today's economic crisis another Great Depression?
NOV 04 2008
banks. Panicked markets. Rising unemployment. For students
of history, or people of a certain age, it all has an all-too-familiar
ring. Is this another Great Depression? Not yet.
By any measure,
our current economic suffering pales in comparison with
what the nation endured from 1929 through 1939. Still, most
economists are predicting a long, difficult period ahead.
Could it eventually become a depression? It's possible —
but not likely.
The Great Depression
left a mark on the world that remains today, nearly 80 years
after it began. It re-created our banking system, molded
our securities laws, and left scars on the nation's psyche
that have faded only modestly with the decades. During the
Depression, savers watched their money evaporate in bank
failures, because deposits weren't insured. Bankers became
so unpopular that bank robbers, such as Bonnie and Clyde,
became folk heroes.
By the depths
of the Depression, 25% of the population was out of work.
The Dow Jones industrial average had fallen 89%. The entire
banking system was shut for four days by presidential order.
Home and farm foreclosures soared. Homeless people created
vast shantytowns, called "Hoovervilles," outside
most major cities.
The word "depression"
became so terrifying that economists stopped using it to
describe a business slump. "It was an active choice
of words," says Peter Bernstein, the celebrated economist,
now 89. The Roosevelt administration judged the word too
terrifying for the public to hear, Bernstein says. And for
people who lived through the Depression, it was terrifying,
indeed. "It was a killer," Bernstein says. Mitchel
Namy, 96, recalls how his family fared. "My father
was very successful in the wholesale dry-goods business,"
Namy recalls. "He lost the business, our home and a
valuable 26-acre tract of land in suburban Pittsburgh."
woes dwindle in comparison. As of the end of June, the latest
data available, the nation's gross domestic product was
still growing at a respectable 2.8% rate. In the third quarter,
it fell at an annual 0.3% rate. Unemployment in September
was 6.1%. "We're a long way from the D-word,"
says David Wyss, chief economist for Standard & Poor's.
"It's a recession."
And, in fact,
it's not even officially a recession. The National Bureau
of Economic Research, the official arbiter of when recessions
begin and end, has yet to declare the end of the most recent
economic recovery. Even the shorthand version of recession
— two consecutive quarters of shrinking gross domestic
product — hasn't happened yet.
How today's situation
sounds similar Few people deny, however, that the current
economic climate bears disturbing similarities to the start
of the Great Depression:
in the stock market reduced people's wealth and decreased
spending, notes Timothy Canova, associate dean of international
economic law at the Chapman University School of Law. The
Dow didn't fall steadily: It plunged 47% from its high of
381 in September 1929 through November 1929 and then started
a famous "sucker's rally" in the spring of 1930
before plunging to 41 in July 1932. The
Dow fell 42% from its Oct. 9, 2007, high to its Oct. 27,
2008, low, roughly equal to the market's initial tumble
in 1929. Far more of the population owns stocks now than
in 1929, however: For many people, stock mutual funds are
the cornerstone of their retirement savings. In 2006, the
latest data available, two-thirds of all 401(k) plans were
invested in stocks, a percentage little-changed in the previous
11 years, according to the Investment Company Institute,
the funds' trade group.
system was crippled by bad loans and speculation. In 1929,
the bad loans were made to stock speculators; most recently,
the bad loans were made to homeowners and investors in mortgage-backed
stopped lending in 1929 to avoid further losses, which slowed
the economy even further. By the mid-1930s, more than 5,000
banks had collapsed. Today, banks have also slowed lending
to avoid losses, and the credit markets have nearly ground
to a halt.
But there are
some big differences today that make a repeat of the Great
Depression unlikely. The biggest: massive intervention by
the world's central banks. "The Federal Reserve has
been very aggressive in its role as lender of last resort,"
says Paul Kasriel, chief economist for Northern Trust. "That's
why the Fed was created — not to prevent recessions,
but to prevent the implosion of the financial system."
In 1929 and 1930, the Fed actually raised interest rates,
draining liquidity from the system, deciding that it was
best to stamp out speculation. Although economists still
debate the exact causes of the Great Depression, the Fed's
moves are often considered one of the prime reasons the
economy tumbled so hard. In addition, President Herbert
Hoover raised taxes in 1930 in an effort to balance the
budget. At the same time, Congress passed the protectionist
Smoot-Hawley Tariff Act, which raised the fees charged on
imported goods, setting off a trade war. Exports fell as
other countries retaliated against the tariffs, crippling
the nation's manufacturing.
the government this time has been active in trying to prevent
an economic meltdown, precisely because officials worried
about another Great Depression. Explaining why President
Bush backed the bailout, spokeswoman Dana Perino said: "It
was when Ben Bernanke and Treasury Secretary Henry Paulson
came to him and said we could be facing something worse
than the Great Depression if we don't act, that the president
realized that he had to put aside his instincts and focus
on what he could do as president of the United States to
help save this economy — not to help save Wall Street,
not to help save any individual economy, but to help individual
Americans all across the country of all economic stripes."
The $700 billion bailout bill, and the fiscal stimulus checks
that went out early this year, although controversial, show
that the government is willing to intervene in the financial
system to keep it afloat.
The Fed has cut
interest rates nine times since the credit crisis began
in September 2007. In addition, the Fed has created several
credit facilities, which allow troubled financial institutions
to exchange assets that they couldn't sell otherwise for
ultrasafe Treasury securities. (The institutions must eventually
take back their illiquid assets and return the Treasury
securities.) Have we done enough for prevention?
Despite the Fed's
activist role — and the role of central banks around
the world — some still worry that further financial
calamity is possible. Chapman University's Canova says that
$700 billion pales in comparison with what the country spent
to get the economy out of the Depression in the 1930s, particularly
if you include the massive spending for World War II. "If
one lesson of the Great Depression is that the Federal Reserve
must be ready to expand the money supply, another lesson
is that monetary expansion alone will not renew a growth
path for the economy," Canova says.
In 1929, stocks were the most overvalued asset. This time,
the U.S. had more than one bubble entering the current crisis,
says Mark Kiesel, executive vice president at Pimco, and
that means that unwinding it all could be more painful and
protracted than many think. "We entered this slowdown
with massive overvaluation in all assets: commodities, stocks,
mortgages and real estate," Kiesel says. Unwinding
all those bubbles will lead to a far weaker economy than
many experts expect, he says.
And, he says,
the worst has yet to come. Unemployment typically lags behind
earnings slowdowns: He expects unemployment to rise to as
high as 8% in the next year or so. Many experts note that
real unemployment may be much higher than the official figure
of 6% because those numbers don't include those who have
stopped looking for work. Also, Kiesel says, home prices,
which have swooned as much as 25% or more in some areas,
still have another 10% to 15% to go.
big question is how long it will take for consumers to feel
confident enough to start spending again. Unlike the economy
of the 1930s, which was largely based on manufacturing and
agriculture, the U.S. today is primarily a consumer and
service economy. Until consumer confidence rises, spending
is likely to stay weak. And that, Kiesel says, won't happen
until corporations and consumers pay down their debts. "We
had companies with weak balance sheets selling to consumers
who were leveraged up, too," he says. The whole process
could take years, Kiesel says. "It won't be a depression,
but it won't feel good."