The global economy echoes 1930s Great Depression

Protectionism, shaky debt, and weak banking systems have consequences

Getty Images/Keystone/Staff

One view of what caused the Great Depression in the 1930s is that the Federal Reserve failed to prevent a collapse in the money supply.

This is the famous thesis of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, 1867-1960, and it was, more or less, the view of Ben Bernanke when he was chairman of the Federal Reserve.

The global economy today resembles that of the 1930s in several ominous ways.

Financial author Edward Chancellor recently called attention to a paper written by Caludio Borio, head economist at the Bank of International Settlements, that provides a fuller picture of the causes of the Great Depression. The paper also draws parallels between global economic conditions that led to the rise of protectionism in the 1930s and our situation now.

The paper’s thesis is that “financial elasticity” characterizes both the pre-Depression global economy and today’s global economy.  Elasticity refers to the buildup of capital imbalances such as money flows into emerging markets because of low rates in developed markets.

Free flowing capital to emerging markets

As Chancellor tells it, the gold exchange standard established in the 1920s allowed U.S. and U.K. bonds to be used together with gold in exchange transactions among central banks. This arrangement encouraged growth in foreign lending.

Specifically, the U.S. lent money to emerging markets in Latin America and Central Europe. Investors in the U.S. enjoyed higher returns for seemingly little extra risk as defaults were initially low.

However, lending standards began to loosen, and American investors brought their dollars home after the Fed hiked rates in 1928. Money flowed into U.S. stocks, among other things, which, of course were poised for a crash.

Capital flow reversal

This reversal of capital flows, combined with a drop in commodity prices, destabilized the emerging markets by 1929, sending their commodity producers into bankruptcy. In 1930, several South American countries devalued their currencies and defaulted on their debt.

The crisis spread to Austria, Germany, and eventually to Britain, a heavy lender to Central Europe. Britain eventually devalued its currency, but in the U.S. the Fed actually raised rates in late 1931 to stem gold outflows. A banking panic ensued, as the U.S. finally “felt the full force of the world depression,” according to Chancellor.

The result of these debt problems was the institution of capital controls. Capital no longer flowed freely among countries. International trade slowed due to tariffs, and foreign debts were not repaid. Economist John Maynard Keynes himself favored the move away from globalization, and Chancellor quotes him as writing, “Let goods be homespun, and, above all, let finance be primarily national.”

Today’s similarities with the 1930s

Now, as in the 1930s, the global economy is stretched. A low interest-rate regime in the developed world has encouraged lending to emerging markets. Additionally, China’s and Europe’s banking systems are burdened with bad debts.

Moreover, last year, as Chancellor reports, emerging markets experienced their first capital outflows in nearly three decades, and that movement of capital appears to be continuing in 2016. Ratings agencies have downgraded South Africa and Brazil sovereign debt, while commodity prices continue to plunge.

Protectionism is in the air with the European Union and the U.S. imposing tariffs on Chinese steel. Also, anti-immigration sentiment is rising.

Although the additional restrictions imposed by a gold standard don’t exist today, the peg of Chinese yuan to the U.S. dollar DXY, -0.26%  is unsustainable in Chancellor’s opinion, as may be the euro EURUSD, +0.1980%

So much elasticity or the buildup of imbalances can be painful during the process of restoring balance. Therefore, regarding monetary policy, it’s important, according to Borio, to lean “against the build-up of financial imbalances even if near-term inflation remains low and stable.”

Borio’s paper was written in August 2014, so it’s difficult to know what advice he’d have for the Federal Reserve today. But in his paper, he notes that the imbalances that low rates and elasticity produce may “return us to the modern-day equivalent of the divisive competitive devaluations of the interwar years; and, ultimately, [trigger] an epoch-defining seismic rupture in policy regimes, back to an era of trade and financial protectionism and, possibly, stagnation combined with inflation.”

MarketWatch

5 Comments on "The global economy echoes 1930s Great Depression"

makati1 on Fri, 19th Feb 2016 7:53 pm 



The Federal Reserve seems to be very successful at their real goal of destroying the Us economy and your income. All of the Central Banks are playing the same game, called: “Take Down”. One World Government vs Climate Change. The race is on. My bet is on Mother Nature having the last say. Wait and see.

In the middle on Fri, 19th Feb 2016 9:14 pm 



The federal reserve is doing what it does best.. Creating just enough stock in the economy so that everyone has a stake and ensuring liquidity so markets can continue operating even in panic mode. The balance is somewhere between fear and greed and it’s never been nor will ever be in perfect balance. Liquidity is for the fearful as well as the greedy, but the smartest of the two will end up the wealthiest.

