The Long Crisis

Posts Tagged ‘Great Depression’

Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley; and formerly Senior Policy Advisor at the International Monetary Fund and a CEPR Research Fellow has collaborated with Kevin H. O’Rourke, Professor of Economics at Trinity College Dublin and CEPR Research Fellow, to write an insightful article comparing the present economic downturn to the Great Depression of the 1930′s.

The two leading economic historians show that the world economy is now plummeting in a Great Depression like manner. Indeed, world industrial production, trade, and stock markets are diving faster now than during 1929-30. No wonder that government leaders around the world are so concerned. Events precipitated by the Great Depression directly contributed to horrible living conditions for billions of people and carried the world into World War Two.

Present world leaders may not fully know how to combat the present financial meltdown but they do know the dangers that it posts to world stability. Unfortunately, some of the hasty actions taken thus far, like trying to save financial institutions that have already failed, may make matters worse. While it very difficult for any leader to do nothing in a crisis situation, I maintain that it is better to do nothing than to quickly put into play a large number of not very well thought out policies and financial programs.

In their study Professors Eichengreen and O’Rourke compare world industrial output, world stock markets, the volume of world trade, central bank discount rates, money supplies, and government budget surpluses, than and now to draw a conclusion as to how the two periods compare. The analysis contains some well laid out charts to assist in the analysis.

As interesting as the article is it would be more beneficial if the learned professors had offered some solutions for the current crisis. To see the conclusions and to view the charts go to World Depressions compared.

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Economists are not in agreement as to the exact causes of the Great Depression of the 1930′s. The current Chairman of the Federal Reserve Bank, Ben Bernanke, is considered an expert on this matter as it was the subject of his PHD thesis and has been a lifetime interest. Bernanke believes that the Great Depression was caused by a failure on the part of government to act in a timely manner, especially in not expanding the money supply fast enough or in great enough amounts.

This would explain the hyperactive level of activity and money creation by the FED during the current downturn. Bernanke, “helicopter Ben” thinks that throwing enough money at the problem will cure or prevent a depression , even if in the end the money is tossed out of helicopters. It seems that Bernanke is yet another important US government figure who believes that deficits don’t matter.

Marriner S. Eccles, who served as Franklin D. Roosevelt’s Chairman of the Federal Reserve from November 1934 to February 1948, detailed what he believed caused the Depression in his memoirs, Beckoning Frontiers (New York, Alfred A. Knopf, 1951). Eccles believed that a misapplication of wealth was largely responsible for the depression. The following is from Eccles’s memoirs.
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As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. [Emphasis in original.]

Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers’ loans, and foreign debt.

The stimulation to spend by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product — in other words, had there been less savings by business and the higher-income groups and more income in the lower groups — we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.

The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality under consumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.

Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay.

Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.

This then, was my reading of what brought on the depression.
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While economists will probably always be in some disagreement as to what caused the Great Depression of the 1930′s the current crop of economic leaders, judging from their actions thus far, obviously are in step with Bernanke even though there is ample evidence that the government’s interventions in the 1930′s made matters deteriorate from bad to worse. That is, what probably would have been a fairly normal self correcting recession was made much worse by FDR’s and the government’s constant interference in the free market place.

Here we are almost eighty years later and it seems like the Obama government is on the same hyperactive course as FDR. I highly doubt that bailout after bailout will achieve the desired results. The size of the derivative bombshells that have so far exploded are small compared to the bombshells that are yet to come. To risk that the constant creation of fiat currency in the trillions will not have disastrous consequences for the value of the US Dollar and the stability of the US economy is a danger that puts the future of the US as a first class world power on the line. I hope that President Obama, Fed Chairman Bernanke, and the Obama economic team have at least some sense of the size and potential fatal nature of the economic bets they are placing. The future welfare of the United States is the stake being placed at risk.

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