Economics is a behavioral science and given present market conditions retailers are predicting gloomy holiday sales. The country is in a steep recession and, numerically, the confirming indicators are alarming. In truth the economy is at a tipping point, between a painful but manageable recession and a seriously deflationary depression. After 16 months of financial collapse, former Federal Reserve Chairman Alan Greenspan has admitted his assumptions were flawed. Fortunately Greenspan’s 2006 successor, macroeconomist Ben Bernanke is a longtime student of the Great Depression.
A recession is defined as an economic slump. Big recessions usually follow the collapse of an asset market boom like Dutch tulips [1600s], gold, or mortgage securities. Typically a recession is characterized by high rates of unemployment, idle industrial capacity, and declining per capita incomes. Alternatively a depression is a phase in the business cycle which includes widespread unemployment, underutilization of industrial capacity; little investment and consumer optimism.
Said Bernanke in his Essays on the Great Depression, “I have enjoyed studying the Great Depression because it is a fascinating event at a pivotal time in modern history…the [1930s] provide a marvelous laboratory for studying the link between economic policies and institutions on the one hand and economic performance on the other.”
Is there a connection between the economy of the 1930s and the super charged information age economy we have now? Yes. Just look at the current economic headlines: high unemployment, failing banks, volatile financial markets, currency crises, and even deflation.
“The Depression was an incredibly dramatic episode – an era of stock market crashes, bread lines, bank runs, and wild currency speculations, with the storm clouds of war gathering all the while,” Bernanke wrote. “The issues raised by the Depression, and its lessons, are still relevant today.”
“To understand the Great Depression is the Holy Grail of macroeconomics,” Bernanke continued. “Not only did the Great Depression give birth to macroeconomics as a distinct field of study, but also – to the extent that is not always fully appreciated – the experience of the 1930s continues to influence macroeconomists’ beliefs, policy recommendations, and research agendas.”
Bottom line, we Americans enter the holiday season in a big recession. The problem will not solve itself soon, or until the housing market stabilizes at a lower equilibrium. The sub-prime sector continues to complicate, affecting both banks and their lending practices for the foreseeable future. The credit crisis is serious so think twice before using credit cards to pay the holiday bills.
America’s first major financial crisis was the Panic of 1819. In part the Panic was an outgrowth of the economic calamities associated with the War of 1812. An indebted government was short on specie (metal coin) which resulted in a monetary contraction. A credit crisis ensued and an earlier agricultural boom went bust. The postwar economy was marked by an agricultural and manufacturing slump; widespread foreclosures, bank failures and urban unemployment.
“The depression had a direct impact on the government in that it produced a drastic decline in revenues, which were largely derived from customs duties,” Harry Ammon wrote. “There was also a marked decrease in the income from the sale of public lands, for many purchasers now defaulted.” President Monroe’s solution: to “obliquely recommend” passage of a higher protective tariff. A tariff is a tax imposed on imports.
Today’s US Federal Reserve System was born of the Panic of 1907. The Panic was caused by the 1906 San Francisco earthquake, shifting collateral and bad stock schemes, and the collapse of New York’s Knickerbocker Trust Company. President Andrew Jackson in 1836 allowed the Second Bank of the United States to expire. In the absence of a central bank, the federal government had no mechanism for responding to the ensuing liquidity crisis. Liquidity is the convertibility of an asset into cash.
“Following two earlier failed attempts, President [Woodrow] Wilson made the establishment of a Federal Reserve one of his early legislative priorities, signing the Federal Reserve Act into law in December 1913,” Bernanke explained. “Wilson helped to negotiate the complex political compromises that finally gave the nation a permanent central bank.”
“Earlier attempts to stabilize US monetary arrangements had frequently been roiled by perceived conflicts of interest: between the farmers and tradespeople of Main Street who believed that they were most advantaged by policies of easy credit, and the financial barons of Wall Street who, as creditors and bondholders, preferred hard money or low inflation policies,” Bernanke concluded.
Initially the Federal Reserve was to provide “an elastic currency” able to fluctuate with seasonal credit demands. Since 1977 the Federal Reserve has operated with three major responsibilities: maximum employment, stable prices, and moderate long-term interest rates. According to Bernanke price stability and maximum employment are mostly complementary.
In an attempt to manage today’s financial conundrum – in addition to existing Federal Reserve policies – Congress has passed the Troubled Asset Relief Program, in essence a $700 billion bailout package targeted to the securities industry. When measured in current dollars, the Program dwarfs history. And now President-elect Obama wants to repay his political debt by including the auto industry in the package.
Responsibility for the current economic chaos belongs to Congressional partisans of both political parties. “How did we get here?” asked Senator Byron Dorgan (D-ND). “In 1999 when Congress debated a large deregulation bill titled the Financial Modernization Act…I warned…that ‘this bill will also raise the likelihood of future massive taxpayer bailouts.’ I wish I had been wrong!”
“Nine years later we are considering a ‘massive taxpayer bailout’ plan that provides no regulation of the hedge funds and derivative trading that has caused much of the financial wreckage in our economy,” Dorgan continued. “The plan also fails to restore the protections [protections resulting from the Great Depression] that were removed in the Financial Modernization Act, especially those which separate FDIC insured bank operations from risky speculative investments [like] real estate and securities.” The ability of banks to operate in unregulated markets, to avoid regulatory oversight must end.
Ours is a global economy. The economic role of the United States is diminishing so as the world’s G-20 meet to discuss such issues as financial accountability ask. Was Ebenezer Scrooge wholly wrong regarding matters of money? May all enjoy genuine prosperity in 2009, as well as A Christmas Carol of the Charles Dickens or other type this holiday season.

 

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