Does The Current Global Crisis Remind Us Of The Great Depression?*
By Sunanda Sen
23 July, 2009
Countercurrents.org
The intensity of the current global economic crisis as claimed by the present Fed Chairman, Ben Bernanke , will be far less than that of the Great Depression of the 1930s as compared by the damaging effects in terms of its decade or more long duration, a drop in the GDP by one-third ( and similar loss of jobs), one third of banks crashed and a total collapse of the stock market. Also he pointed out an absence of what prevails today as “social safety net”. Bernanke's views contrasts what was said by George Bush, the former President of US while defending his rescue plans for the US financial sector. He had warned that the current crisis could be even more grave than what took place in the thirties.
Predictions as above do not tell us much, given that the unfolding of the crisis has just began with an intensity in terms of the crash in the financial sector and the output and job losses which do not convey the message that the crisis is of a less serious nature. It may however, be relevant to compare the two scenes, first by looking at the build-up of the crises at the respective points of time. Second, we look at the set of policies as were adopted in the respective years, mostly to address the failing system. Finally we look at the global spread of the crisis with its repercussions, not just in terms of macro-economic aggregates but also as policy changes at national levels which include protectionism , exchange controls and related moves.
The build-up of the crisis
Let us first look at the factors precipitating the crises in the two periods. As for the crisis of the thirties, it was preceded by uneven economic power of the major industrial nations with disparate output growth rates and major imbalances in international trade and payments across countries. Of these, USA was the major industrial country contributing 42% and 33% of world output in respective years of 1928 and 1933. USA was also the c hief provider of international loans and import demand for Europe . The country absorbed gold inflows with no impact on domestic prices in pre-WW I years of gold standard. In contrast Germany was subject to heavy reparations at end of the first World War and the value of reparations was 1.5 times its national income. Germany was also a major borrower from overseas, and was absorbing 50% of all international loans while its economy was subject to hyper-inflation. As fo the Allied Nations a t end of World War I these nations were supposed to to pay War debt to US while Germany was subject to reparation payments to the Allied Powers. To provide a solution to the above embroglio which arose with Germany 's inability to meet the reparations, US was lending to Germany (in terms of the Daws Plan of 1924 ) to make for German reparations to Allied powers ( Britain , France ) and thus for payments of War Debts by the Allied Powers to USA . A new scheme for such payments was made later in terms of the launching of the Young Plan (1929) which however ended with the crash in the stock markets of Wall Street when capital flows come to standstill.
Comparing the thirties with the recent events, US today ranks first among other countries in terms of GDP and also is a major importer while it happens to be the largest borrower. Unlike the scene during the 1930s, the developing countries, and specially China , are the major lenders, which finances the net export demand and fiscal deficit of US . This is done as China invests in the dollar denominated Treasury Bills of US, with dollar universally rated as the most reliable store of value. China 's growth rate, along with those for other emerging coutries in Asia , were high ( with China 's gdp growth above 10% over the five years ending in 2008 ) while those for advanced countries hovered between 1.7% to 2.7%. As for external accounts, the current account deficits of some major countries in the advanced region have been high, exceeding 6% of GDP in US and 3% in UK . Current account surpluses prevail in other advanced countries , exceeding 5% and 3% of GDP in Germany and Japan . However, for China in the developing region, the surplus exceeded 7% in recent years. The flow of external finance was thus directed from China , Germany and Japan among others to the major borrowers, US and UK . The flow of finance, as long remained uninterrupted, was much in use to provide for varieties of consumer financing including those in the housing market. Speculation was rife , along channels of stock market transactions where the debt- financed Asset Backed Securities came up as major vehicles of leverages. On the whole, the delicate balance between the surplus nations and those running the continuing deficits did not provide a lasting solution , especially with the flow of finance moving along speculatory circuits in deficit countries. US today is a major borrower rather than the chief lender as she was during the thirties. Payments imbalance and capital flows support the over-valued dollar, often in the interest of rentier capital.
As can be seen from the above account, the current account imbalances among the major industrialized nations proved unsustainable in either period , even though for reasons which happen to be different. Flows of finance across countries , in the period of the Great Depression, was hardly contributing to growth in the real economy. These effectively recycled, between USA, the victorious country's currency afloat at an overvalued rate of exchange. Both were Allied powers and defeated Germany, to make it possible that the war related claims are settled. None were, in effect, channelized to create productive assets and to contribute to growth. In case of the current financial crisis the payments imbalances, which financed the US trade and fiscal deficit by Chinese and other developing country current account surpluses as well as reserve accumulations, similarly went astray in terms of the growth potential in the debtor country. Even other countries, including the developing ones faced a similar situation while hosting inflows of short term finance from institutional investors, which were directed to secondary stock market and invested for quick returns. Compared to the earlier years the current crisis has more to do with financial flows with speculation as the driving force for investment, and which swelled the stock market and generated short term gains while keeping the debtor currency afloat at overvalued exchange rates. Both were conducive to keep alive the dominant interests of finance and rentier capital in the global economy.
