Epic Recession: Prelude to Global Depression? Part II


 

This is the second part of a series by Jack Rasmus on the historical context and current trajectory of the financial crisis. The first article appeared in Z Magazine’s February issue.


This coming year may be remembered as the year in which politics began to catch up to the continuing economic crisis. In January, in the Senate election in Massachusetts, working- and middle-class voters emphatically registered their impatience with the $2.3 trillion in bailouts to bankers, insurance companies, big corporations, and wealthy investors—who quickly resumed giving themselves record bonuses once again. They expressed their anger with bankers getting free money from the government at zero percent interest rates—just as quickly used to speculate in foreign currencies, stocks, and properties abroad—while they cannot get their mortgage loans modified, cannot obtain student loans at anything but exorbitant market rates, or are increasingly denied bank loans to keep their small businesses from collapsing. They recorded their disgust with credit card companies successfully thwarting even timid Congressional efforts to place a cap of 34 percent on card charges and fees. They expressed their distrust with the promise of a health care reform bill that morphed daily into a health insurance industry subsidy bill—giving insurance companies millions of new customers at taxpayer expense while workers with health insurance largely pay for it all. They noted their discontent with revelations that giant companies like AIG and Goldman Sachs got reimbursed 100 percent by the U.S. Treasury for their speculative bets and loans while they, the working and middle class, continued to lose their own homes by the millions each year, or were forced to watch as their home values collapsed below mortgages owed. Not least, they recorded their rage with the nearly $500 billion of the $787 billion stimulus package spent by Congress in tax cuts and subsidies that have yet to trickle down to produce jobs.

The Republicans did not win the Massachusetts election. One candidate clever enough to tap into rising populist anger co-opted it. He ran more as a populist than as a Republican. Attempting to put a conservative spin on the Massachusetts election outcome, Republican news outlets like Fox have pushed the talking point that the loss of Massachusetts for the Democrats represents a retreat by independent voters from support for Democratic proposals for health care, economic stimulus, bank regulation, and the like. But a poll conducted by the AFL-CIO immediately after the vote clearly indicated Democrats were rapidly losing support—not from independents, but from working class and union voters. According to AFL-CIO President Richard Trumka, in a publicly distributed communication to union workers nationwide immediately after the Massachusetts election, "Unless Democrats demonstrate that fixing the economy is their overriding priority and begin to create more jobs for working Americans now, we’re going to see more results this November like the Massachusetts election." Trumka went on to add that "working America is demanding major change now—not timid, go-slow, partial solutions."

 

An amazing 31 percent (roughly 50 million) of the 150 million U.S. labor force found themselves unemployed at some point in 2008-2009. Youth, minority, and high school educated workers suffered depression-level unemployment rates of 30 percent, 40 percent, and more. True jobless at year end approached 23-25 million. Adding insult to injury, the unemployed are repeatedly told not to expect lost jobs to come back to previous levels until 2016 at the earliest—after 2020 by some estimates. Meanwhile, those desperately seeking jobs today at the ground level know joblessness is not abating, despite government figures. To the extent businesses began to hire at all at year end, they were hiring hundreds of thousands of temporary workers and part-timers who will be shed again at the slightest indication of downturn. To the extent unemployment did not rise further at year’s end, it is because additional hundreds of thousands were giving up finding work and leaving the labor force and the U.S. labor department continued to insist on making false statistical projections of new business formation and hiring in order to offset continuing real job losses. Real joblessness is still rising. It’s not the official figure of 10 percent and stagnant, but 18 percent and rising.

On the housing front, a record additional 2.4 million homes went into foreclosure last year—more than 6 million since the housing crisis began in 2006. Ten to fourteen million of the fifty-three million outstanding residential mortgages are projected to foreclose during the current crisis. Between a third and a half of all mortgages are projected to be "underwater" at some point. The promise of housing recovery late last summer is beginning to fade once again, as new home sales, new home construction, and home prices began to retreat once again in the closing months of 2009.

Along with rising consumer debt, growing income inequality is a major cause of consumption fragility. Average consumers today still owe 130 percent in debt of their real disposable income—and this real income continues to drop. In 2009, the decline in wages and earnings continued for more than 100 million working and middle class Americans, falling another 1.3 percent. Workers actually earn less today than they did in 2001.

Jobs, foreclosures, earnings decline, unavailability of credit—all have meant a continuing fall in consumption demand which comprises 71 percent of the economy. A sustained economic recovery cannot occur without a turnaround of consumption. And the longer the turnaround is delayed, the more likely there will be a second dip in the economy or even a second financial crisis. Furthermore, should a second financial crisis occur, today’s epic recession may well transition to a global depression.

Epic Recession Today: Type I (1907-1914) or Type II (1929-1931)?

