“That 30s show”

The Economist has a “special” on “Lessons of the 1930´s”:

“YOU’RE right, we did it,” Ben Bernanke told Milton Friedman in a speech celebrating the Nobel laureate’s 90th birthday in 2002. He was referring to Mr Friedman’s conclusion that central bankers were responsible for much of the suffering in the Depression. “But thanks to you,” the future chairman of the Federal Reserve continued, “we won’t do it again.” Nine years later Mr Bernanke’s peers are congratulating themselves for delivering on that promise. “We prevented a Great Depression,” the Bank of England’s governor, Mervyn King, told the Daily Telegraph in March this year.

Maybe they did manage to take away the “Great” out of the “Depression”, but were still left with one. What is interesting is that four years since the recession that turned into a “great recession” that morphed into a “depression” began; the 1930´s is still the “paradigm”!

Apparently the “lessons” were not all learned. But the Economist is more sanguine:

The shock that hit the world economy in 2008 was on a par with that which launched the Depression. In the 12 months following the economic peak in 2008, industrial production fell by as much as it did in the first year of the Depression. Equity prices and global trade fell more. Yet this time no depression followed. Although world industrial output dropped by 13% from peak to trough in what was definitely a deep recession, it fell by nearly 40% in the 1930s. American and European unemployment rates rose to barely more than 10% in the recent crisis; they are estimated to have topped 25% in the 1930s. This remarkable difference in outcomes owes a lot to lessons learned from the Depression.

Let´s define it this way: In a recession you recede (and then begin the trip back, with the recession ending when the “trip back” to where you should be if you hadn´t “receded” begins). In a depression you first recede and then stay “depressed”, i.e. you don´t travel back to where you should be. Where´s that? It´s the trend path you deviated from.

Looking at the world industrial production and world trade indices, it seems “we gave up” trying to get where we should be around the summer of 2010.

During the “Great Depression”, beginning in March 1933 industrial production, which had “deviated” from trend by a large margin, began the “journey back”. After being “interrupted” by N.I.R.A. between July 1933 and May 1935, by May 1937 it was “almost there”, but economic policy turned contractionary again…

And the Economist proceeds:

A more common view among economists, however, is that the simultaneous tightening of fiscal and monetary policy turned a tough situation into an awful one. Governments made no such mistake this time round. Where leaders slashed budgets and central banks raised rates in the 1930s, policy was almost uniformly expansionary after the crash of 2008. Where international co-operation fell apart during the Depression, leading to currency wars and protectionism, leaders hung together in 2008 and 2009. Sir Mervyn has a point.

I “smell a rat”.  How come policy, especially monetary policy, can be considered “almost uniformly expansionary after the crash of 2008”? If it really had been so we would not be “depressed”. Take a look at the charts for the US, EZ (ex Germany) and Brazil (maybe not be representative of emerging markets in general, in particular those in Asia). All are “depressed”, although to be fair Brazil did not initially “fall off a cliff”.

And as the world trade chart above indicates, trade activity is pretty “depressed” and it´s not as if over the past year we haven´t heard talk about “currency wars” and protectionist moves. And then you have the possible (or even likely) “break-up of the EU and the “slow march to the slaughter house” of the “periphery countries” prodded by the adoption of legally binding budgetary “golden rules”.

It´s a “depressing read”, but the Economist conjectures about “where this path leads”:

As panic built in 1931, country after country faced capital flight. The effort to defend against bank and currency runs prompted rounds of austerity and plummeting money supplies in pressured economies, helping generate the collapse in output and employment that turned a nasty downturn into a Depression. It took the end of the gold standard, which freed central banks to expand the money supply and reflate their economies, to spark recovery. Today the ECB has the tools needed to salvage the situation without breaking up the euro. But the fact that the ECB and euro-zone governments have options does not mean that they will take them.

And tries, unsuccessfully, to end with a guarded “positive spin”:

The situation is not yet beyond repair. But the task of repairing it grows harder the longer it is delayed. The lessons of the 1930s spared the world a lot of economic pain after the shock of the 2008 financial crisis. It is not too late to recall other critical lessons of the Depression. Ignore them, and history may well repeat itself.

Unfortunately it seems it already is!

Update: This Munchau piece at the FT is good:

Remember what everybody said a week ago? To solve the crisis, the eurozone requires, in the long run, a fiscal union with a prospect of a eurozone bond and, in the short run, unlimited sovereign bond market support by the European Central Bank. What we now have is no treaty change, no eurozone bond and no increase either in the rescue fund or in ECB support.

Policy changes the ECB announced last week will help banks directly and governments indirectly. But the EU fell short on every element of a comprehensive deal. On Friday, investors reacted positively to what was sold to them as a “fiscal compact”. But once the implications of a separate treaty are understood, I fear disillusionment will set in.

Last week, Europe’s leaders created a diversion. We will be talking about the UK for a while. The crisis, meanwhile, goes on.