Part 1. When Consumers Panic
By all accounts, Ben Bernanke is an exceptionally intelligent, scholarly, and even-tempered fellow. These, I suspect, are good traits to have when, as things starts to crumble, you happen to find yourself the most important person in the world as the steward of roughly one quarter of the globe’s economic output. Bernanke’s predecessor, Alan Greenspan, was an ideologue in the style of post-war dogmatists, whose thinking was improbably shaped by the utopian economic primitivism of Russian émigrée demi-penseuse Ayn Rand. Perhaps we should not be surprised that the outcome of Mr. Greenspan’s tenure should have proven so disastrous, given that his economic perspective derives from a second-rate novelist whose overwrought epic Atlas Shrugged ends (as I recall) with a small group of free-wheeling capitalist pioneers setting up shop literally inside a mountain: James Bond meets Friedrich Hayek.
In a recent profile in the pages of the New Yorker that is well-worth reading, it seems clear enough that Ben Bernanke does not suffer from a surfeit of ideology, which is certainly a good thing since crisis and ideology are not comfortable bedfellows, as the devout Russian Marxists who were forced to swallow the New Economic Policy discovered after 1917. Perhaps the most salient feature of Bernanke’s past is that – oh Irony of Ironies – he was a student of the Great Depression before joining the Fed. In an important and frequently-cited paper he published in 1983, Bernanke argued that indecisive action from the Federal Reserve helped both perpetuate and deepen the crisis of the 1930s by starving markets of liquidity in service to a set of principles that were simply not germane in times of widespread economic collapse. (I’ll consider his arguments at greater length in Part 2). As the profile suggests, many of Bernanke’s actions over the last eighteen months have been shaped by his scholarly underpinnings to the financial and economic ruination of the 1930s. Which, on the whole, seems like a good thing. But while Bernanke can throw money at the financial system, he is largely helpess to do much about the consumer economy. This is frankly a worrying thing.
We have all, over the last few months, become unwitting students of the 1930s since our newspapers and magazines, radios and televisions, have been filled with ominous parallels between then and now. Politicians the world over have invoked the Great Depression in response to market dives, bank collapses, foreclosure spikes and careening unemployment trends. The parallels are, in certain instances, ominous.
Then, as now, a front-end market boom was built on a growing mountain of debt. Then, as now, the concentration of housing sector debt rose precipitously, from $11 billion in 1920 to $27 billion by 1929 (against national income of $87 billion.) Then, as now, the crisis was global in scale, starting in the financial system and spreading rapidly across the consumer economy as a whole.
And perhaps most sinister of all appear to be the parallels between the behaviour of the consumer economy, an aspect that I note is too frequently missing from today’s commentary. Simply put: after the 1929 crash, the global consumer economy stopped in its tracks. Although business spending continued largely apace for the next six months, consumers simply stopped borrowing and buying. That makes sense. There is an underlying inertia to large organisations; they cannot react that quickly to sudden changes in the economy. Consumers on the other hand, can react within weeks, or even days, and they do so with a predictable collective psychology. When things seem bad, we tend to retrench. When markets suffer stomach-churning declines, we tend to freak out. People freaked out in 1929, people freaked out in 1987 and we’re freaking out now. We stop borrowing, we stop spending. Indeed, we try to reduce our debt-levels, since the psychological liability of debt is closely correlated to consumer confidence.
There is an enormous body of literature on the psychology of consumer spending based on reams of data going back a generation. (Interestingly, one of the consequences of the Great Depression was improved statistics gathering.) John Matsukaka and Argia Sbordone asked a fairly obvious question in their 1995 paper, “Consumer Confidence and Economic Fluctuations:”
“If consumers become pessimistic about the state of the economy, can there be a slowdown in output, even if their pessimism is not based on economic fundamentals?”
Short answer: yes. For many economic historians and, indeed, economists generally, the 1929 crash and ensuing recession is an interesting historical artifact because it was the only moment for which we have good evidence as to how quickly the consumer economy contracted. The details of how over-indebtedness accumulated during the "Roaring Twenties" contaminated the global economy are still a matter of some debate. But the correlation between the resulting recession and reduced consumer spending needs no justification. And it was the combination of sharply reduced credit availability combined with consumer fear that pushed a recession into depression and depression into Great Depression. The question we are now facing is what can be gleaned from the historical precedents of the 1930s to avoid the current situation from becoming something rather worse.
