Economists cannot predict the future; most can’t even predict the past. The dismal truth is that no one really knows what is going on – economists, politicians, historians all pretend to have some grasp of events but are only fooling themselves when they aren’t trying to fool others. Journalists at least don’t pretend to have any special insight, but they are also prisoners of the current financial or political orthodoxy – that’s when they haven’t actually bought up by one or other vested interest. (They know who they are).
But it seems reasonable to look to the past if only to rule out what might be happening in the present. So, we have to look at the 1930s, because that was the last time the world faced a stock market crash linked to a crisis of banking insolvency, allied to a burst real estate bubble. Then America dominated the world economy, and what happened there pretty much defined the 1930s. Those of a nervous disposition should look away now.
Three years after 1929, on July 8th, 1932, the Dow reached its lowest level of the 20th century and did not return to pre-1929 levels until 23rd November, 1954. Note that it was a staggered collapse. The Dow Jones actually recovered significantly in 1930-31 and politicians were congratulating themselves on their wisdom. By 1933, everyone realised that they were in what was called “The Great Depression” By then the US stock market had fallen by 89%.
Now that clearly hasn’t happened this time. Though the 2000 dotcom crash was of a similar scale on the Nasdaq index of technology stocks, overall stock markets have not collapsed on the scale of the 1930s – at least not yet. The governments of the west responded very differently to their predecessors in 1929-30. Instead of allowing “creative destruction” to work its way through the overvalued assets after 2000, central banks cut rates to near zero and actively encouraged a global property bubble. This led to the Great Moral Hazard as banks started lending irresponsibly,even to people who could never pay their debts, believing that they were backed by governments and would be bailed out for their losses.
The sub-prime crisis broke in 2006 in America as property crashed, undermining the value of all those dubious bonds based on inflated real estate like collateralised debt obligations. The “Financial Weapons of Mass Destruction” as the investor Warren Buffett described them as early as 2003. After the collapse of Lehman Brothers in 2008, governments reached for the kitchen sink and threw everything they had at the banks in a desperate bid to re-inflate the bubble. Britain alone devoted £1.2 trillion to the bank rescue according tot he Bank of England.
But this was futile because the banks across the world were insolvent, and in pretending that they were not, governments allowed themselves almost to become accessories to fraud. Certainly, it was the most profligate misuse of public money in history. The net financial result was that private debts were taken onto the public accounts leading to sovereign nations becoming insolvent. Hence the Greek crisis. .
Clearly this is all rather different to the 1930s. When President Roosevelt took his oath of office in spring 1933, unemployment in the US had risen from 8 to 15 million – around a third of the work force. American GDP had fallen by nearly half. This hasn’t happened yet. Unemployment has not come anywhere near equalling the levels seen in the early part of the Great Depression. This is largely because of the myriad government schemes for keeping the economy going, plus the massive increases in personal indebtedness. Families have kept their spending up by borrowing. Though this may have reached the tipping point with British households now owing £1.5 trillion, more than GDP
Moreover, in 2011, governments are all over the place and, after three decades of neoliberal policies, have lost confidence in their ability to manage the economy. Even in the eurozone, where only the politicians stand between the nations of Europe and financial catastrophe, they seem unable to mobilise the will to act. In 1933 by contrast, FDR did the following: He created the Securities and Exchange Commission (SEC) to deal with financial fraud; Congress passed the Glass-Steagall Act mandating a separation between commercial banks and investment banks. The Federal Deposit Insurance Corporation (FDIC) was established to insure individual bank accounts for up to $100,000. Finally, various New Deal agencies were set up to put millions of Americans to work on public works under the Works Projects Administration (WPA).
Unfortunately, this didn’t get America back to work. That only happened after 1939, when the government took on colossal debts to generate the war effort. The “employment” of six million soldiers and another 6 million defence workers were what ended the Great Depression. The worrying lesson of the 1930s was that only war was able to get the economies of the west going again. That is one piece of history we don’t want to repeat. Though there are worrying signs that a collapse of the euro may lead to economic nationalism and international conflict. The key here is probably China – of which more later