Thursday, December 11, 2008

Worse than the Great Depression. OR: This is Not the Great Depression - but it could turn into the Great Inflation

Two from Prudent Bear. First up, Martin Hutchinson:

In spite of Friday's alarming rise of 533,000 in unemployment, when you look at the near-term future, there still seems little chance that the current unpleasantness will turn into a rerun of the Great Depression, or anything like it. Gross Domestic Product may decline by more than the 3%-to- 4% declines seen in 1974 and 1981-82, but there seems no immediate danger of it shrinking anywhere near the magnitude of the 1929-33 decline. However, in the long term, things are not so rosy; over the next 15 years, Americans and Europeans may suffer a worse fall in their living standards than during the Great Depression, albeit played out agonizingly slowly.

Benchmarking first: According to Bureau of Economic Analysis statistics, GDP declined 26.6% between 1929 and 1933 while real personal income declined 25.7%. Real personal consumption expenditures declined 18.2%. Per capita, with U.S. population increasing about 1.5% per annum during those years, real personal income declined 30% and consumption 23%. In terms of living standards, real per capita personal consumption expenditures did not recover to their 1929 level until 1941, giving American consumers 12 years of living standards lower than they had become used to.

There is only one way (apart from gross government ineptitude, which fortunately under President-elect Barack Obama seems fairly unlikely) that U.S. or Western European GDP could fall anything like it did in the Great Depression, and that is through globalization.

It is now abundantly clear that, through the simultaneous arrival of the Internet and cheap cell-phone technology, the pace of globalization increased markedly around 1995, with global supply chains for time-sensitive products and services being for the first time possible without enormous effort, thus propelling new participants, notably India and China, into the global free-market economy....MUCH MORE
And from Rob Lee:
...As a model for the current crisis the Great Depression does not stand up to even cursory examination. Two catastrophic policy mistakes transformed the severe economic downturn following the 1929 stock market crash into a deflationary depression. The first was the general adoption of aggressive trade protection, epitomised by the Smoot-Hawley tariffs. One redeeming feature of the present crisis is the absence of significant protectionist pressures. It is apparent that key global policymakers - including President-elect Obama - understand they must not impose new trade barriers.

The most crucial policy error though was that the Fed allowed widespread bank failures to cause a severe contraction in money supply. This was a key finding of the seminal work “ A Monetary History of the United States 1863-1960 ” by Milton Friedman and Anna Scharwtz. The current Fed Chairman’s principal claim to academic excellence rests precisely on his detailed knowledge of the monetary policy mistakes made then. In a tribute to Milton Friedman in 2002 Mr Bernanke wrote the following :

“ I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we (the Fed) did it. We’re very sorry. But thanks to you, we won’t do it again ”

It is clear from the speed, scale, and radicalism of the Fed’s ongoing response to the “credit crunch” that Mr Bernanke meant every word of that tribute.

There are other crucial differences with the 1930’s. Most bank deposits are now federally insured. Government spending forms a much larger part of the economy and significant components of it automatically rise if the economy declines, while tax revenues fall. These “automatic fiscal stabilisers” are much larger than they were then. Furthermore these factors are replicated across the globe as fiscal stabilisers exist in every economy now and bank deposits are widely protected.

These key factors - the absence of protectionism, inbuilt fiscal stabilisation, and avoidance of money supply contraction - will ensure that nothing like a deflationary depression occurs....MORE