Policies in response
As for the policies which proved wrong in mitigating the crisis in these peri ods, Britain and USA can be found following policies in the 1920s which contributed to the recession. These included the launching an overvalued exchange rate with gold backing as Pound-Sterling by Britain and pitching it to the pre-war sterling - gold parity in 1925. In a bid to attract capital from overseas, the move was matched by a deflationary policy with high discount rates. The revival of Gold standard could continue in Britain as long as inflows of capital to the country continued . The latter failed in 1931 when Britain was again off-gold standard. A package of as above was clearly pro-finance and opposed to interests of industrial capital and labour in the country. The consequence for the latter was clearly adverse while generating positive benefits to finance as well as rentier capital . In US the stock market boomed till the onset of the crisis in 1929, which, as mentioned above, was largely nourished by speculation and capital inflows . Regional banks in the country fuelled credit expansion with ‘perverse flexibility' with low rates during boom and vice versa during slumps. Also the Fed can be held responsible for continuing with a high interest rate policy, as again, held by Bernanke and endorsed by no other than Milton Friedman! Credit booms were also accentuated with Holding companies operating on ‘margins' which required little cash. However, the boom, largely fuelled by credit flows to stock markets, ended as the market crashed in 1929, with expectations of speculators remaining unfulfilled. To arrest the free fall in the stock market the Federal Reserve Board raised interest rates without much effect. The chaos in the stock market also disrupted the cross-border flows of capital . Following Britain's move in 1931 to end gold standard, USA delinked from gold in 1933 and exchange rates of major currencies started floating again. Attempts in the World economic conference of 1933 to achieve exchange rate coodination remained in the meantime abandoned.
In US President Roosevelt introduced the New Deal (1934-39) which helped farm sector with subsidies. This followed an earlier devaluation of dollar in 1933 and the enactment of the Glass-Stegall Act 1933 which prevented banks from speculation with investments in securities. However, the short-lived revival of the US economy for a couple of years ended in 1937 when it collapsed with the re-imposition of fiscal austerity .
Germany, which was the biggest debtor during these years was already subject to hyperinflation by mid 1920s. However, with deflationary policies, the country faced, by 1930s drop in prices, output, employment along with a debt-deflation which of course by finally led Germany to default on reparations in 1932, followed by a failure on part of Allied Powers to pay War debt in 1934.
If we now look at the current scenario of a global economic crisis, we notice some parallels in terms of the policies followed. Ignoring the message as follow from the standard Keynesian policy frame, those in charge of devising the course of action chose to abide by the neo-liberal precepts which included a tight money policy to avoid inflationary potentials. Thus the Federal Reserve in US was continuing with a high interest rate of 4% to 5% over the five years which preceded the crisis in 2008-09. Similar policies of tight monetary policy was followed in other countries including Britain and rest of Europe, despite the low or stagnating growth rates of output and employment. As for exchange rates, one notices tendencies to maintain status quo, say with an overvalued rate of dollar by US, which was contrary to any adjustment related to the country's current account deficits. Attempts at a coordination were ruled out by major nations, with resistance rooted in national economic interests. These include the denials by Germany as well as China to revalue against US dollar, pitted against USA's bid to continue with its exchange rate. In Europe fiscal deficits had to be kept within limits prescribed under the Maastrich Treaty. On the whole the low growth in these economies was hardly an issue in framing policies which continued to follow the course dictated by conservative macro-economic policies. A shock was felt by fall of 2008 which, with a regime-change in USA, contributed to a move in the direction of a Keynesian stimulus. A similar course of action is observable in other parts of the world, with fiscal expansions, cuts in interest rates and bail-outs for major financial institutions. While these changes are still too early or inadequate in dealing with the magnitude of financial losses and real sector contractions, one can observe a pattern of corrective actions, distancing from the wrong policies of the past.
Repercussions
The repercussions of the Great Depression of the thirties included a sharp decline in world trade and international capital flows, the latter dropping by 9% during 1927-33 and matched by significant declines in primary commodity prices which hit developing countries. These included India and other colonies which faced the brunt of the depression. Migration across nations also fell drastically in the process.
The Great Depression also witnessed a revival of economic nationalism ,neo-mercantilism and protectionism which was matched by a rise of fascism in in Germany (1934) and Italy (1936). with considerable loss of labour status.
