With all the recent talk of “moral hazards” and “socializing the loss, privatizing the profit”, it seems the time is right to look for any parallels between the current mess and the Big One of 1929. This article lays out a pretty persuasive case that there are enough similarities between now and then to wonder whether we risk careening into a new Greater Depression:
Given the grim political prospect ahead of us, we can now examine the checklist for Great Depression causation, and see how many we can check off for today’s leaders:
1. Asset price crash: Check! We’ve already had the crash in asset prices, twice, in 2000-02 with stocks and now with housing. As the stock market crash of 1987 demonstrated, asset price crashes don’t necessarily lead to Great Depressions, but they do thoroughly shake the financial system and reveal hidden weaknesses. This time around, there have been plenty to reveal.
2. Protectionism: Yes, but less severe. Protectionism is definitely reviving, but to nothing like the level of the Smoot-Hawley tariff. Obama’s threat to renegotiate NAFTA, combined with a substantial recession, could produce a substantial leap in protectionism. We can however have at least moderate confidence that Obama has no intention of actually doing anything so foolish as to reopen trade agreements in the middle of an economic downturn.
3. Bank failures: Check! We need an actual bank or two to go under however, not just these investment banking houses of cards, and we need an international bankruptcy along the lines of Creditanstalt. My money would be on one of the thoroughly opaque Chinese behemoths. The Fed and other central banks will doubtless try to avoid a collapse of the money supply following a bankruptcy; they may simply produce hyperinflation, a problem we didn’t have in the 1930s.
4. Expansion of the public sector: Check! Treasury Secretary Hank Paulson’s $700 billion housing bailout fund certainly qualifies here. Commentators have noted the similarity to Hoover’s Reconstruction Finance Corporation, without noting that the RFC was a colossal economic failure. It diverted resources to politically selected companies, increasing the level of Federal debt raising and thereby crowding truly private sector entities out of the capital market. The diversion of resources from the private to the public sector was itself deflationary, weakening the system’s productivity growth potential and deepening the downturn. Paulson appears to be operating on the basis that federal resources are essentially infinite. A $700 billion bailout and the $1 trillion deficits to which it will lead will “destruction test” this bizarre theory. Obama’s spending plans, which presumably won’t be abandoned altogether, will also be a problem here, Indeed it is likely that by 2012 the ratio of federal spending to GDP will be at a new high level never before seen in peacetime. As with bank failures, this time around an excessively accommodative Fed is likely to monetize the additional debt and thereby cause rapidly accelerating inflation.
5. Tax increases in a downturn: Probable. Obama has already promised tax increases, which he will probably make larger than planned to attack the $1 trillion deficits. That’s precisely the mistake Hoover made. McCain hasn’t promised tax increases, but appears to have no great philosophical objection to higher taxes and a commitment to reducing the deficit – it thus looks like tax increases will be forthcoming from him, too.
6. Abandonment of Capitalism: Probable. The principles of capitalism will have little popular support in the years ahead, as in the 1930s. Hence there will be no immediate opposition (other than from politically discredited industries) to daft new schemes of regulation that destroy market incentives. Obama has some idea how markets work, but the barons in the Congressional Democrat majority don’t, so there is likely to be some truly damaging legislation in our future. Even if McCain becomes President, he appears to have no instincts as to which controls and restrictions would wreak most destruction so “compromise” legislation with Congressional Democrats might be as bad or worse than under a President Obama.
7. Destruction of Capital markets: Possible. This is the big question-mark. In the 1930s, the Glass-Steagall Act, by separating investment banking from commercial banking at the bottom of a recession, when capital was scarce and entrepreneurial spirits non-existent, produced investment banks that were truly undercapitalized and indeed unprofitable – even Merrill Lynch, among the largest of them even then, lost money over the decade of the 1930s and survived only through subventions from Charles Merrill’s mother’s trust fund. The result was a level of capital raising in bond and stock markets throughout the late 1930s that was below that at the bottom of the 1920-21 recession, in a much larger economy. It is not unimaginable that draconian legislation along the same lines, backed by popular outrage against Wall Street, might have a similar effect.
What’s needed now is calm and a step back from hysteria. I don’t believe a couple guys (Bernanke and Paulson) cooking up huge backroom buyback schemes to ostensibly save the country from itself would have better answers than a market allowed to adjust on its own.
Thus not all of these factors operate to repeat the 1930s exactly; on the other hand, some of them merely promise a more inflationary version of that sorry decade, which would probably be even more unpleasant. While a re-run of the Great Depression, with or without hyperinflation, is still by no means inevitable, we are a lot closer than we were a month ago.
If we’re heading into an inflationary spiral and peak oil, then I’m putting my money in frontline suppliers like oil, food producers and utilities.
Here’s a guy who says the right answer is bankruptcy, not a bailout.
This bailout was a terrible idea. Here’s why.
The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk. […]
The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.
I agree. The bailout was a terrible idea and I’m glad it collapsed. It ignored a fundamental principle of human nature — when you shield someone from the consequences of his failures, he is more likely to repeat the same mistakes.
The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government. […]
So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.
The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.
The federal government is an evil gluttonous behemoth like it has never been in American history, and I place most of the blame for this suffocating clutch of tentacled anti-liberty at the exact moment women were given the right to vote. It was virtually inevitable that women, being the sex more concerned with security and stability and less enamored of freedom and risk, with the help of their alpha male co-conspirators and lickspittle beta male suckasses begging for a pussy handout, would vote in more government-as-daddy-and-husband-substitute, with the attendant confiscatory and redistributive taxes, regulations, and government intrusion that entails.
We are now reaping the girlwind.