April 24, 2009

The Great Depression...and Now (updated 6-09)

While listening to Simon Johnson on Bill Moyer's Journal tonight, it struck me that the primary cause of the Great Depression, the main factor that deepened then prolonged the 1929-30 recession, isn't clear for many people. Near the end of the first segment in Moyer's program, Simon quips that economists will still be debating the Great Depression 50 years from now. While some may, I believe we can decipher these events in a way that will decisively end the general debate soon.

When I reflect on the hundreds of articles and blog posts I've read on the Great Depression and our situation now, and on my own evolving thoughts over the last two years, one fundamental economic process stands out in this grand worldwide train wreck. Let me illustrate this decisive force and its play within the complex string of events.

The 1929 recession came after a period of significantly increasing consumer installment and mortgage debt. When a growing stock speculation bubble continued in 1928, the Federal Reserve raised rates to slow the expanding stock borrowing. A recession began in the summer of 1929, which in turn helped destabilize the stock market bubble, leading to the October crash, which contributed to a reduction in demand and availability of consumer credit. As job losses mounted from the 1929 recession into 1930-1931, increasing numbers of bank loans went bad, which made more and more banks reluctant to lend just as more consumers became reluctant to borrow. Banks were taking in payments from those able to pay on their (still significant) debts, but not lending out much. This was a reversal of the run-up in credit, and the deflation which followed made debts harder to pay and the balloon mortgages unrefinanceable.

Various other effects further crimped demand and income: tax increases meant to gather more revenues from those still working, and trade wars which destroyed jobs in export industries.

As the job losses and fear mounted, many with jobs became more cautious in spending what they had. The circle of reduced spending leading to job losses which in turn further reduced spending drove the economy downward towards its essentials, its base, where what was being produced and sold were largely necessities. The slide continued under its own momentum.

By early 1933, this process had advanced far enough and long enough that the remaining demand and economy still in operation was the harder stuff of necessity. From this point, it should be no surprise that Roosevelt and Congress were able to quickly halt the downward drift and move things upward by ending the bank runs for the surviving (hardier) banks with new FDIC insurance, by widening economic rescue efforts, and by calming the people with fireside chats.

By 1933 the weak, frothy parts of the 1929 economy were all gone, and only the strong, hard base remained, ready to build upon.

Nevertheless, people had been trained into frugality by this time, and the debt burden was still significant. It would take years of gradual psychological gains in general confidence and the gradual development and appearance of new products and new wants to strengthen and broaden the economy so that more and more people could find work. Time was required to re-weave economic fabric exactly because so many who had lost jobs were also broke and had unpaid debts, so that even when they worked they were still miserly. World War II capped this process of slowly building up jobs and paying down debt, ending the remaining lack of demand and unemployment and accelerating technological innovation. By the end of the war, the U.S. was prepared in all essential ways for significant economic growth -- with increased general confidence and new technology ready to be put to work -- and only needed to be turned loose from wartime governmental control, which is exactly what happened next.

An analogy for America and its economy of 1928-1945 would be a story that starts with a drunk driver on a mountain road.

Drunk on overindulgence (stock speculation and debt) and driving too fast, our Driver careens into roadside trees at high speed (October 1929). But then worse, our hero tumbles down the cliff face (1930-31), taking further injuries, and finally goes without help or food for days (1931-33).

After what seems an eternity, our desperately injured Driver is finally rescued and put in hospital for a long, slow recovery (1933-1940). After gradually regaining health in this painful, slow recovery, our patient is then put into a strenuous, lengthy physical therapy program (WWII).

Finally, our Driver is released one day (1945), after what seems ages, now hale and full of strength and power, his confidence restored. He is a new man.


Will it take us 10 or 12 years to get back to a thriving economy?

Only if we have years of downward spiral, which is a threat due to the weight of household debts. And for the "thriving" part -- only if we undergo serious re-conditioning.

But our tumble down the cliff (joblessness) is being seriously fought and contested by the Fed and the Federal stimulus program, with multiple ropes.

Our modern Accident included air bags.

Rescuers are hard at work, bringing the Driver water and oxygen through the broken car window, hanging by ropes on the face of the cliff.

We may not need a 12-year recovery -- we have not yet suffered 1931-1933.

The ropes are creaking, and several have snapped or slipped off, but others have been hurriedly attached.

Nothing is clear yet at this point. ...Except, perhaps, that the old jalopy is totaled.

Nothing is certain. The car may yet go tumbling, or the ropes may hold.


Update: Here is a good source of ongoing world economy graphs showing our progress vs. the Great Depression. It takes time for the effects of the stimulus program, and also of general confidence to show up in this kind of data. Perhaps by late summer we will have a better idea whether the world economy can deviate upward from the Great Depression trends we have followed so far.


  1. "We may not need a 12-year recovery," you write. "We have not yet suffered 1931-33."

    An excellent statement. It captures the urgency of our need for a timely and adequate response to the threat of Depression.

    Hi, Hal. I came here after reading Planet Money on the BLS's "most depressing" study. Your little history of the Great Depression held my interest. I like your point that it took time before people were willing to spend again.

  2. Yeah, it's a matter of conditioning and expectations in that longer term, and the conditioning will be depending on how poorly or well things go for the next 2 years. WWII and its outcome and the changed world profoundly changed the US psychology, and one wonders what the psychology would have been in the 1950s without the war and the change it brought.

    thanks ArtS