As the election nears I’m sure my blog entries will focus on the politics of the McCain-Obama race quite a bit in the next two weeks. But today I want to reflect on the issue that will be with us no matter who wins: the financial crisis and the possibility of a deep recession, or even a depression.
I recently re-read the book The Great Crash of 1929, a 1954 classic by John Kenneth Galbraith. The book is very readable, and describes the crash and its aftermath in dramatic detail, making personalities come alive, and describing the culture and mood of the country well. While that crisis was in many ways quite different than the one we face now, there are numerous similarities. The most obvious one is how oblivious so many people were to the clear imbalances in the economy, and the irrationality of the speculative bubble. In 1929 only the New York Times consistently kept up the drumbeat of expecting a crash and reporting that stock market bubble was unsustainable. Other Cassandras became weighted down by being wrong so often when the stock market and the economy kept growing that they embraced the conventional wisdom: the economy was strong, this was a new era, and the naysayers were just “gloom and doom” pessimists who didn’t understand how markets work. The big shots – the movers, shakers and pundits – gave every reason to believe that things were good and would only get better.
That has been the case this time too. The pundits, economic leaders, and main investment banks were convinced, and convinced average folk, that this was prosperity to last. No recession on the horizon (or perhaps just a small one) and we’re in a new era. While The Economists and a few Cassandras remained unconvinced, they were on the margins, ridiculed especially by the conservative pundits who accused the cynics of “talking down” the economy.
However, the book really strikes paydirt when it lists the five reasons Galbraith finds for why the Great Depression occurred after the stockmarket crash:
1. A bad distribution of income, with too much wealth concentrated in the extremely rich. 2008: Arguably the situation in 2008 is worse than it was in the late 20s. While we lack the breadth of the underclass of the pre-New Deal era, the concentration of wealth has been consistently becoming more warped from about 1980 on. The Clinton years were as bad as the Bush years in that regard, it was a bi-partisan maldistribution of wealth. That creates imbalances throughout the economy which can make a real depression likely. It is, bottom line, necessary to spread the wealth better. That isn’t socialism, that’s recognizing that a warped distribution of wealth leads to economic crisis.
2. The bad corporate structure. The similarities between 1929 and 2008 are immense here. High CEO salaries and corporate inside deals have dominated, especially as it appears economic growth was endless and the corporate leaders could do no wrong. Whether it’s health insurance companies putting profits ahead of health care, Enron like debacles, or just the general mismanagement now coming to light as corporate structures are put under extreme stress, it’s clear that corporations were accountable to no one, and had (no doubt still have) embedded corruption.
3. The bad banking structure. Well, this is obvious, given the scope of the credit crisis, the mortgage backed securities, and the way that intra-bank lending dried up in light of the current crisis. A banking structure built on a sound foundation doesn’t require a bailout of about $1 trillion. Simply, it was, as in 1929, predicated on a belief the economy would continue to grow and people would continue to borrow at the same rates. That was never a realistic assumption.
4. The dubious state of the foreign balance. Anyone reading my blog knows that I go on ad nauseum about the danger of the high current accounts deficit the US has been building from 1981 onward. I won’t go into the litany of problems I’ve noted there (here is a link to a post containing links to what I’ve written about the economy since May, when I started this blog); suffice it to say the situation in 2008 was probably worse than that of 1929.
5. The poor state of economic intelligence. That also clearly has been on parade in 2008, given how unprepared people were for the crisis, and how unsteady the political reaction has been. It would be a mistake to think they are on top of things now.
One other thing comparable between then and now is that directly after the crisis became known, for over a year in 1929-30 almost all the economic pundits and leaders were convinced that it would be a short recession, and not a depression. They consistently predicted growth would return within a year or so, and were reassuring in making it sound like it had simply been a speculation crisis, not one threatening the economic fundamentals. But then, as now, it’s the fundamentals which are out of whack. I still think, as I argued in Another Great Depression, that while we are facing extreme economic problems in the coming decade, it won’t be the same kind of depression. Yet I believe more people are underestimating the scope of the current crisis than overestimating it.