Saturday, November 22, 2008

The Difference Between Now and the Early 1930s

Bad Monetary Policy is Not Being Made Worse

A few people have been asking Workers about the economy now compared to the 1930s and the Great Depression and what to expect in the moments ahead. So here is the short answer.

First off, both the Great Contraction of 1929 - 1933 and today's start of a recessionary period were both at least partly (mostly) caused by bad monetary policy. The Fed inflated money in the late 1920s and popped the bubble in 1928 by stopping the monetary expansion and raising interest rates. The Fed inflated the money and kept rates too low from 2002-2005 this time around. So this is what is similar between now and then.

The stock market bubble in the 1920s USA was in part caused by a new retail class of investors, made possible by the introduction of war bonds for US participation in WWI. So another similarity is that the bubble in the housing market today, like that of the 1920s, was cause by government distortions in the demand for financial instruments. (Today's bubble of course was supported by the Fan and Fred 100% guarantees of housing mortgages and the ability to write the interest payments on these mortgages off on taxes).

Between the distortionary public policy skewing investment and the bad price signals sent by the Fed inflating resources into these skewed sectors, in both periods too capital investment was made in places which were unsustainable.

But at least today, unlike in the early 1930s, the Fed is not keeping interest rates above what might be a natural rate of interest and we do not have fixed exchange rates based on the Gold Standard like we did in the 1930s. The Fed not making a bad situation worse now means that hopefully recovery can be quicker in the US, and international growth can recover more quickly absent fixed exchange rates.

Another similarity between now and then is that bad assets aren't being allowed to be cleansed from the system and government is directing in part the flow of (or preventing the flow) of financial resources. Today we have the big bailouts and the Fed negotiating marriages of failed banks. In the 1920s we had Hoover's Reconstruction Finance Corporation (RFC) mucking around in the market preventing solid sustainable entrepreneurial investment. FDR then used the RFC for all kinds of central planning and unsustainable (unemployment causing) investment when he took office after Hoover.

Another unfortunate similarity between now and then is that our new new President to be feels the need to make government jobs with a ' vast stimulus package ' and do other types of central planning like FDR did when he took office. And as we all know, those that study history anyway, FDR's New Deal expanded a monetary-created contraction into a government-created Depression with long-term high unemployment that only a ramp-up in military spending was able to curtail. To paraphrase Karl Marx, 'history repeats itself as farce'.