Learning from the Great Depression

By Robert Samuelson

 

What is striking about the latest bouts of financial turmoil — the recent wild swings in global stock and bond markets — is that they provide a sobering reminder of the potential hazards of economic instability. There are parallels between the present tumultuous situation and past episodes of economic disruption, including the Great Depression of the 1930s.

Just for the record: This is not a forecast of another Depression, when annual U.S. unemployment peaked at about 25% in 1933. For the moment, we are not anywhere near that level of distress. Still, if a deeper crisis ensues, President Trump’s strident economic nationalism will be partially blamed, because he ignored the lessons of history.

The name that comes to mind is Charles Kindleberger, an eminent economic historian of the post-World War II era who taught for years at the Massachusetts Institute of Technology and was a prolific author of books and articles. One of his masterpieces was “The World in Depression, 1929-1939.”

The crux of Kindleberger’s thesis was that the underlying cause of the Depression was a vacuum of leadership. By this, he meant that Great Britain — which had provided that leadership in the 19th century — had been so weakened by World War I that it could no longer perform that function in the 1920s and early 1930s. Meanwhile, the United States — which would fill that role after World War II — was not ready to do so.

In this context, the dominant country would keep its markets open to imports, so the trading system would not collapse under the weight of mounting protectionism. Another requirement was that the leading country (the “hegemon”) had to have the financial strength so that it could lend to banks and other needy borrowers during a crisis so that the financial system, the repository of much wealth, would not self-destruct.

In the recent foreword of the latest version of Kindleberger’s book, economists J. Bradford DeLong and Barry Eichengreen of the University of California, Berkeley put it this way:

“The root of Europe’s and the world’s problems was the absence of a benevolent hegemon: a dominant economic power able and willing to take the interests of smaller powers and the operation of the larger international system into account by stabilizing the flow of spending through the global [economy] … by acting as a lender and consumer of last resort.”

Kindleberger’s own explanation is similar:

“The 1929 depression was so wide, so deep and so long because the international economic system was rendered unstable. … When every country turned to protect its national private interest, the world’s public interest went down the drain, and with it the private interests of all.”

Flash forward. Look around. Leadership is conspicuous by its absence. Nations pursue their self-identified private interests. The United States and China — the world’s two largest economies — are engaged in a bitter trade war that hurts both countries. The British are poised to leave the European Union (Brexit), with what consequences no one knows. At home, the Federal Reserve is under relentless assault by Trump, making its job doubly difficult, even granting that the best monetary policy is a legitimate subject of debate and disagreement.

What about Germany, Europe’s traditional powerhouse? In the past year, its industrial production is down about 5%, says economist Desmond Lachman of the American Enterprise Institute. If Germany does not change its “rigid policy view on the need to balance their budget under all circumstances, both Germany and Europe should brace themselves for a hard economic landing,” he argues.

Economic leadership is a two-step process, each difficult. First, you must conceptualize the nature of the crisis; then you must devise and implement remedies that prevent it from worsening.

In the 2007-09 financial crisis, that is what happened. The administrations of George W. Bush and Barack Obama recognized that the financial system might collapse, as panicked depositors and investors withdrew their funds. The remedy, organized on a global scale, was to pump money into the system until confidence returned.

Trump officials don’t seem to think Kindleberger matters. Their pursuit of “greatness” may prove self-destructive. The good news is that the financial system is stronger now, meaning it has more capital to absorb losses, than in 2008. The bad news is that private debt levels in many countries, including the United States and China, are high. If too many borrowers default, losses may still cripple the financial system.

There’s the old cliché that those who don’t remember history are condemned to repeat it. Let’s hope that’s not true this time.

 

(c) 2019, The Washington Post Writers Group