Lessons from the Great Depression

I decided my first post should be this essay I wrote about the Great Depression and our current economic crisis. It's very broad, but it touches upon a lot of ideas that I will most likely write about more thoroughly at a later date. Enjoy:

In understanding the current economic downturn, many pundits, reporters, and average citizens have looked at the Great Depression to calculate the severity of today’s crisis. Many have claimed that the world, particularly the United States, had lost its historical perspective and no one was able to predict the unfortunate events of 2008 that left the world economy in a tangled mess. In actuality there were many, such as New York University’s economics professor Nouriel Roubini, who did predict the housing bust, the trouble of sub-prime loans, the decline of consumer confidence, and the ensuing recession. Nevertheless, these predictions went unnoticed due to the large sum of quick cash being made around the world. Therefore, in trying to develop a recovery plan for a situation that increasingly looks more and more like the Great Depression, there needs to be a careful understanding of the Great Depression, its causes, and finally its recovery.

The most important thing to note about the Great Depression, as well as this crisis, is that there was no one single cause. Both affairs occurred due to many factors occurring under adverse circumstances. Even then, some may try to pinpoint “main” causes, but historians continue to dispute what factors should be emphasized when evaluating the causes of the Great Depression. Likewise, it is impossible to identify a prime cause for the current economic situation, especially since it is still unfolding. In mainstream thought, the Great Depression began after the stock market crash of 1929. This is dangerously short-sighted. If this were the only cause, we would be in an even more vulnerable position now because the stock market is considerably larger than it was in 1929. Thankfully, that was not the only cause of the Great Depression. Some historians may suggest that the origins of the Great Depression began during the industrialization of the late nineteenth century, but for our purposes we will begin immediately after World War I.

Just like our current economic crisis, there were those who predicted the Great Depression, but were ultimately ignored. John Maynard Keynes was one of those disregarded prophets. In The Economic Consequences of Peace, Keynes warns that the harsh penalties given to Germany after World War I would negatively affect the rest of the world economy. He writes, “If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany… they invite their own destruction, being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds.” Unfortunately, the leaders of Europe did not listen to Keynes and the deep economic ties were exposed due to the harsh demands on Germany and Austria-Hungary. Similarly, all of the warning signs for our sharp economic downturn were ignored, despite several economists’ predictions. Furthermore, what Keynes recognized was that the world economy was too integrated for nationalism to have any sort of positive effect on the financial system. For the current crisis, there was no major war that exposed economic globalization; the profound global economic ties were known, but simply overlooked.

The economic ties of the 1920s, just like today, were essentially based on loans. After World War I the United States was considered the world creditor. They had loaned England so much money during the war, and England loaned so much money to France, Italy, Russia, and other allies. However, since all of these economies, except the United States, were devastated by the war, they looked for German reparations to help pay back Britain and the United States. To further confuse this economic mess, the German economy was in utter chaos, so the United States loaned Germany money to ease their incredible inflation and to help pay back the allied powers. This intergovernmental debt left the world economy in an unstable house of cards, waiting for one card to fall. The cards certainly began to fall rather quickly, and nearly simultaneously. From what is known about the current crisis, there is a similar intergovernmental credit disaster. In fact, it is even more complex than the one that led to the Great Depression. The private financial institutions of today devised a complex scheme of packaging loans and trading bad assets. It is commonly thought that this begins with the so called sub-prime loans that were packaged and traded by financial insurance companies. Since these companies are so global this mess has not only affected the United States; it has caused financial disaster to most of the world. In terms of overall national debt, in our current crisis, the players are reversed. It is the United States that is in enormous debt, and now it is Germany and China that are giving credit. In American thought, it is usually considered that the Great Depression was a product of the United States. This is clearly a fallacy, and one of the most important things we can learn from the Great Depression is that it was a global crisis, caused by global affairs.

The interconnectedness of the global economy was a main reason why the depression was so vast in scope, but historians have calculated many other causes for the downturn, and these causes are very comparable to today’s crisis. Four main factors that are considered are: consumption, investments, net exports, and government policies. The main argument for the “underconsumption” cause is that during the 1920s, labor production grew rapidly as a result of technological advances, but this increase was not reflected in rising real wages. Therefore, as productivity increased and more products were put out into the market, but people no longer had the means to purchase the products, there became a waste of capital and production. This argument for a Great Depression cause is very much comparable to today’s crisis. A study by the New York Times showed that real wages were at their lowest share of G.D.P. on record in 2006, while corporate profits were at their highest share since the 1960s. This disparity between real wages and corporate profits is significant, but certainly not the only cause of either economic downturn.

