Recession How deep how long?

The US economic analyst Nouriel Roubini nicknamed “Dr Doom” for his pessimistic, foresighted and funny analyses of the US financial catastrophe, correctly called the peak of the housing market and accurately foresaw the scale of the sub-prime debacle. He suggests that the US is headed for its worst post-war recession, and certainly as bad as 1974-75 or 1982.

The contraction of credit in a debt-financed economy has seen consumer spending (70% of GDP) fall off a cliff since the summer and the trends in redundancies and output would support his guesstimate.

But could it be worse? Or better? Comparisons have been made between the current financial crisis and the crash of 1929, which was followed by a Great Depression lasting 10 years. The stock market lost 90% of its value between 1929 and 1932 in a succession of falls. Real output in most industries declined dramatically – steel for example ran at 17% of its 1928 capacity in 1932 while overall output fell about 30%. Unemployment in the US reached 25% and stayed at 20% for many years. By 1939, employment and output remained well below their 1929 levels.

In the thirties the government refused to use fiscal or monetary policy to restore liquidity or to boost investment or consumption; they had little or no regulation in place to protect depositors savings and prevent serial bank collapses. Business investment fell nearly 80% between 1929 and 1933 and remained 51% below its 1929 level in 1939. In 1933, consumption of consumer durables was about 28% below its 1929 level. By 1939, consumption remained about 25% below this level.

Critically in the late twenties and early thirties, tariffs – domestic taxes on foreign goods – rose in the US and in other countries. The League of Nations reported in 1933 that world trade fell about 65% between 1929 and 1932.

The Great Depression was a result of the combination of the Wall Street Crash and of the paralysis of the world economy still suffocated by the colonial system. The growth of the productive resources during the belle époque from 1890-1914, meant that the colonial system was an intolerable barrier on new powers like Germany and the US, excluded from the colonial system of the older imperialist powers, notably France and the UK. It was this system that made the First World War inevitable, as Germany developed into a great industrial power.

The overthrow of capitalism in Russia in 1917 massively exacerbated the crisis by further limiting the scale of the world market and leading to revolutionary crises and civil wars throughout Europe and the world. In 1929 Germany was convulsed by the conflict between the communists and fascists. Spain was entering a civil war. China was in a civil war. The UK was reeling from the effects of the General Strike. The Wall Street Crash certainly damaged the US economy profoundly, but more importantly it coincided with and accelerated the growth of economic nationalism across the world.

Those who make comparisons between the Great Crash of 1929 and today should ponder these facts and realise the real differences between the economic and political reality then and now.

The most severe post-war recession in the US was that of 1974-75. The recession lasted 18 months but the last six months were very deep (Q4 1974-Q1 1975). Industrial output fell at an annualised rate of 24% and GDP by 8.5%. Unemployment jumped from 5% in March 1974 to 8.9% a year later. That recession was brought to an abrupt end by extensive Federal intervention.

The most benign scenario would be a course similar to the 1907 banking crash in the US. A strong period of economic growth followed by speculative frenzy ended in a series of bank failures in the US in 1907. A deep recession followed in 1908 (an 8% fall in GDP) before the economy resumed its strong upward growth that characterised the long expansionary wave of the world economy in 1895-1913.

But for this to be possible, credit conditions would have to return to “normality” soon, and the strong capital development underpinning China, India and Latin America’s growth this decade would have to be sustained.

Deflation will rebuild purchasing power and restore profit margins and government intervention programmes will stimulate the world’s economies but the extent and speed of their impact remains unclear at present.

Sat 28, February 2009 @ 12:17