Monday, March 9, 2009

Monday Morning Musings on the Economy.

The second week of March and we wake up to snowfall in the Village on the Edge of the Rainforest.


A few ramblings this A.M.

The U.S. economy’s vital signs may not confirm a diagnosis of depression but the symptoms increasingly point to one. As mentioned in an earlier post, many comparisions are being made to the Great Depression of the 1930s: world trade is collapsing, wealth is evaporating and the banking system is broken. Deflation is a growing threat as companies slash production, pay and prices. And leaders worldwide are having difficulty making headway in halting the self-perpetuating decline.

A few comments from around North America...

“We are tracking 1929-1930,” says Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley.

“You’ve had a major disruption of the financial system, just like the 1930s,” says Mark Gertler, a New York University professor who collaborated on research about the Depression with Fed Chairman Ben S. Bernanke. "In the 30s, more than 10,000 banks went bust. That disruption is making it hard for Bernanke and his fellow policy makers to get much traction in their efforts to stop the economic decline. Strapped with losses, banks are hoarding capital rather than lending."

"This type of breakdown happens only two or three times a century and can lead to a 'downward vortex' in which weaknesses in the economy and the financial industry feed on each other and are difficult to break," Lawrence Summers, director of the White House’s National Economic Council, said Feb. 26. “It’s the kind of vicious cycle Franklin Roosevelt talked about,” he told a forum in Arlington, Virginia.

Stanford University professor Robert Hall says, "Particularly worrying is the collapse of the jobs market. Over the past four months, payrolls have plunged 2.6 million. It raises the concern about a return of deflation, which wreaked havoc on the economy during the Great Depression. As wages fell back then, workers had a harder time paying their debts, aggravating the banking industry’s woes."

The disconcerting result these experts fear?

This contraction may leave a lasting imprint on the economy and society, just as the Depression did. In the wake of the devastation of the 1930s, Americans swore off stocks, husbanded their own resources and looked to the government for help. Now, another generation might draw some of the same lessons from the deepest economic collapse of their lifetime.

“This is going to scar the collective psyche,” says Mark Zandi, chief economist at Moody’s in West Chester, Pennsylvania. “People will become much more conservative in borrowing, lending and investing.”

There’s no official definition of what qualifies as a depression. In the 1930s, the unemployment rate rose to 25 percent and the economy shrank by more than a quarter. No economist forecasts a return to the breadlines and shantytowns of that era, even as the economy gets closer to some of the metrics academics cite as constituting a depression, if not a “great” one.

Nobel Prize-winning economist Robert Barro defines a depression as a 10 percent fall in per-capita gross domestic product and consumption. The Harvard University professor sees roughly a 30 percent chance of that occurring now. [recall that last week Mr. Barro had upped his odds from 20 percent to 30]

On the bright side, it is generally agreed that government officials, especially in the U.S., are moving more rapidly to tackle the turmoil than their counterparts did during the early years of the Great Depression. Bernanke has cut the benchmark interest rate to as low as zero, while President Barack Obama won congressional approval of a $787 billion stimulus package.

Massachusetts Institute of Technology professor Peter Temin says the trouble is that the economy seems to be collapsing faster than policy makers are reacting. “They’ve only done enough to cushion the downturn,” says Temin, author of the book 'Lessons from the Great Depression'. "That leaves the U.S. -- and the rest of the world economy - in danger of being mired in an extended period of little or no growth, much like that which afflicted Japan during the 1990s." Eichengreen says such an outcome would be equivalent to a depression.

“We’re in the midst of a massive economic and financial crisis,” former Fed Chairman Paul Volcker said at a Columbia University conference on Feb. 20. “We’re going to hear reverberations about this for a long time.”

More thoughts on this as the week progresses.



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