Obama and his advisors do not adequately understand the fundamental nature of the current crisis. Today’s epic recession is not a normal recession. It is quite unlike any of the nine previous recessions that occurred in the U.S. from 1945-2001. On the other hand, it is not unique. It has happened before, on several occasions in fact, both in the 19th and 20th centuries, in the U.S. and elsewhere.

In the U.S., a Type I epic recession occurred in 1907-1914, following the severe banking crash and financial panic of 1907. An equally severe contraction in credit and the real economy followed that crisis, resulting in an eventual major restructuring of the banking system in the U.S., with the formation of the Federal Reserve and the introduction of a permanent income tax for the first time. That is, fundamental changes in both monetary and fiscal policy were implemented at the time (neither of which have occurred in the current epic recession).

Nevertheless, these basic changes in the banking and tax systems only served to prevent a deeper economic decline. They did not succeed in generating a sustained economic recovery. Things did not get worse, but they didn’t significantly improve for more than a short period. After 1907, the U.S. economy essentially stagnated for six more years, from 1908 to 1914, incapable of generating a long-term recovery but preventing a continued long-term collapse. Following the financial crash and initial economic decline, a brief and mild recovery of approximately 24 months occurred. It was followed, in turn, by another decline of 21 months, by a second mild recovery of 15 months and still another decline lasting 24 months—after which World War I intervened and provided major economic stimulus. The two short, weak recoveries and two brief moderate declines averaged out to virtually no sustained longer-term economic recovery. It was, in other words, a lost decade. The long run stagnation that ensued was only resolved by a sharp acceleration of government spending—i.e. a massive fiscal stimulus—that marked the entry of the U.S. economically into World War I after 1915.

In contrast to 1907-1914, a Type II epic recession occurred in 1929-1931. A Type II is an epic recession in which the economy fails to even level out in an extended period of stagnation, but rather continues to decline in further stages and transitions into a bona fide depression. In a Type I, financial fragility and the collapse of the banking system is checked and contained, but consumption fragility continues, preventing sustained recovery. In a Type II, financial and consumption fragility both continue to deteriorate, leading to a further fracturing of the economic system in stages and a series of deeper declines.

The first 24 months of the Great Depression of the 1930s was a classic epic recession event, lasting from late summer 1929 through the summer of 1931. The public consensus was that the economy was not in a depression. Layoffs were significant, but not disastrous. Manufacturing and construction had declined sharply, but not the entire economy. Banking was not yet in a freefall. However, unlike the 1907-1914 experience, the initial financial crisis (stock market crash of October 1929) and the credit contraction and real economic decline that followed transformed into the Great Depression after mid-1931, instead of a period of extended stagnation, as after 1907. The rest of the economy joined manufacturing and construction, and the economy in general entered a period of more rapid decline. Unemployment rose sharply after mid-1931, and the banking system itself finally collapsed in dramatic fashion.

 

This different trajectory for 1929-1931 was initially due to the failure to stabilize the banking system as it progressively deteriorated, i.e., as it grew progressively more fragile. The real economy and consumption fragility fractured together in the summer of 1931. The financial system crashed for a second time in mid-1931, but this time the banks themselves instead of just the stock market. The event dragged down the real economy further in the second half of 1931. Part of the reason for the second financial crash in 1931 was the decision by the Hoover administration to prematurely "balance the budget" and for the Federal Reserve to prematurely raise interest rates in order to protect the value of the U.S. dollar in global markets (talk that has been echoed in 2010). The Federal Reserve in 1931 thus chose to sacrifice domestic economic recovery to protect the investments of bankers, wealthy investors, and U.S. companies expanding abroad. With the first true banking panic in 1931, credit contracted sharply, businesses began defaulting and folding, massive unemployment ensued, price deflation and wage cutting followed, and defaults (consumer, business, and local government) rose rapidly.

This general scenario was repeated in 1932 and early 1933. By the summer of 1933, unemployment was 25-30 percent, production down by more than half, more than 15,000 small banks had failed, the stock market had declined 89 percent, and the Great Depression was at its low point. The Great Depression of the 1930s was not a simple, linear decline of the economy from 1929 to 1941. It was composed of several phases and multiple stages. The opening phase was an epic recession, 1929-1931, that was allowed to deteriorate and which consequently transitioned eventually into a series of subsequent contractions, ratcheting down from 1931 to 1933. In 1933-34 the decline leveled off as FDR stabilized the banking system. But that stabilization was insufficient to generate a sustained economic recovery and 1933-1934 was a period of real economy stagnation, although one during which stock prices and investments began to recover, creating the illusion that recovery was underway. But leveling off is not recovery. In fact, from 1929-34, there were no fewer than five stock market recoveries, though the appearance did not last.

