Even the Great Depression had green shoots We will repeat the 1930s if we stop the stimulus too soon
First published in the Telegraph on 9 April 2009
What does a Great Depression feel like? Everyone has seen the pictures of the breadlines and the starving families in the American Dust Bowl; everyone knows about the deprivation, the suicides and the despondency. Today doesn’t feel like the 1930s. But here’s the thing: neither, at first, did the 1930s.
The worst economic slide in modern history did not happen in one fell swoop. It evolved over a number of years, growing organically and almost imperceptibly. It was punctuated with moments of optimism, months where things seemed tantalisingly to be improving – genuine green shoots.
Few springs were sweeter than that of 1931. After 18 months of bad news, those shoots appeared to be sprouting everywhere. Industrial production in the United States was recovering, and for the first time in months the stock market was buoyant.
The parallels between then and now are striking. Economies were still shuddering in the wake of a catastrophic financial and stock market collapse (in that instance, the Great Crash of 1929); unemployment was rising as fast as economic growth was plunging; world trade was in freefall. The statistics were horrendous. Yet there were enough signs to suggest that the recession would, like so many before it, be over relatively quickly. And all the while, at the back of people’s minds, was the risk of inflation.
There were some governments that had endured nasty bouts of inflation and were determined not to do so again (the American, French and Germans). At the first sign of recovery, they argued in favour of withdrawing the stimulus that had been put in place; that is when the seeds of the true depression were laid.
Painful as the German episode of 1920s hyperinflation was, it was as nothing compared with the hyper-deflation that ensued in the 1930s. It was deflation that caused the deprivation which helped brew up Nazism. We are in danger of forgetting that.
Those early years of what we now call the Great Depression were where the real mistakes were made, and they were made precisely because governments started to anticipate recovery far too early. It is a perennial error. The horrors of inflation are branded so deep into our collective global consciousness that, in the wake of an economic collapse, we are apt to try to fight it off before it has arrived. It is what happened in the 1930s; and again in the 1990s when the Bank of Japan withdrew its fiscal and monetary medicine too early, consigning the world’s second-largest economy to five more years of stagnation.
History is in danger of repeating itself. So unrelenting has been the flow of bad news for 18 months that we are in danger of mistaking a few recent signs of stabilisation for genuine recovery. They are not. House prices are not falling as fast or as steadily as they have been for the past two years, but they are not bottoming out; inflation may have picked up a touch last month, but it won’t be shaken from its downward path for long; economic growth and stock market prices may appear to be recovering, but this is more likely to be the result of companies running down inventories.
In 1931, spring gave way to a terrifying summer as swathes of US banks collapsed, leaving millions bereft of savings; Credit Anstalt in Austria imploded and triggered the onset of European economic misery. Months later, about a thousand British sailors took part in the Invergordon Mutiny – one of the few strikes involving the Armed Forces – and triggered our departure from the Gold Standard.
It is hard to express the fragility of the economic and financial system; any hint of complacency would be foolhardy. On the one hand, governments have done far more than those 75 years ago to prevent their economies from sliding into permafrost. A $5 trillion wall of money has been thrown at the crisis. It will soon start working, dragging us away from the precipice. State-funded social welfare systems mean that, as nasty as the downturn will be, destitution will be far less common.
On the other hand, this stimulus could easily be withdrawn as governments baulk at the size of the deficits they are running up. They might start to raise interest rates too early (while inflation will be a threat in a few years, it is not the most immediate danger). The second banking bail-outs on both sides of the Atlantic are half-baked schemes which neither dispose of the impaired assets nor cleanse the banks that hold them. Further horrors almost certainly lie dormant in the depths of the financial system, with much of the toxic waste still unaccounted for.
It is remarkable – though, upon reflection, hardly surprising – that we have let a couple of pieces of better-than-expected economic news distract us from the financial meltdown that is still unfolding. But consider: should another British bank stumble – or an insurance company or pension fund – the Government may have to pour more taxpayers’ cash in or contemplate outright default.
In the face of such a financial firestorm, the eventual recovery may not be V-shaped, or even L-shaped, but IMF-shaped.