Like the current economic situation, the Great Depression had some roots in the housing market. Investment began to decline as early as 1926 following a housing boom. As Attack and Passall point out, this decrease in the housing market was in part caused by the slowing of immigration and the fewer number of families. Although the current crisis has much to do with the housing market, where it differs from the Great Depression is that this housing bubble burst due to the complicated and risky behavior of financial institutions. Another factor discussed by Attack and Passall is net exports. This factor more than any other shows how interconnected the Depression was. The United States had been the world’s leading industrial exporter, but after the war, the European market drastically declined. One way of addressing this problem would be for the United States to import more from Europe, but this was unrealistic because of the simple fact that the there were no European products that the United States wanted. After all, the United States was the leading industrial producer of the time, so there was no incentive for Americans to import from Europe. As mentioned earlier, the United States’ role is currently reversed. The problem of net exports is now that the United States is in the position of Europe. The United States has not been an exporter nation for many years, but in order to get out of their debt, like Germany needed in the 1920s, is to receive capital through exports. The problem is still the same, but reversed, with China in the United States’ prior role. There are no products that the United States could export to China, which would help America pay back their current massive debt.

As mentioned earlier, the Great Depression was not solely provoked by the stock market crash of 1929. These other factors allowed the crash to be so devastating, but it did not end there. The government understood that there was a significant recession and that they needed to take some action to ease the economic downturn. Unfortunately, the model that was used was the recession of 1920, which was very short and not exceptionally damaging. The thought at the time was that the 1929 recession would be very similar and the same policies would relieve the situation. Like other explanations for the depression there are contending views. Usually this falls into two different camps: the government did too much, or the government did too little. Under President Hoover, there were indeed public works projects and other government spending to try and offset decline in private consumption. In addition the government cut taxes to help stimulate the economy. These measures may have alleviated the situation at first, but by cutting taxes while spending, the government loses revenue. This led to a budget deficit of $2.7 billion in 1932. The solution to the deficit was to raise taxes, and to raise taxes in a time of recession ultimately makes the recession worse. According to this view, the failure of governmental policy exacerbated what might have been a less sever recession.

Since the current crisis is still uncertain, it is practically impossible to fully compare the eventual recovery of the Great Depression with today, especially since this is indeed only a comparison and not a suggestion that we are heading toward another Great Depression. However, the attempts that are being taken today to solve our economic problems certainly resemble the measures that were taken during the 1930s. The Obama stimulus plan, which is inevitably political, has taken measures to funnel money into education, environmental and energy issues, public works, and other spending that parallels the New Deal. Some of the New Deal spending is what created much of the infrastructure that we have today. The biggest lesson to learn from this is that the United States needs to maintain its infrastructure and continue to make innovations in areas such as transportation, construction, and energy sources.

Economics ultimately ends up being political. The current economic crisis is very much at the whim of how the United States responds. It is a global affair, but the United States has such a significant economy, but has also been slower to respond to the dilemma. This has been in large part due to a deep ideology and a trepidation about anything that might be considered “socialist.” The biggest lesson we can learn from the Great Depression is that we need to cut these deep rooted ideological ties and act in a pragmatic way to solve the current situation. Every economic crisis is different, and thus the responses should be made by understanding the situation and developing policies that are suitable to the problem. What worked for the Great Depression, most likely will not work today. In fact, what is considered the biggest factor that led the world out of the Depression was the military industry and World War II. Today, the United States spends more money than any other nation on the military. In fact out of every tax dollar, 37 cents is used for the military. Therefore, this crisis needs to be treated carefully and new ideas need to be allowed into political economic thought. History does not repeat itself, but what we can learn from the past is that every action we have today will drastically affect the future in ways we need to take very seriously. We can either look at the Great Depression as a looming potential reality for the future, or use it to learn the complexities of not only the economy, but also of human and political actions.