Global Economic Crises

Economic crises in one country can have catastrophic consequences in other parts of the world.

The Great Depression of the 1930s

The Great Depression of the 1930s, began as a financial meltdown in the U.S. with millions of Americans losing their jobs and countless companies and farms going bankrupt.  

When the Federal Reserve moved to restrict money supply after the 1929 crash, it led to an even more severe slowdown in economic activity, which increased unemployment and bankruptcies.  

Faced with a severe crisis in funding, U.S. banks called in loans to foreign countries leading to a collapse in the banking system in such debtor countries as Germany and Argentina.

The U.S. government then raised tariffs and quotas on imported goods, ostensibly to protect U.S. companies and farmers.  But this immediately led countries around the world to raise tariffs of their own, creating a vicious cycle where the economic downturn and isolationism in one country led to a greater downturn and even more protectionism in another - and eventually worldwide depression.

Unemployment reached unprecedented levels of more than 25% of the workforce unemployed in in Germany, Great Britain and the United States.  

In Germany, the economic situation was a major cause of the rise in fascism, with Hitler's National Socialist Party seizing power as the economy failed and inflation soared.

The Worldwide Recession of the 2008

The worldwide recession of the 2008 started with the collapse of the housing market in the U.S.  But the enormity of the financial collapse required a level of government and central bank intervention never before attempted.  

When banks began failing across the globe - primarily because of catastrophic investments in U.S. subprime securities funded by unstable, short-term money market borrowing - it was clear that a full-blown worldwide crisis had arrived.  

Stock market declines of more than 50% in some countries presaged a global economic meltdown.  

The concerted actions of the world's central banks, including the U.S. Federal Reserves, the Bank of England, the European Central Bank, and the Bank of Japan, helped calm things down for a while.  But when entire countries began to go bankrupt - like Iceland and Greece - it was clear that the fallout of the 2008 crisis would last for years to come.

The task facing the Fed as well as the other central banks of the world in 2008 was to somehow solve the immediate problem without setting precedents that would exacerbate future crises.

What caused the 2008 recession?

1.  Some say that the reaction of the Federal Reserve to the meltdown of the dot-com sector in 2000 - increasing liquidity and facilitating drastically lower interest rates - set the stage for the housing bubble and the eventual meltdown of financial markets several years later.

2.  Others say the "savings glut" in the emerging economies in Asia as well as in Germany and other export-oriented countries led to the 2008 recession, during which easy access to mortgages led to overheated housing market from Dublin to Madrid to San Francisco.

3.  Some point to the discovery by banks and mortgage companies in the U.S. that they could make a lot of money by providing loans to home buyers who normally wouldn't be given credit.  

• The market for subprime mortgages really took off when the banks and mortgage companies figured out that they could repackage these dubious mortgages and sell them as bonds to investors through-out the world economy - mainly to cash-flush banks and financial institutions.
• With hundred of billions of dollars' worth of mortgage-backed securities traded annually by 2007, the market for subprime debt had become bigger than the entire market for U.S. Treasury bonds - the biggest bond market in the world at the time.  

Governments Moving to Cut Spending, in Echo of 1930s

June 29, 2010
Governments Moving to Cut Spending, in Echo of 1930s
By DAVID LEONHARDT

The world’s rich countries are now conducting a dangerous experiment. They are repeating an economic policy out of the 1930s — starting to cut spending and raise taxes before a recovery is assured — and hoping today’s situation is different enough to assure a different outcome.

In effect, policy makers are betting that the private sector can make up for the withdrawal of stimulus over the next couple of years. If they’re right, they will have made a head start on closing their enormous budget deficits. If they’re wrong, they may set off a vicious new cycle, in which public spending cuts weaken the world economy and beget new private spending cuts.

On Tuesday, pessimism seemed the better bet. Stocks fell around the world, over worries about economic growth.

Longer term, though, it’s still impossible to know which prediction will turn out to be right. You can find good evidence to support either one.

The private sector in many rich countries has continued to grow at a fairly good clip in recent months. In the United States, wages, total hours worked, industrial production and corporate profits have all risen significantly. And unlike in the 1930s, developing countries are now big enough that their growth can lift other countries’ economies.

