|from The American Prospect www.prospect.org
Worse than 1929?
If government doesn't do more, and fast, the country could be in worse
shape than it was during the 1930s.
THIS CRISIS DOESN'T yet have a name. It has all the hallmarks of a
depression, but people are understandably reluctant too use the
D-word. So let me suggest one: The Great Collapse, since this was both
a financial collapse and an ideological one.
This great collapse doesn't have to be a second Great Depression – if
government does nearly everything right, and soon. And when we come
out the other side, we could have a more decent and sustainable
But if government doesn't do more, and fast, this could be worse than the 1930s.
Why? Three big reasons:
Finance: A Doomsday Machine.
The financial system is in far worse shape than it was when the stock
market crashed in October 1929. In the 1920s, we had a stock market
bubble, mainly because people could play the market "on margin,"
borrowing to invest in stocks. There were also scams like the original
Mr. Ponzi's. Like the present decade, the Federal Reserve helped to
enable the game, with low interest rates and few rules.
But today, thanks to "securitization" of loans and the ability of
insiders to create exotic and unfathomable financial instruments, the
current speculative system makes buying stocks on margin look like
child's play. In the aftermath of the crash of 2008, the process of
sorting it all out and getting banks functioning again is something
that markets simply cannot do.
We are not even clear who owns what. The wise guys on Wall Street
invented a doomsday machine from which there is no market escape.
In 1929 when the stock market crashed, the banking system was
relatively healthy. Bank customers played these speculative games and
took the losses, not banks. This time, the banks drank their own
It took until the awful winter of 1932-1933 for the general depression
to fully infect the banking system. Over 4,000 banks failed in that
winter alone. But Roosevelt's cure -- deposit insurance and a
temporary bank holiday to sort out good banks from bad -- quickly got
the financial system up and running again. There were fewer bank
failures after 1933 than in any year during the 1920s. Today, by
contrast, the banking mess is still dragging down the real economy,
with no effective cure in sight.
Collapsing Wealth, Dwindling Demand.
The economy now bears all the hallmarks of a depression. Between the
housing collapse and the stock market crash, American households are
out several trillion dollars (in the 1920s, there were no 401 (k)
plans and less than 2 percent of Americans owned stock).
When people are suddenly out a lot of money, they spend less. Weak
demand in one sector cascades into other sectors. People spend less on
autos, air travel, hotels, restaurants, clothing -- any optional
purchase. Business sales and profits are down, which causes other
layoffs, and the cycle deepens.
Between 1929 and 1933, the stock market lost 89 percent of its value.
This time, stocks are down about 50 percent from their 2007 peak.
Worse is very likely to come, because stock values are based on two
things -- corporate profits and expectations of future gains. Profits
are continuing to slide, and few analysts expect a return to a bull
market anytime soon. So there are more sellers than buyers.
As stocks slide, the values of retirement accounts diminish, and
people feel even poorer, reducing their inclination to spend. That's
why declining stock prices and collapsing demand feed on each other --
and why a dramatic increase in government demand is the only available
Roosevelt was said to be a big spender, but his biggest peacetime
deficit was only about 6 percent of gross domestic product. This year,
the deficit will exceed 11 percent, and the recession will deepen all
year. It took the truly massive deficits of World War II -- nearly 30
percent of GDP -- to finally end the Great Depression.
A Debtor Nation.
America in 1929 was a major international creditor. Today, we are the
world's biggest debtor. The financial bubble of the past decade,
puffed up by foreign borrowing, created the illusion of prosperity.
During the bubble years, the borrowing from overseas disguised
domestic weaknesses, such as our much diminished manufacturing sector
and the fact that wages for most Americans were not keeping up with
inflation. Households, like Wall Street, became overly reliant on
debt. For now, foreigners are still willing to lend us vast sums, but
that may not continue indefinitely as nations like China invest more
in their own internal development.
In 1933, we could go off the gold standard, not hold the dollar
hostage to international currency trading, and concentrate on domestic
recovery. If foreign currency traders feared that deficits would cause
a drop in the value of the dollar, they didn't matter because we
didn't owe them anything. This time, we have to worry about keeping
their confidence. (The only reason why the dollar is holding its value
is that the euro, for now, looks even shakier, and the Japanese and
Chinese are resisting letting their currencies appreciate -- but that
could also change.)
All of these economic calamities have solutions, but each is more
radical that what's currently on offer. The government will have to
temporarily nationalize major banks, sort out good assets from bad
ones, and then return banks to responsible private ownership. To cure
the housing collapse, government should directly refinance mortgages,
rather than trying to bribe banks to ease terms.
Deficits will have to be a lot larger before they can get smaller.
That should not require a war; this is just as grave a national
emergency. Those deficits could purchase much broader prosperity, just
as the World War II deficits did. If foreign borrowing dries up, we
may need to sell massive amounts of recovery bonds to Americans, just
as we relied on war bonds rather than borrowing from abroad during
World War II.
If government is spending upward of a trillion dollars to stimulate
demand, those dollars can be used for social investments that we
should have had all along -- things like decent early childhood
education and comprehensive health insurance and clean energy. The
government needs to view these investments not as a one-shot but as an
ongoing commitment to a just society.
President Obama needs to grasp just how radical a set of solutions we
need. Then he needs to use his gifts as teacher-in-chief to persuade
the public and the Congress to follow his lead.
Can America recover from a Great Collapse? Can we avert a second great
depression? To coin a phrase, yes we can. But we need the right
strategies and we don't have much time.