Download Then … and Now – Let`s Not make the Same Mistakes

Then … and Now – Let’s Not Make the Same Mistakes
The similarities between the Great Depression and now are striking. Let’s not make the
same policy mistakes.
In the 1920s the U.S. experienced rapid economic growth and rising living standards.
Since 1995 the U.S. has enjoyed rapid growth and rising living standards.
Then the farming sector did not share in the wealth due to renewed competition from
Europe after the war.
Now less educated workers work for low wages due to competition from developing
nations.
In the 1920s a Florida real estate boom was followed by a stock market bubble. Both
burst.
In the past decade a real estate bubble followed a stock market boom. Both burst.
A mild economic downturn began in August 1929.
A mild economic downturn began in December 2007.
The 1929-1933 U.S. contraction spread to other major economies.
The 2008 U.S. recession is spreading around the globe.
Then, many families lost their homes in the economic contraction.
Now, households are losing homes from the sub-prime mortgage crisis.
From 1930 through 1933 a series of bank runs greatly increased the severity of the
economic contraction.
In 2008 the sub-prime mortgage crisis involving commercial and investment banks
increased the severity of the recession.
Then, extensive financial regulations were enacted in the wake of the financial crisis.
Now, expanded financial regulation is anticipated in the aftermath of the financial crisis.
In 1931 the head of the Federal Reserve Board wanted help to assist troubled banks,
resulting in the creation of the Reconstruction Finance Corporation, funded by the
Treasury.
In 2008 the head of the Federal Reserve Board sought help assisting troubled financial
institutions, leading to the creation of the Troubled Asset Relief Program, funded by the
Treasury.
In 1932 the Federal Reserve injected a large amount of money into the economy. The
policy was criticized in the press as a failure because cautious banks did not make loans.
In 2008 the Federal Reserve is greatly increasing its balance sheet, injecting new money
into the economy. The policy has been labeled a failure because fearful banks resist
lending.
Until March 1933 the value of the dollar was fixed in terms of gold and foreign
currencies. At crucial junctures in 1931 and 1932 the Federal Reserve reversed its
expansionary policies, raising interest rates and stopping the increase of the money
supply to preserve the fixed dollar price of gold, exacerbation the contraction.
In 2008 the value of the dollar floats relative to gold and major currencies. The Fed
recently lowered its target interest rate to the absolute minimum and committed to
continue to inject money into the economy. Critics of these policies worry about
inflation and cite the depreciation of the dollar and jump in the price of gold as evidence
that the policy is incorrect.
Worrying now about inflation, the price of gold and the value of the dollar would repeat
the mistakes of 1931 and 1932.
During the 1930s crisis, people hoarded currency, and later gold.
When the crisis began last fall, there was no rush to gold. Individuals and institutions
around the world rushed to the asset they felt the safest, U.S. Treasury securities. During
the liquidity crisis the dollar appreciated, even though low U.S. interest rates should have
driven money away from dollar assets. And the dollar price of gold fell. In a crisis
people today prefer dollars to gold.
The fact that the Fed’s latest interest rate cut and promise to inject more money into the
economy have resulted in dollar depreciation and rising gold prices is a welcome sign.
Prices are working again. Money is flowing to higher returns. The panic is over, at least
for now.
Once a recovery is in progress, the Fed will need to withdraw some of its newly created
money. But it is better to face that challenge than to repeat the mistakes of the 1930s.
James L. Butkiewicz
Professor of Economics
University of Delaware