On the other hand, the most recent economic numbers have offered some reason for worry, and the coming fiscal tightening in this country won’t be much smaller than the 1930s version. From 1936 to 1938, when the Roosevelt administration believed that the Great Depression was largely over, tax increases and spending declines combined to equal 5 percent of gross domestic product.

Back then, however, European governments were raising their spending in the run-up to World War II. This time, almost the entire world will be withdrawing its stimulus at once. From 2009 to 2011, the tightening in the United States will equal 4.6 percent of G.D.P., according to the International Monetary Fund. In Britain, even before taking into account the recently announced budget cuts, it was set to equal 2.5 percent. Worldwide, it will equal a little more than 2 percent of total output.

Today, no wealthy country is an obvious candidate to be the world’s growth engine, and the simultaneous moves have the potential to unnerve consumers, businesses and investors, says Adam Posen, an American expert on financial crises now working for the Bank of England. “The world may be making a mistake, and it may turn out to make things worse rather than better,” Mr. Posen said.

But he added — after mentioning China, India and the relative health of the financial system, today versus the 1930s — that, “The chances we’re going to come out of this O.K. are still larger than the chances that we aren’t.”

•

The policy mistakes of the 1930s stemmed mostly from ignorance. John Maynard Keynes was still a practicing economist in those days, and his central insight about depressions — that governments need to spend when the private sector isn’t — was not widely understood. In the 1932 presidential campaign, Franklin D. Roosevelt vowed to outdo Herbert Hoover by balancing the budget. Much of Europe was also tightening at the time.

If anything, the initial stages of our own recent crisis were more severe than the Great Depression. Global trade, industrial production and stocks all dropped more in 2008-9 than in 1929-30, as a study by Barry Eichengreen and Kevin H. O’Rourke found.

In 2008, though, policy makers in most countries knew to act aggressively. The Federal Reserve and other central banks flooded the world with cheap money. The United States, China, Japan and, to a lesser extent, Europe, increased spending and cut taxes.

It worked. By early last year, within six months of the collapse of Lehman Brothers, economies were starting to recover.

The recovery has continued this year, and it has the potential to create a virtuous cycle. Higher profits and incomes can lead to more spending — and yet higher profits and incomes. Government stimulus, in that case, would no longer be necessary.

An internal memo from White House economists to other senior aides last week noted that policy makers “necessarily tend to focus on the impediments to recovery.” But, the memo argued, the economy’s strengths, like exports and manufacturing, “more than make up for continued areas of weakness, like housing and commercial real estate.”

That optimistic take, however, is more debatable today than it would have been a month or two ago.

As is often the case after a financial crisis, this recovery is turning out to be a choppy one. Companies kept increasing pay and hours last month, for example, but did little new hiring. On Tuesday, the Conference Board reported that consumer confidence fell sharply this month.

And just as households and businesses are becoming skittish, governments are getting ready to let stimulus programs expire, the equivalent of cutting spending and raising taxes. The Senate has so far refused to pass a bill that would extend unemployment insurance or send aid to ailing state governments. Goldman Sachs economists this week described the Senate’s inaction as “an increasingly important risk to growth.”

The parallels to 1937 are not reassuring. From 1933 to 1937, the United States economy expanded more than 40 percent, even surpassing its 1929 high. But the recovery was still not durable enough to survive Roosevelt’s spending cuts and new Social Security tax. In 1938, the economy shrank 3.4 percent, and unemployment spiked.

Given this history, why would policy makers want to put on another fiscal hair shirt today?

The reasons vary by country. Greece has no choice. It is out of money, and the markets will not lend to it at a reasonable rate. Several other countries are worried — not ludicrously — that financial markets may turn on them, too, if they delay deficit reduction. Spain falls into this category, and even Britain may.

Then there are the countries that still have the cash or borrowing ability to push for more growth, like the United States, Germany and China, which happen to be three of the world’s biggest economies. Yet they are also reluctant.

China, until recently at least, has been worried about its housing market overheating. Germany has long been afraid of stimulus, because of inflation’s role in the Nazis’ political rise. In responding to the recent financial crisis, Europe, led by Germany, was much more timid than the United States, which is one reason the European economy is in worse shape today.

The reasons for the new American austerity are subtler, but not shocking. Our economy remains in rough shape, by any measure. So it’s easy to confuse its condition (bad) with its direction (better) and to lose sight of how much worse it could be. The unyielding criticism from those who opposed stimulus from the get-go — laissez-faire economists, Congressional Republicans, German leaders — plays a role, too. They’re able to shout louder than the data.