It may, in fact, be too late to avoid depression.
One of the first casualties of the 1930 recession was the car industry. Vehicle sales plunged between
November 1929 and May 1930. Car makers were caught unawares. They had been profiting more
than most from the boom times of the 1920s since cars were the new must-have for the 1920s consumer. Moreover, the rise of easy credit meant that the automobile was becoming a mass consumer item, which could be financed in installments. When consumer fear took grip, this was the first “big-ticket” item to fall. The percentage of US households buying a car dropped from a peak of 24% in 1929 to less than 8% by 1933. (See the chart below, taken from Olney, 1999) Similar figures attained elsewhere. In Germany, for instance, of the 80-odd manufacturers that were in
existence in the 1920s, only a dozen survived through the next decade. Mass bankruptcies threw large numbers out of work, severely disrupting the core economy. Sound familiar?
Car sales are a canary in the coal mine, in 1930 as today. Only a few months ago, J.D. Powers, an industry analyst group, predicted a forthcoming “catastrophe” for the automotive sector, based on the impact of the credit crunch which they felt (accurately enough) would impede consumer ability to buy cars. But now, consider the change that took place in the month of October. Vehicle sales in the United States sank 36.7 percent in November to the lowest rate in 26 years. Perhaps this headline says it all: German car sales ‘plunging at unprecedented speed’ Actually, it is not really unprecedented, because this is what happened in 1930-1933.
Then, as now, a credit squeeze becomes a consumer freeze in a matter of weeks. And the “catastrophic” sales figures that J.D. Powers was predicting in August now appear to be positively robust compared to the scale of retraction in car sales we are likely to witness over the next six months. As with the many automaker bankruptcies of the 1930s, it seems likely that the world’s leading car makers will not survive the current climate without major layoffs, plant closings, and probably significant direct government intervention.
The similarities between 1930 and today in the rapid drop in car sales suggests to me that we are witnessing the first stage of a consumption collapse. And there are two points to consider in conclusion. First, the advent of consumption collapse is an independent, far-reaching and potentially catastrophic phenomenon that needs to be separated from its causes. In 1930, many state economists blamed cheap credit and expanding money supply through the 1920s for the recession. They therefore looked to credit and money supply (M2) policy for a solution, instead of finding ways to reduce the burden of individual debt management (by extending repayment schedules, for instance). Martha Olney provides an apt summary:
Households were shouldering an unprecedented burden of installment debt. Down payments were large. Contracts were short. Equity in durable goods was therefore acquired quickly. Missed installment payments triggered repossession, reducing consumer wealth in 1930 because households lost all acquired equity. Cutting consumption was the only viable strategy in 1930 for avoiding default.
So they did. And the result was a self-feeding decline in almost every sector of the economy that pushed down industrial production almost 50% in less than five years. Thus, once a consumption collapse has been triggered (November 1929, October 2008), it no longer matters what has induced it. It needs to be considered and remedied on its own terms.
Second, I suspect that in both 1929 and 2008, the individual, indebted consumer was aware (or fearful) that a day of reckoning was forthcoming. The unprecedented rise of equity markets, consumer spending, and household debt was not unconsciously achieved. People knew, even if only vaguely, that there could be a consequence for this kind of behaviour. Therefore, when the crash of 1929 occurred, it fulfilled expectations – what goes up must come down. And it was that expectation fulfillment that helps explain why the consumer economy collapsed so quickly.
And so, I fear, it is today. After years of cheap money and ballooning debt across the globe, I suspect that many have been harbouring similar, gnawing expectations that the good times would not last forever, that a foundation built off debt is a shaky one, that housing prices were not going to expand forever. The stock market tumble this September/October thus may have served the same role that the tumble in 1929 served. It fulfilled the expectation that the good times were over and that the time had come to reckon with the consequences for wanton economic bingeing.
(Part Two next week)
Articles Cited
Martha L. Olney (1999), “Avoiding Default: The Role of Credit in the Consumption Collapse of 1930.” Quarterly Journal of Economics CXIV (February 1999): 319-335
Matsusaka, John G & Sbordone, Argia M (1995), "Consumer Confidence and Economic Fluctuations," Economic Inquiry (Oxford University Press), v.33, no.2 (April 1995): 296-318
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