Peter Schramm at No Left Turns directs readers to this piece by Niall Ferguson. It is the clearest piece I have seen on the really big question raised by the current economic crisis: will it lead to another depression? Harry Truman once said "it's a recession when your neighbor loses his job; it's a depression when you lose your job." Clever, but not correct. It's a depression when it lasts not for fifteen months but for fifteen years. That kind of economic trauma scars a generation. So what caused the first Big D? Here is Ferguson's key point:
[T]he underlying cause of the Great Depression — as Milton Friedman and Anna Jacobson Schwartz argued in their seminal book A Monetary History of the United States: 1867-1960, published in 1963 — was not the stock-market crash but a "great contraction" of credit due to an epidemic of bank failures.
The credit crunch had surfaced several months before the stock-market crash, when commercial banks with combined deposits of more than $80 million suspended payments. It reached critical mass in late 1930, when 608 banks failed — among them the Bank of the United States, which accounted for about a third of the total deposits lost.
As Friedman and Schwartz saw it, the Fed could have mitigated the crisis by cutting rates, making loans and buying bonds (so-called open-market operations). Instead, it made a bad situation worse by reducing its credit to the banking system.
Ferguson's piece is somewhat reassuring. Contemporary governments have a reasonably good grasp of the history of the Great Depression, and almost everyone is taking serious steps to avoid it. From this point of view, the $700 billion bailout was probably the right thing to do, precisely because we handed a big wad of spending authority to Secretary Paulson without a lot of strings on how he must use it. That will allow him to rapidly adapt to the situation, if it continues to deteriorate.
There may be no great human concern for which human beings are less psychologically prepared than macroeconomics. Consider this passage from Ferguson's piece.
[T]his is no longer an exclusively American crisis. European banks are going under as well. Growth rates in the euro zone and Japan have fallen further than in the U.S. Emerging markets too are suffering. With the exception of Brazil, stock markets in the BRIC economies (Brazil, Russia, India and China) are now down about 40% or more on the year.
The notion that Asia has somehow "decoupled" itself from the U.S. now seems fanciful. China and America have come so close to merging financially that we can almost speak of "Chimerica." When Fannie and Freddie were on the brink of collapse, many were surprised to learn that fully a fifth of China's currency reserves was composed of their bonds.
I find that emotionally satisfying. It's not just us, but them as well. We're not in this alone! And it's kinda cool to note that a good 20% of China's cash is tied up in bad mortgage loans that are in turn tied up in overvalued American houses. But of course, my emotions are being stupid. A global crisis is much worse than a regional one, because there is no one to borrow from. That is one of the things that made the Great Depression so greatly depressing: no one could bail anyone else out.
Someone once asked me if I ever swim. I replied: "in emergencies." This looks to me like an emergency. It is one of God's jokes that it comes in the Fall of an election year.
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