Business and banking interests vigorously opposed FDR’s initial recovery program in 1933, except for the bank bailouts and stabilization measures. FDR decided in 1934, after nearly two years in office with no recovery, to dramatically shift policy and oppose business interests more directly and aggressively. It was at this point the non-bank, non-business programs of FDR’s New Deal began to take form. But Roosevelt’s moderate New Deal programs of the mid-1930s proved insufficient to engineer a sustained economic recovery. Moreover, business interests in Congress, the Courts, and the media launched a political counter-offensive to begin dismantling key elements of the New Deal. To them, the Depression was over, with stock prices rising briskly and corporate profits returning. In their view, there was no need to continue fiscal spending on jobs, housing, and other measures benefiting workers and small businesses. Balancing the budget once again became the policy mantra. Therefore, by 1937, stimulus spending was consequently reduced and taxes were raised.

The retreat from fiscal stimulus predictably meant the economy fell back once again into depression by late 1937-1938. Panicked by the evidence of what they had done, Congress in 1938 restored some of the spending. But it returned as well to a focus on Federal Reserve monetary policies, which took precedence once again over fiscal. The new policy focus could not generate a sustained recovery and by early 1941 there was still 15 percent unemployment.

The Great Depression did not conclusively end until the entry of the U.S. into World War II, when massive government spending rapidly rose from 15 percent to 40 percent of annual economic production (or GDP) in 1942 and to 70 percent at one point in 1944. Thus, sustained recovery from depression and Type II epic recession was possible only as a result of massive fiscal spending by the government—as was the case in 1915-1918 with the conclusive ending of the Type I epic recession.

This fundamental point does not mean that world war, per se, is the only solution to epic recessions or classic depressions. It does mean, however, that only massive government spending in some form has historically proved the necessary solution to achieve a sustained economic recovery once extraordinary economic contractions like epic recessions and depressions occur. Not increases of 5 percent of GDP, such as occurred in early 2009 with Obama’s $787 billion first stimulus package—but stimulus packages consisting of 15-20 percent of GDP, or, in today’s terms equivalent to $2.5-3 trillion. (It is perhaps useful to note that only one major economy in response to the current global epic recession launched a stimulus package that amounted to approximately 20 percent of its GDP. That country and economy was China which, by all accounts, quickly returned to prior levels and rates of economic growth by 2010.)

The Lessons of Past Epic Recessions

To date, the Obama administration has addressed the current crisis as if it were a normal recession. They have bailed out only part of the financial system and thus temporarily prevented its further collapse. But a banking stabilization can, at best, produce only an extended period of economic stagnation. It cannot generate a sustained recovery. Obama’s whole strategy in 2009 was predicated on the assumption that bailing out the banks would get credit flowing again, as he and his advisors said time and again. But it hasn’t. The record is now clear that the banks will not lend—at least not to small and medium businesses that need it most. They will continue to speculate globally, seeking quick and fast speculative profits. It will take a fundamental banking system restructuring to change this. Just as other fundamental restructurings of the U.S. economy will be necessary.

Having blown trillions of dollars bailing out banks and big companies (like GM, who is now investing feverishly in China and elsewhere instead of the U.S.), consumer and household debt levels still remain at dangerously high levels. Meanwhile, the average household’s real disposable income continues to fall in general due to unresolved massive unemployment, continuing wage and earnings cuts, progressive benefits declines, deteriorating retirement income, various negative wealth effects, and a host of other forces.

Such was the case after 1907, in 1930-1931, in Japan after 1991, and elsewhere. Massive injections of liquidity into the banking system following the initial financial crisis that precipitates epic recession may, at best, succeed in only temporarily stabilizing the banking system; but it does not result in a return to credit and lending necessary to generate a sustained economic recovery. For recovery is not simply stabilizing the banking system. Nor is it even a return of GDP levels to positive growth—GDP is grossly inadequate for measuring trajectories of epic recessions or depressions. Normal fiscal policy responses—i.e., moderate tax and government spending programs—are likewise insufficient in generating a sustained recovery and, at best, succeed in placing a floor under the collapse of consumption and business investment.

Obama and his administration, Congress, and the welfare of tens of millions are thus at a crossroads in 2010. Does Obama have the strategic foresight and personal fortitude to make a turn to an FDR-like populist program? Or will he continue with another token jobs program, a tweaking of an already timid housing recovery program, and a lot of tough talk about bankers but little else? This writer’s view is that he will play it safe and consequently seal his fate in November and after. The next 60 days will tell if his proposals for 2010 continue to be too little too late.

Z


Jack Rasmus is the author of the forthcoming Epic Recession: Prelude to Global Depression (Palgrave-Macmillan and Pluto Press).