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Great Depression II?
Hollywood loves sequels. Either good or horrible, every movie seems eventually to end up as a sequel.
But can life imitate art--or at least a Hollywood movie? Is a re-run of the Great Depression possible?
When I was an undergraduate at Columbia University some 25 years
ago, my economics teachers insisted it wasn’t. They listed four good
reasons why a Depression couldn’t happen again:
1. There are safeguards against a sudden stock market crash.
2. Deposit insurance protects banks from runs on deposits.
3. The government plays a larger role in the economy. Public spending rises
in a downturn, supporting aggregate demand.
4. The Federal Reserve has learned the lessons of the Depression and stands
ready to prevent its repetition.
As US financial markets veer out of control, and pieces of a once-formidable US economic edifice break off, one can be forgiven for being apprehensive. In fact, if those four factors are the only safeguards against Depression II, I suggest we run for cover.
True, the stock market didn’t collapse all at once as it did in October 1929. However, a sudden crash would have been easier to deal with. In October 1987, for instance, the Fed simply opened its monetary spigots and a major economic downturn was avoided.
This time, the stock market selloff has been gradual, starting with dot-coms in April 2000 and spreading into high-tech and blue chips over the past 12 months. However, a slow meltdown may be even more damaging than a one-time plunge.
Let me cite an example. A friend of mine, a scientist at a biotech startup, successfully dabbled in stocks in the 1990s. First-hand knowledge helped him pick promising biotech firms. As the sector started to unravel, he saw it as a buying opportunity, loading up on depreciating stocks. He is now sitting on huge paper losses.
The conviction that Intel, Cisco, Yahoo, Oracle and other star performers of the 1990s have become extremely cheap keeps luring investors into the market. Moreover, professionals have been taken in along with amateurs. Repeated bear traps keep the market falling gradually, but it will probably end up by saddling investors with even heavier losses.
While there is indeed no danger that depositors would rush to withdraw their money from commercial banks, it doesn’t mean that the financial sector is safe. Today, the weak link is on-line brokers. Their results have deteriorated sharply, as industry leaders Charles Schwab and E*Trade can attest. Ameritrade’s debt rating has fallen near default levels. If a smaller on-line broker goes belly-up, investors may stage a run even on healthy brokerages and money managers. Such sudden withdrawals could cause another shudder for an already depressed stock market.
Today, the government could provide support for the economy to a much larger extent than in the early 1930s. Unemployment insurance, when it was introduced in the 1930s, was meant not only to alleviate pain for individual, but to support demand during recessions. Yet, in today’s entrepreneurial economy, many people work for themselves—as consultants, free-lancers or outsourcers—and are not eligible for benefits. While making the US economy more flexible in an upswing, this factor may prove a major drawback in a recession.
Worse, the government is currently a drag on the economy, running a $200 billion fiscal surplus. This surplus should be used to support the economy—and not in the form of tax cuts which in a gloomy economic climate won’t be spent by consumers. Instead, the economy needs a quick infusion of public money into the hard-hit high-tech sector. But, just as in 1929, we have a hands-off Republican in the White House, who believes that the free market would always right itself up. Curiously, the Bush administration doesn’t even seem to be aware how much it resembles the Hoover administration that was in office at the start of the Great Depression.
Finally, the Fed has shown over the past year that it learned
no lessons from 1929. Even at this late date, the Fed seems happy that the
stock market bubble has been pricked. It sees only a shallow, short-lived
downturn.
At the onset of Depression I, America’s establishment similarly discounted
the importance of the stock market and pooh-poohed signs of a nascent economic
slump. By the end of 1929, nine weeks after the stock market crash, the New
York Times had forgotten all about it and named some obscure polar expedition
as the event of the year.
Agree? Or disagree? Let NABE know what you think. Suitable replies will be published
Alexei Bayer is President and Chief Economist of KAFAN FX Information Services, a New York business consulting firm.
All Op-Ed articles are the opinions of the authors and not of NABE.
...a slow meltdown may be even more damaging than a one-time plunge...
... the government is currently a drag on the economy, running a $200 billion fiscal surplus....
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