From the November 1, 2008 Sunday Times (London)
November 1, 2008
by Irwin Stelzer
November was much celebrated by investors in 1954. On the 23rd of that month the Dow Jones average of shares of industrial companies for the first time closed above the level it had reached at its peak on September 3, 1929. Are we in for another 25-year wait before share prices match their October 9, 2007 peaks?
Only a brave man or a fool would attempt to predict the course of share prices, which have been gyrating at a rate that would be the pride of any belly dancer. And it would take an even braver and more foolhardy one to venture the prediction that the situation in which we find ourselves, unpleasant and dangerous as it is, is not going to reach levels last seen in the depression of the 1930s. So here goes.
A bit of history. In the 1930s the American economy shrank by 30%, the unemployment rate rose to 25%, and prices fell at an annual rate of 10% during the early part of the decade. Since the second world war we have lived through ten expansions, averaging four years in length, and ten recessions, with an average length of one year. The two longest recessions (1969-70 and 1973-74) lasted for five quarters, and recorded only modest declines, at least by the standards of the Great Depression. That history might provide a bit of comfort to those worried that recessions typically collapse into a 1930s-style debacle.
Still, this recession is not like those of the recent past. It has many similarities to those setbacks, of course. Unemployment is rising, consumer confidence is fading, output is shrinking, many investors are being burnt, some firms are being driven to the wall.
Sigmund Freud is alleged to have said: “Sometimes a cigar is only a cigar.” And sometimes a recession is only a recession, with the consequences described above. The one in which we are stuck is different. The seizing up of credit markets, the ubiquity of bad IOUs on the books of financial institutions, the huge indebtedness of consumers, the rattling of the banks’ credit bowls at the doors of the Treasury and the Federal Reserve — a clamour made louder by car, insurance and construction companies, and American subsidiaries of foreign banks — are fairly new features. Yes, we have had bailouts in the past — of Chrysler in 1979, and Long-Term Capital Management in the early days of Alan Greenspan’s tenure as chairman of the Fed — but we did not see the government buying shares in banks, or guaranteeing money funds, or the Fed opening its “window” to collateral that, to put it politely, is not of the highest quality.
But note a common thread: all these moves are generally correct policy responses to what some call the worst financial crisis in 100 years. In the Great Depression the Fed got it wrong, and tightened when it should have been loosening credit. Franklin Roosevelt almost got it wrong when he promised to cut spending and balance the budget, a promise he wisely decided not to keep.
Now the authorities are getting things right, but not before some stumbles. US Treasury secretary Hank Paulson decided to let Lehman Brothers go down (he says he had no choice because Lehman had no decent collateral to pledge in return for bailout cash). And the government and the governor of the Bank of England were slow to realise what had to be done. But that was then, and this is now.
Federal Reserve chairman Ben Bernanke has added a variety of innovative credit-loosening measures to a series of interest-rate cuts that culminated in last week’s reduction to 1%. The recapitalisation of the banks is under way on a huge scale, putting them in a position to resume lending. The extension of government deposit guarantees has calmed the panic that threatened to create queues at the withdrawal windows of the world’s banks. Measures to encourage banks to resume lending to each other seem to be having some effect, although bank hoarding of cash remains a problem. There are tentative signs that the steps taken to ease conditions in the moribund commercial-paper market are working, so that businesses can again cover their short-term cash. Everywhere, fiscal policy is becoming more stimulative. There are certainly more shocks to come, but the policy trajectory is in the right direction.
It is important to note that few of these measures have had time to work any magic they might contain. Interest-rate cuts have their full effect only after an 18-month lag. It was only last week that some of Paulson’s $700 billion began to find its way onto banks’ balance sheets. And all the talk in Europe about leading the way to recovery has yet to be followed by the injection of cash in quantities that match French president Nicolas Sarkozy’s words.
Those words might prove to be the most important result of the current financial trauma. In the 1930s, America’s model of free-market capitalism was challenged by Hitler’s National Socialism and Stalin’s Communism. Some people, such as America’s ambassador to Britain, Joe Kennedy, professed to see National Socialism as the eventual winner over Britain and America, while more than a few woolly-minded liberals went to the Soviet Union and proclaimed that they had seen the future, and it works. In the end, neither model survived its internal contradictions, while Roosevelt made the reforms capitalism needed to produce a post-war surge in living standards.
Now Sarkozy and Gordon Brown are posing still another challenge to the American model with an alternative replete with new regulations and international bureaucracies. Sarkozy would add a return to protectionism and, if he can pull it off, something approximating the fixed-exchange-rate regime of Bretton Woods. France has long wanted to replace the American model with its state-run variant of capitalism — only some dare to call it socialism — and Sarkozy believes a President Barack Obama will prove more tractable than the reviled George Bush. Obama will certainly move American policy to the left, but he is unlikely to have fought this hard for control of American affairs only to turn it over to the hyperactive Sarkozy and the self-proclaimed leader of the global economy, Gordon Brown.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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