On the economic front there was exchange control , especially by Germany in the thirties and trade restrictions, with US raising tariff barriers in terms of the Smoot-HawleyTariff Act (1930). With Britain initiating the Ottawa Agreement (1932) on tariff preference among the Commonwalth countries and Germany launching exchange control and clearing agreements for external payments, retaliations were not unusual , with econonomic nationslism dominating policies of most induatruialised nations. In 1933 attempts were made to stall these moves, especially by means of an exchange rate co-ordination among nations. However the attempt was soon abandoned . The pace of trade and exchange restrictions continued along with fluctuating exchange rates during the inter-war and the Second World War days, until the allied nations got together to agree on the Charter of the Bretton Woods Agreement in 1944. In the meantime the major industrialized nations were embroiled in a War , which can be viewed as the culmination of the unrest and disruptions in the economic front as was unleashed by the Great Depression.
Comparing the current scene, the immediate impact of the crisis was en end to the financial boom, which was brought about by end of 2007 with a collapse of the sub-prime loan market in US .Losses therein were spread to the rest of the financial business, in US as well as in other advanced countries by October 2008. In US a large number of investment banks and other financial institutions including the mega insurance company AIG felt the heat and were nearly at a point of collapse. Monetary and fiscal measures to bail out and to instill liquidity in the system via banks have not worked sufficiently so far.On the whole the impact has been pervasive , especially as one considers the contractions in the real economy, with fall in output and employment all over the world. Thus gdp of the advanced nations have recorded a negative growth rate while those for the fast growing developing countries have fallen drastically, both with domestic contraction and drop in export demand from abroad.
A direct response of the output and job losses as have followed the financial crisis in the advanced countries has been the emergence of protectionism, which is happening in disguise, thanks to the formal compliance to the WTO regime. The above include the moves initiated in US to ”buy American”, to scratch H-1B visa for professionals, especially from India, and an end to tax breaks for US companies which outsource jobs. Clearly the WTO has been totally ineffective and even silent in terms of resisting these moves.
As a consequence of above, most countries including the developing ones today are facing sharp drop in exports, output and employment. While many( including the advanced countries) are trying fiscal-monetary expansionary path there has been no effective curb on speculation in any part of the world, including the widespread use of financial derivatives , hedge funds or flows of speculatory short term capital flows.
Conclusion
Concluding, one identifies strong parallels between what happened with the Great Depression of the 1930s and what the world is passing through this day. While the build up of the crisis shared a similar pattern, with payments imbalances and capital flows directed to channels which failed to contribute to real growth in the capital importing debtor nations, official policies as precipitated the crisis also were similar. These included Britain's move to re-incarnate pre-war gold standard in 1925 with overvalued gold parity for Pound Sterling and a dear money policy, both to attract funds from abroad which finally failed to work. In US free use was made of funds to stimulate the country's stock market transactions with a boom which finally came to an end in October 1929. Likewise, Alan Greenspan's strategy of high interest rate and overvalued dollar during the years preceeding the financial crash in 2008 certainly worked as factors precipitating the collapse. Notwithstanding the acceptance of Keynesianism in post-war Europe, policymakers swang back by mid seventies to pre-Keynesian neo-liberal ideas of monetarist variety. The unprecedented boom in stock markets, with leveraged finance supporting the securitized assets, and the continuing flows of capital to finance the trade and fiscal deficits of US had to give way to unfulfilled expectations in the market. Again, as for reactions, the protectionist wave has re-emerged in Europe and USA, with economic nationalism ruling over notions of multilateralism and free trade. Racial discrimination which led to fascist upheavals during the thirties today remain much camouflaged, garbed in the language of economic nationalism. As for the magnitude of the losss in terms of output anf employment, the current scene certainly overtakes the thirties in terms of absolute magnitudes. One only hopes that duration of the slump will not be as long as it happened earlier and also that the world will witness the revival of progressive new ideas, as it happened with the Keynesian revolution in the 1930s!
The paper was presented as a public lecture in a conference on “ Writing of Indian Economic History “ in a session on ‘Comparing the Depressions' held in the Department of History Jamia Millia Islamia, New Delhi on 27 th February 2009
“ Bernanke says crisis no comparison' to Great Depression “ Dec 1, 2008 www.worldnetdaily.com
“ Bernanke: Federal Reserve caused Great Depression Fed chief says, 'We did it. …very sorry, won't do it again' ” Posted: March 19, 2008 9:02 pm Eastern By David Kupelian © 2009 WorldNetDaily www.worldnetdaily.com