Finally, the idea that the world’s rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change.

In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that.

Instead, we are left to hope that we have absorbed just enough of the 1930s lesson.

E-mail: leonhardt@nytimes.com

http://www.nytimes.com/2010/06/30/business/economy/30leonhardt.html?src=me&ref=business

World industrial production, trade and stock markets are diving faster now than during 1929-30.

Tuesday, April 7, 2009

World Economy Falling Faster Than in 1929-1930


Barry Eichengreen, an expert on the Great Depression, and Kevin O'Rourke, take issue with the notion that the current downturn is less severe than the Great Depression. While the slump in the US is not as bad, that mis-states the global picture.

Note that many economists expect the US to suffer less than the big exporters, namely China, Germany, Japan. The reason is that the economic adjustment required of surplus nations is greater than that of debtors. Similarly, in the Great Depression, the US, then a major exporter, was harder hit than the overconsuming importers such as Britain, who defaulted on their debts.

The one bit of cheer is that this time around, government action is more aggressive, but it remains to be seen whether it is sufficient.

From VoxEU:

Often cited comparisons – which look only at the US – find that today’s crisis is milder than the Great Depression. In this column, two leading economic historians show that the world economy is now plummeting as it did in the Great Depression; indeed, world industrial production, trade and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better.

The parallels between the Great Depression of the 1930s and our current Great Recession have been widely remarked upon. Paul Krugman has compared the fall in US industrial production from its mid-1929 and late-2007 peaks, showing that it has been milder this time. On this basis he refers to the current situation, with characteristic black humour, as only “half a Great Depression.” The “Four Bad Bears” graph comparing the Dow in 1929-30 and S&P 500 in 2008-9 has similarly had wide circulation (Short 2009). It shows the US stock market since late 2007 falling just about as fast as in 1929-30.

Comparing the Great Depression to now for the world, not just the US

This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences.

Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.

In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then.

Figure 1. World Industrial Output, Now vs Then
Source: Eichengreen and O’Rourke (2009).

Similarly, while the fall in US stock market has tracked 1929, global stock markets are falling even faster now than in the Great Depression (Figure 2). Again this is contrary to the impression left by those who, basing their comparison on the US market alone, suggest that the current crash is no more serious than that of 1929-30.

Figure 2. World Stock Markets, Now vs Then
Source: Global Financial Database.

Another area where we are “surpassing” our forbearers is in destroying trade. World trade is falling much faster now than in 1929-30 (Figure 3). This is highly alarming given the prominence attached in the historical literature to trade destruction as a factor compounding the Great Depression.

Figure 3. The Volume of World Trade, Now vs Then
Sources: League of Nations Monthly Bulletin of Statistics, http://www.cpb.nl/eng/research/sector2/data/trademonitor.html

It’s a Depression alright

To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimize this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline. We therefore turn to the policy response.

Policy responses: Then and now

Figure 4 shows a GDP-weighted average of central bank discount rates for 7 countries. As can be seen, in both crises there was a lag of five or six months before discount rates responded to the passing of the peak, although in the present crisis rates have been cut more rapidly and from a lower level. There is more at work here than simply the difference between George Harrison and Ben Bernanke. The central bank response has differed globally.

Figure 4. Central Bank Discount Rates, Now vs Then (7 country average)
Source: Bernanke and Mihov (2000); Bank of England, ECB, Bank of Japan, St. Louis Fed, National Bank of Poland, Sveriges Riksbank.

Figure 5 shows money supply for a GDP-weighted average of 19 countries accounting for more than half of world GDP in 2004. Clearly, monetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29, which is a reminder that the stage-setting events were not the same in the two cases. Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline.

Figure 5. Money Supplies, 19 Countries, Now vs Then
Source: Bordo et al. (2001), IMF International Financial Statistics, OECD Monthly Economic Indicators.

Figure 6 is the analogous picture for fiscal policy, in this case for 24 countries. The interwar measure is the fiscal surplus as a percentage of GDP. The current data include the IMF’s World Economic Outlook Update forecasts for 2009 and 2010. As can be seen, fiscal deficits expanded after 1929 but only modestly. Clearly, willingness to run deficits today is considerably greater.

