Outside editorial: About that second Great Depression

Posted: Thursday, April 24, 2008

The U.S. economy has, for many weeks, had Americans (and their politicians) talking recession: The economy grew only marginally, 0.6 percent, in the fourth quarter of 2007 - and may have dipped into negative territory in the first quarter of 2008.

Or the chatter might be a false alarm. We were struck over the weekend by a punchy post from economic forecaster Donald Luskin on SmartMoney.com: "Economic Recovery Already Underway." His thesis: "What a difference a month makes! ... Compared to the bleak expectations then, even just hanging in there would have been an upside surprise. But it's more than that. Things actually are getting better."

The wealth of up-tilting data Luskin cites won't silence the gloomiest Jeremiahs. But it plays havoc with their recent fun: predicting a second Great Depression. So before our economy emerges from its torpor (or whatever it does next), this is a useful time to explore what happened in the Depression - and what it taught us about handling a devastating economic collapse.

In the depth of the Depression, 1933, the jobless rate was 25 percent (roughly five times today's). Economic output had shrunk more than 30 percent. Trade shriveled. Nearly 11,000 banks failed - 43 percent of all U.S. banks. Bread lines lengthened. Desperate, dispossessed people searching for work roamed the nation on foot, in rattle-trap Model T's, and by hitching rides on the rails.

The Depression was a decade-long series of calamities. It began with the stock market crash of 1929, which, almost overnight, wiped out 40 percent of the value of stocks. Each time the economy seemed to gain traction, well-intentioned but wrongheaded government policies sank it anew:

Congress passed the 1930 Smoot-Hawley Tariff Act to blunt competition from low-priced imports. But retaliatory actions overseas closed foreign markets for U.S. exports, primarily farm goods. Prices plummeted. President Herbert Hoover urged businesses to keep wages high to protect workers' purchasing power. Many complied. That led to the odd specter of sharply higher wage rates in 1930 and 1931 - but many fewer jobs.

Why so? Had wages dropped along with prices, employers might have kept more workers. Washington raised taxes in 1932, leaving those who still had jobs with a greater burden. Even as bank panics grew epidemic, the Federal Reserve allowed the nation's money supply to shrink by more than 30 percent between 1929 and 1933.

President Franklin D. Roosevelt's first attempts to jump-start recovery - the Agricultural Adjustment Act and the National Recovery Administration - were aimed at eliminating competition and reducing production. As late as 1937, the government pursued policies to increase the cost of labor and shrink the money supply.

Social Security, jobless benefits and bank deposit insurance are all legacies of the Depression that today serve to blunt the hard edges of downturns. So is a much larger role for government regulation and intervention. The upshot?

Today's Fed chairman, Ben Bernanke, is a student of the Great Depression. His creative approach to this year's crisis is the mirror opposite of what the central bank did in the 1930s. Bernanke's Fed has lowered interest rates, flooded markets with liquidity and prevented an investment bank failure that could have cascaded into public panic - and more failures. Many economists think that, as a result, we've traded a potential crisis for a long stretch of slow growth.

Since World War II, the United States has endured 10 recessions - unofficially defined as at least six months of declining economic output. They lasted an average of 10 months, during which unemployment rose by 2 or 3 percentage points and economic output dropped by about 2 percentage points.

So if the TV talking heads who spent the winter warning of a second Great Depression scared you into a bunker, it may be safe to step out in the sunshine. We'll need more bad news and some serious policy mistakes to make this downturn a replay of the '30s.



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