Is The Old Mechanic’s, Old Hammer Functioning Now?

All of my previous post dealt with evaluating the great depression. This post will dig up the past to look for any valuable tool to use for the great recession, because of its similarity with 1930s depression. 2007 recession in U.S is anticipated to be the replica of Great Depression.The recession kicked-off in the same manner as the great depression, with subprime-mortgage crisis as key event this time and various other factors as its fuel. Similarities in both, forecast a possible return of the1930s nightmare. But fundamental analysis clears the air of worry. It shows that the current recession may be devasting enough, but it is nowhere closer to the 1930s financial catastrophe. The below table describes how 1930s was far more disastrous than the 2000s.

                                             GREAT                    GREAT
                                       DEPRESSION          RECESSION

Period	1929-1940	2007-2012 (expected to go till 2016)
Bank Failures	9096 (50% of banks) (Jan 1930-March 1933)	57 (0.6% of banks) (Dec 2007- May 2009)
Unemployment Rate	25%	8.4%
Economic Decline	-26.5% (1929-1933)	-3.0% (4th quarter of 2011)
Biggest decline in Dow Jones industrial average	-89.2% (Sept. 3, 1929- July8, 1932)	-53.8% (Oct 9, 2007- March 9, 2009)
Change in prices	-25% (1929-1933)	+0.5% (Dec.2007- March 2009)
Decline in international trade	50%	30%
Emergency spending programs	1.5% of GDP for 1 year (Increase in 1934 budget deficit)	2.5% of GDP for 2 years (2009 American Reinvestment and Recovery Act)
State’s Response	Raises taxes, cut spending	Federal stimulus plan gives fiscal relief to states to lessen impact of tax increases)
Increase in money supply by federal reserve	17% (1933)	125% (Sept. 2008- May 2009)
Use of fiscal policy	Minimum	Maximum

(Source: US Department of commerce, BEA; FDIC, Federal Reserve; Commerce Department; Dow Jones; Christina Romer, Obama economic adviser, “Lessons from the Great Depression for Economic Recovery in 2009” (March 9) and JEC testimony;Jonathon Eaton, 2010; http://money.cnn.com/news/storysupplement/economy/recession_depression/)

This gives consolation to lot of Americans, as well as hope that sooner or later we will get rid of the problem. Now the question is; can we speed up the recovery by mastering the past lessons learnt?

Past lessons taught us that tight monetary policy by FED and poor fiscal policy by Hoover prolonged the recovery of great depression, and the rescue was possible only when monetary base was expanded. So logically; increasing money supply, decreasing taxes and increasing government spending would suffice the recovery. Than why are the policies contradicting their usefulness now? The government have been pumping sufficient money and engaging in free market, with no satisfactory result. The fiscal policy is also a failure. Fiscal policy was tried because of the criticism it bore in 1930s, which stated “Fiscal policy failed to generate recovery not because it does not work, but because it was not tried.” (E. Cary Brown). Another lesson of decreasing interest rates and reserve requirements of banks, is also trialed. Instead of supporting recovery they have entangled it more. It led to easy lending and investment with borrowed money.

Only one untouched strong combating weapon remains in the bag of past; the advantage of war . So should America use this weapon? Sorry, but the era has moved forward and now is the age of Nuclear war, which sadly cannot give any employment or alleviate production. Hence the past lessons are not applicable to wipe out the financial crisis faced by this generation.  Like the mechanic cannot work with an old hammer, the policy-makers cannot rely on old strategy.

Journey Through Night To Dawn

The recovery of US economy from the captivity of Great Depression was a very long and difficult journey. The slide of US economy to great depression was like an epidemic disease to the country, for which the doctors (government, economists & monetarists), neither had any precautionary methods nor any prescribed medicines. There is no concrete evidence to what caused the great depression, neither any concrete evidence to what caused the recovery. The initial year’s recovery action was a series of hits & misses. However it is thought that the monetary policy, fiscal policy, New Deal by Roosevelt, Suspension of Gold Standard in 1933 and finally the World War 2 combinedly spurred the recovery process.