Figure 6. Government Budget Surpluses, Now vs Then
Source: Bordo et al. (2001), IMF World Economic Outlook, January 2009.


Conclusion

To summarize: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.


Topics: Economic fundamentals, Globalization, Macroeconomic policy
Posted by Yves Smith at 1:26 AM



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How a Modern Depression Might Look -- if the U.S. Gets There

How a Modern Depression Might Look -- if the U.S. Gets There
by Justin Lahart
Monday, March 30, 2009


In the wake of the biggest financial shock since 1929, economists say the odds of a depression are less than 50-50 -- though still uncomfortably high. But even if a depression comes to pass, a 21st-century version would look very different from the one 80 years ago.

There is no consensus definition for "depression." Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%, and puts the odds of a depression at about 20%. Many economic historians say the line between recession and depression is crossed when unemployment rises above 10% and stays there for several years.

The current recession, though severe, is not at depression levels now. Unemployment in February was at 8.1%, not as bad as in the early 1980s -- the last time the idea of a depression was being kicked around seriously, when it remained over 10% for 10 months. In the Great Depression it reached 25%

"When you get an unemployment rate of 25%, it's everywhere," recalls economist Anna Schwartz, who is 94 years old and best known for her analysis of the causes of the Great Depression with the late Milton Friedman. "Everyone is conscious of that and fearful. We're not talking in that league at all."

Using the Barro definition, economists in a Journal poll conducted in early March put the odds of a depression at 15%, on average. But there was wide disagreement. John Lonski, chief economist at Moody's Investors Service, put the depression odds at 30% in early March, but better-than-expected news recently has led him to put it closer to 20%. In contrast, Paul Kasriel of Northern Trust put the odds of a depression at just 1% because of the aggressive lending by the Federal Reserve and the fiscal stimulus just beginning to hit the economy. "There are just too many powerful countercyclical policies in place that will prevent the worst-case scenario," he says.

Today's government response is a far cry from the early 1930s, when the Fed raised interest rates, the infamous Smoot-Hawley Tariff Act crushed trade and Treasury Secretary Andrew Mellon's prescription for the economy was "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate."

"The Great Depression was a mass of policy errors that made it worse," says historian and investment consultant Peter Bernstein, 90. "This time we have our fill of policy errors, but at least they're not making it worse."

Mr. Bernstein lived on Manhattan's Upper West Side during the Depression. "You were conscious of it all the time when you were out in the street," he says. "People looked so threadbare."

The different structure of today's economy means that a modern depression would differ from the Great Depression of the 1930s. Fewer than 2% of Americans working today have agricultural jobs, compared with one in five in 1930. Three-quarters of today's workers are in service-related jobs, which tend to be more stable than manufacturing, compared with fewer than half in 1930.

And then there are the social-safety-net programs that emerged after the Great Depression to blunt the blows. "There were no unemployment insurance, no food stamps, none of the automatic things that maintain some income for people who are out of work," says former Massachusetts Institute of Technology economist Robert Solow, a Nobel laureate. Mr. Solow, 84, grew up in Brooklyn, N.Y., and remembers his parents' constant worry about the next month's money.

With spending on food accounting for a little less than a tenth of a typical family's disposable income today, compared with a little less than a quarter in 1930, a modern depression wouldn't hit people in the stomach as the Great Depression did. Growing up on a Wisconsin farm, Catherine Jotka, 89, remembers taking dried corn meant for animal feed out of the granary and sifting dirt out of it to make corn bread.

Today's cutbacks would be for more discretionary purchases -- cable television, iTunes songs and restaurant meals. And there's plenty of room for trimming, says Victor Goetz, 81, a retired engineer who lives outside Seattle. "This has a whole different feel than anything we had in the 1930s," he says.

Even if the downturn isn't deep enough to be called a depression, the restructuring that it needs to go through means that even after the economy bottoms out, there could be a "lost" four or five years of sluggish growth, says Nobel laureate Paul Samuelson, 93.

As a University of Chicago student during the Depression, Mr. Samuelson remembers attending economic lectures that seemed completely out of step with the times, based on laissez-faire principles that stopped making sense after the 1929 crash. "I was perplexed because I could not reconcile the assignments I got from these great economists with what I heard out the windows and I heard from the street," he says.

