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We've Been Here Before

Black Tuesday and How We Got Out of It

by MIKE WHITNEY

October 29, marks the 80th anniversary of the Stock Market Crash of 1929, the event which most historians point to as the beginning of the Great Depression. On Black Tuesday, traders dumped 16 million shares in one day, sending the markets into freefall.  In the months that followed, stocks rallied — sometimes for long periods at a time — but the underlying economy continued to deteriorate as consumers curtailed spending and cut back sharply on credit. As a result, hundreds of banks were shuttered, thousands of businesses failed, and unemployment soared to 25 percent. Public confidence plunged and the economy slipped into a decade-long slump. Tariffs were thrown up, international trade slowed to a crawl, and shanty towns began to sprout up across the country. 

In his article, "The Main Causes of the Great Depression" Paul Alexander Gusmorino said:

"Many factors played a role in bringing about the Great Depression, however, the main cause was the combination of the greatly unequal distribution of wealth throughout the 1920’s, and the extensive stock market speculation that took place during the latter part that same decade".

Income disparity widened throughout the 1920’s. While disposable income rose 9 percent from 1920 to 1929, those in the top 1 percent enjoyed a 75 percent boost in disposable income. A similar, though larger, gap has emerged in recent years as a larger share of the nation’s wealth has been shifted to the country’s richest people.

"By 2006 the top 1 percent of households received close to a quarter of all income and the top 10 percent got 50 percent of the income pie. In 2006, the 400 richest Americans had a collective net wealth of $1.6 trillion, more than the combined wealth of the bottom 150 million people. This degree of income and wealth inequality was last seen just before the beginning of the Great Depression." ("The ABCs of the Economic Crisis: What Working People Need to Know" By Fred Magdoff and Michael Yates, Monthly Review Press)

Also, between 1925 and 1929 total credit more than doubled (from $1.38 billion to around $3 billion) just as it has in the last decade. According to McKinsey Global Institute:

"Between 2000 and 2007 US households led a national borrowing binge nearly doubling their outstanding debt to $13.8 trillion. The amount of US household debt amassed by 2007 was unprecedented whether measured in nominal terms, as a share of GDP (98 per cent) or as a ratio of liabilities to personal disposable income (138 per cent) (McKinsey Global Institute, "Will U.S. Consumer Debt Reduction Cripple the Recovery?")

Stagnant wages, shrinking personal savings, and record household debt, have created conditions nearly identical to those preceding the Great Depression. The symptoms have been masked by the trillions in monetary and fiscal stimulus, but the glaring inequality and the huge burden of personal debt portend a long period of misery ahead.  People are poorer than before the crisis, and their needs need to be addressed by the government. The economist James K. Galbraith takes aim at the current policy in a recent article in the Washington Monthly:

"The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.

“But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.

“The credit flow metaphor implies that people came flocking to the new-car showrooms last November and were turned away because there were no loans to be had. This is not true—what happened was that people stopped coming in. And they stopped coming in because, suddenly, they felt poor." ("No Return to Normal:Why the economic crisis, and its solution, are bigger than you think" James K. Galbraith, Washington Monthly)

Key policymakers in the Obama administration don’t seem to grasp the problem at hand. That’s made a bad situation even worse. Galbraith thinks that we’re using the wrong model for dealing with a Depression. If the banking system is broken and consumers are too burdened with debt to spend, then alternatives need to be considered.

James K. Galbraith again:

"Roosevelt employed Americans on a vast scale, bringing the unemployment rates down to levels that were tolerable, even before the war—from 25 percent in 1933 to below 10 percent in 1936…

The New Deal rebuilt America physically, providing a foundation (the TVA’s power plants, for example) from which the mobilization of World War II could be launched. But it also saved the country politically and morally, providing jobs, hope, and confidence that in the end democracy was worth preserving. There were many, in the 1930s, who did not think so.

“What did not recover, under Roosevelt, was the private banking system. Borrowing and lending—mortgages and home construction—contributed far less to the growth of output in the 1930s and ’40s than they had in the 1920s or would come to do after the war. If they had savings at all, people stayed in Treasuries, and despite huge deficits interest rates for federal debt remained near zero. The liquidity trap wasn’t overcome until the war ended….. the relaunching of private finance took twenty years, and the war besides.

“A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around."("No Return to Normal:Why the economic crisis, and its solution, are bigger than you think" James K. Galbraith, Washington Monthly)

History can help point the way out of this mess, but not if policymakers shrug-off the lessons of the past and press on with half-measures that just eat up resources and extend the misery.  Stuffing the banks with reserves and hoping that struggling consumers start borrowing again, is pointless. It is equally pointless to ignore tattered household balance sheets which will have to be patched before spending resumes. Government has to get more engaged and play a bigger role. This isn’t a problem that can be worked out by the Fed and Treasury alone. It will take a major public mobilization, similar to preparing for a war. Federal money will have to be used to make up for lost state revenues. Government work programs will have to be created to rebuild critical infrastructure, expand green technologies, and modernize energy systems. At the same time, the administration will have to re-regulate the financial system, resolve or euthanize insolvent banks, and create a system of locally-controlled banks which function as public utilities to provide low interest loans to businesses and consumers.

All of this will cost trillions; trillions that won’t be flushed down a black-hole on Wall Street or used as bonuses for shifty bank tycoons. In other words, money well spent.

Big government means big deficits, and the looming threat of capital flight. Will central banks and foreign investors grow wary of the deficits and ditch the dollar and US Treasuries? No way. The world is looking for leadership; for some indication that the US still knows how to shape its own future and clean up its own nest. They want to see the Obama administration "take charge" and fix the banking system, conduct criminal investigations, increase regulation, restore confidence in the markets, and rebuild the engine of global demand, the middle class.

This is a job for big government. Big government is back. 

MIKE WHITNEY lives in Washington state. He can be reached at fergiewhitney@msn.com