Depression 2010?

It is now conventional wisdom that the world has avoided a second Great Depression. Governments and the economists who advise them learned the lessons of the 1930s.

When the gravity of the financial crisis became apparent in late 2008, the response was swift and aggressive. Central banks like the Federal Reserve and the European Central Bank dropped interest rates and lent liberally to threatened financial institutions and rattled investors.

The United States and many countries approved "stimulus" programs of tax cuts and additional spending. Panic was halted. A downward spiral of falling private spending and rising unemployment was reversed. The resulting economic slump was awful. But it was not another Great Depression. The worst has passed.

Or has it? Greece's plight challenges this optimistic interpretation. It implies that celebration is premature and that the economic crisis has moved into a new phase: one dominated by the huge debt burdens of governments in advanced societies. Comparisons with the Great Depression remain relevant — and unsettling. Now, as then, we may be prisoners of deep and poorly understood changes to the world economic system.

Historians increasingly attribute the Depression to broad geopolitical upheavals. World War I shattered the existing global economic order. Dominated by Great Britain, it fostered vibrant trade and rested on the gold standard. (Under the gold standard, paper currencies could be converted into gold coins or bullion.)

“The Great Depression may have started in 1929 but it was about three years later before the full effect started being felt.”

1929 was mostly confined to the collapse of the stock market. What made that recession become the Great Depression was trouble in the banking system over the years 1930-33. About one third of American banks failed, in turn making one third of the American money supply simply disappear completely.

It’s a potential collapse of the banking system and the money supply that put the fear of a second great depression into the mind of economists. That was the driving force behind the push for bailouts.

I was reading some history books which stated that the Great Depression actually started with the collapse of land prices followed by the stock market. Banks failed because people no longer had assets. Their lands were heavily mortgaged against depressed prices and they lost what savings they had in stocks. Sound familiar?

One can not help but think that this sounds exactly like the situation we find ourselves in now. The difference was that while Hoover and governments refused to pump money into the economy, the world governments are doing the opposite. It wouldn’t be bad if they started manufacturing something like they did in WWII which drove down prices of manufactured goods. But throwing money into bailouts and things that produce nothing is only going to make the situation worst.

“I was reading some history books which stated that the Great Depression actually started with the collapse of land prices followed by the stock market. Banks failed because people no longer had assets. Their lands were heavily mortgaged against depressed prices and they lost what savings they had in stocks. Sound familiar”

That’s plausible. Farm land was bid up during the boom created by the First World War only to fall sharply following the armistice. Which histories are you reading if I may inquire? Friedman and Schwartz’s A Monetary History of the United States includes an interesting 100 page section on the Depression, “The Great Contraction 1929-1933”. The 1920s were a period of great innovation and productivity that generated a beneficial deflation. The Fed misread the fall in prices and provided too much credit, which found its way into asset prices. The asset bubble in stocks blew in 1929. It’s not clear to me if the following banking crisis was a result of the stock market crash or had its own causes. For instance thousands of rural banks were wiped out by the Dust Bowl’s destruction of the farms of 2 1/2 million people in the Great Plains, something entirely independent of the stock market crash.

In that era you couldn’t get a 30 yr mortgage. You needed to renew your mortgage every 3 years. Banks that were hit by declining asset values needed to call in loans, or at least they were in no position to renew the loans on their books as they matured. Even borrowers who were still employed couldn’t get their loans and mortgages rolled over, so they lost their houses and businesses. Fannie Mae was created to alleviate the situation in the mortgage market. Banks were willing to offer 30 yr mortgages once they were able to sell them to Fannie.

“One can not help but think that this sounds exactly like the situation we find ourselves in now. The difference was that while Hoover and governments refused to pump money into the economy, the world governments are doing the opposite”

You may find that both Hoover and FDR tried pumping money into the economy. They just didn’t do it at anything near to the level that became commonplace after WWII. The level of government spending by Hoover and FDR during the Depression was less than 10% of GNP. Contrast that to the 18-20% level of government spending that is the norm for post WWII spending. WWII ramped government spending to well over 50% of GNP, and pulled a very large percentage of the population into the government workforce. A full 10% of the population was in the military alone.

” It wouldn’t be bad if they started manufacturing something like they did in WWII which drove down prices of manufactured goods. But throwing money into bailouts and things that produce nothing is only going to make the situation worst.”

There is truth in what you say. WWII spending gave millions of Americans paychecks. The only paychecks I see that the bailouts are providing are bonuses to some of the malefactors who helped create the fiasco we are living through.

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