                                                           (Source: fotolia.com)


This recovery could have been faster, if government refrained from creating barriers and prolonging the intervention. President Herbert Hoover (1929-33), tried many methods to stabilize the financial condition, but his every effort seemed to be swallowed by the whale of great depression. He introduced the Smoot-Hawley Tariff Act, in an attempt to increase reliability on US made products, so that domestic demand can lead to a higher production, and hence lend a supporting hand to the economy. But little did he knew that this Act will backfire. In retaliation, every other country increased their import tariffs on US products and international trade went face down. Securing hopes among people for a better future was the election of Roosevelt as president. He launched New Deal, which was designed to reform, regulate and recover the economy.Monetary base was increased through devaluation of dollar and suspension of gold standard. The devaluation helped attract huge gold inflow from Europe and money multiplier took front seat again.
The monetary policy healed the pain, but it was not able to completely deal with the burgeoning unemployment or slumping GDP. The onset of World War 2 eradicated the entire problem. It created urgency of production and decreased unemployment as huge numbers of people were required in the war front. The countries involved in War were hoarding gold in U.S banks to keep them secured, creating monetary expansion within U.S. Thus, war was crucial in eradicating the depression, and monetary policy in accelerating the recovery before war.

A Documentary About The Great Depression

                                                        (Source: Youtube.com)

1930s Great Depression: Why things went wrong

The reasons as to why crises occur are not always clear but more often it constitutes a chain of causes, rather than a single blunder to be at the root. Wall street crash of 1929 is blamed by many to be the igniting factor but the exact cause of Great Depression is still blurry.View on cause vary from people to people. Historians justify share market crash & bank failures to be the reason because of which US plunged into a dark economy. This downturn in US economy knocked down other countries and created a global havoc. But economists believe share market collapse was the indicator rather than the destroyer.

                                      
               (Source: http://www.sharehunter.com/news/tag/1929-wall-street-crash/)

They blame US Federal Reserve for their inaction. They argued that the Federal failed to supply money and bail out banks, especially the New York Bank of United States.This created a domino effect & was spread into series of bank panics and runs.

                                        (Source: http://learnhowtobeprepared.com) 

Milton Friedman & Ben Bernanke also argued that the Great Depression was result of the monetary contraction; the stringent regulation of Federal Reserve Act and the gold standard which limited the issue of notes, as the possession of gold by Federal Reserve were not enough that was required to issue Federal Reserve notes. The government also contributed in stretching the depression, by introduction of Smoot-Hawley Tariff Act, which worsened the situation.  The Act increased tariffs on US imports. This resulted in retaliatory tariffs by other countries and plummet in international trade. Indebtedness and deflation was also held responsible to aggravate the situation.Therefore, the plunge in share trading was backed up by many other contributing factors to smooth its way from recession to a great depression.

History Repeats itself

  (Source:http://microfinancehub.com/2010/02/20/impact-microfinance-surviving-economic-crisis)

It is not that the financial world has stumbled now; it has been grasped by many such predicaments even before.The financial breakdown in countries can be found in the history since 16^th century, when the concept of banks was not popular & goldsmiths used to issue promissory notes. However, some people argue the occurrence of these crises to be more fatal after the establishment of banks were regarded dominant factor in rising economy. Even Prof Rodrigue Tremblay writes: "Banking Establishments Are More Dangerous Than Standing Armies" Thomas Jefferson (1743-1826), 3rd US President.
Examples of some crises are the Dutch Tulip manias (1634-1637), the British South Sea Bubble (1717-1719), the French Mississippi Company (1717-1720), the post-Napoleonic depression (1815–1830) and the Great Depression (1929–1939). Among all of these crises through years, it is 1930’s Great Depression in U.S. which almost handicapped the whole world’s economy. The great depression commenced its journey with the stock market crash in 1929 and kept going with bank runs, panics, plummet in production, consumption, economical breakdown and recessions, back to back. It felt like the U.S economy has gone into a mood of having a roller-coaster ride, leaving the government, monetarists & economist with no gadget to stop the ride. Finally with many hit-&-miss plans, they managed to put an end to this chapter and emerged as a powerful economy. This horrendous episode in US prompted the world-wide government to introduce various Reforms, Acts and Revolutionization in financial system to abate any future crises. They were confident enough of their precautionary methods and thought no recession can haunt them again. The confidence gradually matured into over-confidence, paving way for another disaster. The appearance of 2007 Great Recession was the result of over-confidence and negligence of past lessons. Thus it can be stated “Those who do not learn from history are doomed to repeat it.” With speculation going around that we are headed for a tougher time ahead, and the great recession may turn into second great depression, only one question pops out. Is the savior of 1930 depression reusable to get out of this difficult time?

To find an answer to this, we need to go back in history and search for the causes and battle weapons of the 1930s great depression.

(Some of the information has been obtained from wikipedia & other relevant articles)