That was then, this is now

There is a line of thought that has persisted amongst some people since the financial crisis began, that because it looks similar to what happened in 1929, we must be in for another Great Depression. (Similarly, some media pundits have referred to the current recession as the Great Recession.)

First of all, the fact that something looks similar does not indicate that it is the same thing. There are definite differences between then and now.

It has long been conventional wisdom that the Depression was caused by the stock market crash of 1929. That is not correct. The crash was an early symptom of what was going on at that time, but it was not a cause. It did precipitate a banking crisis which became very serious. But where 1929 diverges from 2008 was in the response to the banking crisis.

In 1929, the Federal reserve kept on following the tight money, deflationary policy it had been following for some time before the crisis. It was a course of action that had been followed many times in the past by those who controlled banking systems, to keep the currency stable and weed out weak and overextended players. However, this time the result was worse than ever before, because the imbalances in the economy, on a long term basis, were more extreme, and the powers-that-be of that time basically read the whole situation incorrectly (to put it charitably). The result was made worse by the persistence in the deflationary policy long after the crisis developed.

Conversely, in 2008 the Federal Reserve pulled out all the stops in an effort to provide liquidity to the system and even invented new ways to keep everything afloat. There was no deflationary policy in play. One might even argue that the crisis developed partly because the Fed had been too accommodating for too long in the years leading up to the crisis. The Federal Reserve did learn something from the Great Depression. They learned what not to do, and in our present day crisis they basically did just the opposite of what they did then.

Three other factors were different then. One is that, just as the Depression was getting started, major income tax increases were put into effect. That has not happened yet in the present. However, (1) the new health care law could act like a tax increase and be a damper on the economy, and (2) the tax cuts that were enacted during the Bush administration are scheduled to expire at the end of this year. If they are allowed to expire, the result would be an automatic tax increase. It is more widely understood today, even in Congress, that tax increases are counterproductive in a weak economic environment. Therefore there is some hope that Congress will extend those tax cuts for another year. But nothing is certain at this point.

Another difference between then and now is that in the 1930's, world trade was seriously hampered by extremely high tariffs passed by all the major trading nations. There has been a little of that today, but nothing like back then.

The third major difference is that during the Depression, the whole world was affected. Today, several important countries have already resumed rapid growth, in particular China. Germany, whose economy depends to a large extent on exports, is experiencing growth through its trade with China and others. The prospects for US exports to China and India, etc., are good, and some major companies (e.g., Caterpillar) are already benefiting strongly.

Looking back, it almost seems a miracle that we survived the egregious policy mistakes of the first half of the twentieth century, and we should keep in mind that today we are doing our best not to make the same mistakes. Also, today is not yesterday. Today is today.

Mass growth

Rosy payroll growth stats released by U Mass on 7/30/10 are thrown off a bit by US Census hiring. The 4.5 percent annual growth rate was the best since 1984, but government spending and hiring played a big role in it. Still, up is up, and the private sector did show some growth. The unemployment rate declined from 9.3% in March to 9.0 in June.

China and other developing countries are growing quickly again. This is good for any company that exports to them, including Massachusetts information technology firms.