Like most economists, those at the International Monetary Fund are lowering their growth forecasts. The financial turmoil gripping Wall Street will probably spill over onto every other street in America. Most likely, current job losses are only the tip of an ugly iceberg.
But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.”
Yes, we have. But have we learned what caused the Depression of the 1930s? Most important, have we learned enough to avoid doing the same thing again?
There are some things we [i]ought[/i] to have learnt from the 1930s Depression, but probably — based on recent polling data — have [i]not[/i] learnt.
a) A recession in an inventory adjustment. A depression is a [i]balance sheet[/i] adjustment. We have recently begun such an adjustment, and it is not alarmist to talk of economic depression.
b) Once burst, it is impossible to re-flate a bubble. You [i]must[/i] let all the bad debt and malinvestment burn away. That usually takes things back to roughly where the bubble began … in our case that’s roughly 1995. Just for reference, that’s a Dow Jones at about 4000 … adjusting for inflation, 5500 if we’re fortunate. The DJIA-to-gold ratio [i]will[/i] fall to less than 5.
c) Raising taxes in a recession causes problems. Raising taxes in a profound recession (or depression) cripples the economy, to no small degree because it hamstrings the very people whose spending and investment would have led to an economic resurgence.
d) Trade restrictions lead to a “beggar thy neighbour” situation that drags down the entire world, making it much harder for the world to escape its financial problems. The USA is the world’s “buyer of last resort,” and troubles here will be magnified elsewhere.
e) The real problems will come from [i]unexpected[/i] places. The 1929 Crash was triggered by the Hatry collapse in London. The Depression, however, began in earnest with the May 1931 collapse of Credit Anstalt, in Austria. Austrian banks’ exposure to questionable debt in emerging markets is approaching 90% of that nation’s GDP. It could happen again.
f) Government intervention almost always makes things worse. Here I specifically [i]exclude[/i] emergency provision of liquidity intended to keep credit markets fluid. Government programs to “provide relief,” however, are almost always political boondoggles intended to procure votes and reward political allies. This applies to the depression of 1837 as much as those of 1873, 1893, and 1931.
g) The ‘New Deal’ actually made the 1930s Depression last longer in America than it did in most other nations, including Britain, France, Canada, Australia, and even Argentina.
h) People always look for scapegoats, and politicians wishing to increase their personal power through greater government involvement in the economy will [i]always[/i] use economic troubles to promote their own careers.
i) Every political drama has three characters: the villain, the victim, and the saviour. Power-hungry politicians will always present themselves as the latter, ever-ready to punish the presented villain on behalf of the putative victims.
William Harrison (my cousin) did it in 1840. William Bryan did it in 1896. FDR did it in 1932. Senator Obama is doing it this year. Of all America’s economic crises, none except the present one has arrived in an election year. Most came at least two years ahead of a presidential election, reducing the opportunities for demagoguery.
Consequently, 2008 is a particularly dangerous election, not because of the candidates, but because of the circumstances. Be, therefore, particularly prudent in your choice.