printing ever increasing amounts of money. Governments have nationalised most banks which was absent during the great depression and they have provided huge bailouts in the hope consumer spending will kick start the economy.

Whilst there is much more detail than has been presented, there are also many details which both crashes do not share. The Western world pulled itself out of the great depression by the massive mobilisation for WW2. This today is not an option as the US is bleeding from two wars, increasing the theatre of war would be suicidal.

Conclusions

It is difficult to see how the world economy will be stimulated. The US is finding consumer spending drastically falling as more and more citizens sit on debt they cannot afford to repay. The US economy is so lopsided towards consumer spending until positive sentiment does not return, it is unlikely consumers will begin to spend.

In Britain the financial sector, long the symbol of London, is losing staff almost weekly. There is no sector in Britain remotely large enough to replace the financial sector. For these reasons it is very likely the recession will turn into a pro-longed deep recession. As the price of assets and the general price level falls it is possible spending will kick start, however until confidence does not return to the global economy the recession will continue. If the world’s largest economies are in recession after a year than they would have entered great depression territory. The great depression saw the US economy shrink for two consecutive years.

As the world economy goes into recession and banks and companies go bankrupt in a years time the global financial crisis will be in a much worse state, it is very likely at this time sentiment will be even worse than it is today, which makes the recession turning into a depression much more likely.

The fundamental problem lies at the heart of what Capitalism attempts to achieve with the economy – perpetual economic growth. Western governments have attempted one after another to stimulate spending in the hope that the economy will be kick started. But it was consumer spending through accumulating debt that created the original problem. Western governments are attempting to cure the patient with the virus itself.