The Economic Crisis Mirrored (part 3 of 3)

Written on February 6, 2009 by Rolf Strom-Olsen in Arts & Cultures & Societies

Rolf Strom-Olsen

Part 1 Consumer Panic   
Part 2 Providing Cash

Part 3. Is Hope Enough?


By early 1932 it was clear that in the US opportunity beckoned for profound political change. By this point, the economic recession of 1930 had turned into full-fledged depression with soaring unemployment and bank failures, a deep freeze in credit, rising foreclosures. A frustrated American left, which had been sidelined for over a decade by three successive business-friendly Republican administrations, looked expectantly to the Democratic Party as the vehicle for change. (One of the groups that came into the Democratic fold was agricultural workers whose later slogan, si se puede, would eventually be recycled into a presidential campaign theme.)

The ineffectiveness of the Hoover Administration's policies was matched by a general inability to fathom the degree to which an economy could contract and the complicated calculus that led to the erosion of confidence. The creation of the Federal Reserve system, which was supposed to have given government a greater ability to manage monetary policy, ended up aggravating the problem in a climate of political economy that was unable to grasp the magnitude of what was taking place. As the current Fed Chairman Ben Bernanke observed in his 1983 paper:      

With the advent of the Federal Reserve the roughly stable institutional arrangement [that had earlier contained financial panics] was upset. Although the Federal Reserve introduced no specific injunctions against the suspension of convertibility [i.e. of a bank’s assets], the clearing houses apparently felt the existence of the new institution relieved them of the responsibility of fighting runs [on banks]. Unfortunately, the Federal Reserve turned out to be unable or unwilling to assume this responsibility. (Ben Bernanke, "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," The American Economic Review, Vol. 73, No. 3 (Jun., 1983), 260. Emphasis is mine.)

It was not inability, it was unwillingness, since the prevailing political thought of the day was unable to imagine the kind of intervention that, in the end, would have proven necessary to forestall the worst of the crisis. That helped to turn a nasty recession into a catastrophic Depression. Given the speed with which the consumer economy can react psychologically to perceived rapid economic decline, it is clear that the window of intervention is brief, and the scale of intervention must be massive. By failing to act in 1929/30, the Fed let the perceived crisis turn itself into a reality. By the middle of 1930, the consumer freeze had precipitated a major decline in industrial production. The US banking sector was plunged into crisis; many banks went under and those that did survive stopped extending credit except to the safest of bets. These factors fed upon each other, creating massive unemployment and home foreclosures, industrial retraction and deflation.

John Dos Passos, the progressive American author, attended the 1932 Democratic convention for the magazine The New Republic.  Popular clamour for more effective policies placed the Democratic Party and its candidate under enormous pressure to bring about a new era of change and hope. Dos Passos was not impressed with the party's choice. "This stalwart Democrat," Dos Passos wrote of Franklin Delano Roosevelt,

was to rise in his might, wrench the government out of the hands of the old bogey Republicans, Wall Street, Privilege, Graft and Corruption, return it to the People and thus in some mystic way give jobs to the jobless, relieve the farmers of their mortgages, save the money the little fellow had deposited in teetering banks, restore business to the small storekeeper and producer … But when the myth took flesh in the crippled boy and unassuming speech of the actual Governor of New York, the illusion crashed. Too late.

Dos Passos, who had spent the last decade flirting with various blends of mostly non-Marxist leftism, objected to the class interests that FDR represented: rich and privileged, from an old Northeast family. For Dos Passos, the Democrats choice amounted to political calumny and betrayal. The nasty personal jab he leveled at the polio-stricken FDR – the crippled boy – adds a dollop of viciousness to flavour his epic historical misjudgment.

Dos Passos was right about one thing though. It was too late – not, as he thought, for the opportunity to reinvent social policy and the role of government in the lives of the citizenry, nor to implement the kinds of progressive legislative initiatives that were simmering in the political thought of the day. But it was too late to counter the crippling impact of economic decline. By the time Roosevelt assumed office in March 1933, the scale of decline was unthinkable. Fully half the workforce in the US was either un- or under- employed. In the climate of the 1930s, the scale of government intervention that would have been required to lift the US, indeed the world economy out of Depression was simply unimaginable. When Roosevelt took office, he brought with him a great hope for restoring  economic vitality. But hope was simply not enough; it was the Second World War, an event so singular and traumatic, that finally pushed lawmakers into the kind of action that created conditions for recovery. That, simply put, was massive amounts of public debt. By 1945, US government debt had reached 120% of GDP. War spending accomplished what the New Deal could not.

The current debate over President Obama's massive stimulus package is very reminiscent of the 1930s debate over the role government can play in restoring economic health. As Obama deals with the extraordinary economic mess left him by his predecessor, the lessons of the Great Depression are, I think, relatively easy to assimilate and appear to be taking shape in the policies of the new Administration. The creation of a "bad bank" – a government-backed repository for junk assets – is one example of acting to defuse the structural problems that in the 1930s choked credit availability. But if history serves as a reliable guide, tens of trillions of dollars in public debt will be needed to right the staggering economies around the world.


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