Starting in the 1980s, the U.S. saw an extraordinary period of economic quiescence, where growth was steady and policy makers dealt with financial crises handily. Economists began to doubt the possibility of a financial crisis so severe it would upend the economy. And that left them as blindsided as their counterparts when the crisis came 80 years ago.

http://finance.yahoo.com/banking-budgeting/article/106822/How-a-Modern-Depression-Might-Look-if-the-U.S.-Gets-There?sec=topStories&pos=3&asset=TBD&ccode=TBD

2009 threatens to be "a dangerous year"

World Bank wants Britain and US to track how well stimulus works

The head of the World Bank has called on Britain, the US and other major economies to establish ways of tracking the effectiveness of their growing fiscal stimulus packages.

By Richard Blackden
Last Updated: 9:37PM GMT 21 Mar 2009

World Bank President Robert Zoellick says that 2009 threatens to be "a dangerous year"

"There is a legitimate debate about how the stimulus will be used," World Bank President Robert Zoellick said yesterday. "If you are going to have very big expansionary programmes, you need to show some fiscal discipline." The comments come less than two weeks before a critical G20 Summit in London at which leaders of the world's major economies will be seeking a consensus on a new set of measures to help drag the world out of recession.
Mr Zoellick says that 2009 threatens to be "a dangerous year" in which the economic crisis has the potential to spill over into political and social unrest in a number of countries.

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The World Bank last week forecast the global economy will contract by as much as 2pc this year.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5029116/World-Bank-wants-Britain-and-US-to-track-how-well-stimulus-works.html

World now in grip of 'Great Recession' warns IMF

World now in grip of 'Great Recession' warns IMF
The world is mired in what future generations may dub the "Great Recession", the head of the International Monetary Fund has declared, in the face of a flurry of negative economic news.

By Edmund Conway
Last Updated: 10:40AM GMT 11 Mar 2009

Mr Strauss-Kahn said that the Fund was poised to cut its forecast for 2009 global economic growth from the paltry 0.5pc expansion it predicted in January.
The global economy faces a contraction in overall gross domestic product for the first time since the Second World War, said Dominique Strauss-Kahn. His warning came as:

• Britain's leading economic forecaster, the National Institute for Economic and Social Research, said the UK economy has given up more than two years' worth of expansion, sliding back to the same size it was in summer 2006. It added that the recession had deepened in the first quarter of the year.

Global economy to shrink for first time since the Second World War

• China slid into deflation for the first time in the crisis, underlining the fact that Western nations' reliance on Chinese growth in the recession may be futile.

• Evidence emerged of an industrial production collapse across Europe, while the Irish central bank chief predicted his economy would shrink by a staggering 6pc this year.

• Eastern Europe's problems intensified, with the European Union pledging its readiness to give money to Romania and experts warning that Serbia's economy will shrink by 3pc unless it is bailed out by the IMF.

Mr Strauss-Kahn said that the Fund was poised to cut its forecast for 2009 global economic growth from the paltry 0.5pc expansion it predicted in January, saying a negative figure was now more likely.

"Since then the news hasn't been good," he said. "I think that we can now say that we've entered a Great Recession. This recession may last a long time unless the policies we're expecting are put in place, in which case 2010 can be a year of return to growth."

The world economy has not shrunk since 1945 because usually the contraction in recession countries has been balanced out by economic growth from elsewhere. However, the IMF chief said this recession was unusual for its breadth and ferocity. "The IMF expects global growth to slow below zero this year, the worst performance in most of our lifetimes," he said. "Continued deleveraging by world financial institutions, combined with a collapse in consumer and business confidence is depressing domestic demand across the globe, while world trade is falling at an alarming rate and commodity prices have tumbled."

The warning comes only days ahead of the G20 leading economies finance summit, which takes place this weekend. Ministers, including Chancellor Alistair Darling and US Treasury Secretary Tim Geithner, are due to meet to discuss a concerted response to the latest stages of the economic crisis.

NIESR said it had calculated that in the three months to the end of February Britain's economy shrank by 1.8pc. This is steeper than the official contraction of 1.5pc recorded by the ONS in the final quarter of 2009 and means the economy is now back to the same level it was in August 2006 .

http://www.telegraph.co.uk/finance/financetopics/recession/4969652/World-now-in-grip-of-Great-Recession-warns-IMF.html