Northwest Resident on Sat, 20th Feb 2016 2:32 am 



The global economy is in severe crisis. Governments and central banks around the world are taking concerted action to delay and mitigate oncoming economic collapse, but their actions are beginning to take on the appearance of desperation. The tricks that used to work so well are all played out — those delaying tactics were bound to lose their potency with repeated use. Investors are losing confidence. Uncertainty and fear are in the air. The masses begin to get the feeling that something is really wrong in this world as thousands lose their jobs daily and trade and commerce continue their extended plunge downward. Rumors of war in the ME only increase nervous sentiment. Investors have already lost $trillions in “wealth” this year, and they are starting to take their money and run — $5.7 billion outflows from US-based stocks just last week. The spring is coiled tight and when it finally unwinds in a violent burst of energy, we all better be ready.

Davy on Sat, 20th Feb 2016 7:30 am 



Trying to understand the global problems today in relation to the 20th century is not valid anymore except with some of the lessor details. Looking at today’s issues with 20th century economic analysis is just inviting us to continue with the same irrational policies that are creating more dysfunction. Global central banker’s decisions to take the global economy into Zirp, Nirp and QE is an example. China’s huge credit and physical development growth is another.

What is happening now is much more in a world that is vastly different at almost every level. We are now a complex global world at limits of growth with a population in overshoot. That population in overshoot is in over shoot for quantitative reasons of numbers but also just as dangerous with qualitative reasons from consumption requirements for support. Too many people along with a significant amount of those “too many people” relying on our complex global world for the basics of survival.

We now have a complex global world economy along with its absolutely vital “foundational commodity” oil both in demand destruction. This is an economic compression destroying demand which will destroy supply and economic networks. The supply of high quality oil has declined. Our 20th century way of life was built on the economics of plentiful higher quality oil. Our 20th century civilization is increasingly unworkable in the 21st century because of demand compression. Our wants of developing a 21century world is likewise confronted by limits. An energy transition is likely not possible in scale of time nor economics. On the economy side of the equation our financial system has grown outsized and has become parasitic. That financial system has become a bubble in a global economy that is itself a bubble. That bubble with all its malinvestment, overcapacity, and irrational development is now surfacing as nonperforming loans and assets. This is a huge deflationary event that is compressing the rate of growth which is all important to our hyper complex and dynamic global economy.

This is deeper than economics with symptoms of existential collapse with limits restricting our growth and our ability to solve macro problems. It is deeper because of a population many times past normal carrying capacity even in relation to the 1930’s. This is deeper than economics because it is about demand destruction of not only from economic problems but also resource problems. High quality resources are in decline. The ecosystem and waste stream is dangerously destabilized now. This ecological factor is not yet extreme but it is certainly close.

It is the combination of so many problems converging in negative reinforcement that is driving us into dangerous territory. We are in territory like man has never been in with global locals delocalized from decades of efficiency efforts of globalization. This globalization was economic and partly social but on the political side we are still stuck in an earlier time. We have a vacuum from the rapid decline of American dominance. We have a dangerous multipolar world polarizing under the stress of global problems armed to the teeth with sophisticate weapons with global reach. Globalism is polarizing at a time of vital need for cooperation because we can no longer decouple economically without collapsing.

The 1930’s was an economic event without the delocalization of globalism and overpopulation of 21st century. We survived demand destruction without much trouble then. We will likely not survive such a drop this time and remain as we are now with globalism intact. Without globalism there is no way we can feed almost 7BIL people. Our food system has been globalized just like the rest of the edifice.

Death at a macro level with all its disruptive qualities is very disruptive to complexity and growth. Death at a macro level with its corresponding declining population is by definition not growth. You cannot grow our type of global system while people are dying more than are being born. This is existential demand destruction with a corresponding decay of all aspects of our global system both hard assets and soft assets like vital knowledge that supports vital complexity.

This can’t end well. We are not there yet. We are still in aggregate growth maybe not healthy but still satisfactory to avoid collapse. This predicament is subtle. Globalism is all or nothing which makes it very dangerous because the whole high performance machine could size up at any time for multiple diverse reasons. We have no plan B’s especially for delivery of vital food and fuel. Cities are too large with many poorly placed geographically for sustainability. We have a macro situation of multiple predicaments in a fog of catch 22’s. In such a systematic situation we must break to a lower level by definition. The problem for all of us is when and how hard. There is no way to know these answers.

onlooker on Sat, 20th Feb 2016 9:47 am 



Here is a great article you might find interesting on how the Federal Reserve from 2008 onward has chosen to save the Banks at the expense of the real Economy. http://www.nakedcapitalism.com/2016/02/michael-hudson-discusses-the-federal-reserve-and-the-global-fracture.html