Uncharted territory

October 16, 2012

I recently came across yet another excellent article by Steve Randy Waldman over at Interfluidity, which led me to several erudite posts from Ashwin Parameswaran at macroresilience.com. I’ve got a lot more reading to do but first wanted to share a simple thought.

One significant difference between the Great Depression and the Great Recession is, during the Great Depression, we essentially stood by and let the wave of bankruptcies wash over the entire financial system. It was a tragedy. Many otherwise healthy banks were washed away along with the hopelessly insolvent. Credit froze, unemployment soared. Millions of people suffered without work and income, lacking the means to care for themselves and their families.

However, once the flood receded, all the gross financial excess and disparity that led to disaster had been washed away. The economic terrain was now clear for more stable, balanced growth to resume. We had to endure a very painful decade to reach that point, but once we did, the economic skies were much bluer than they had been before. This “new beginning” of sorts led to the most stable and productive generation the world has ever seen. The standard of living of the average middle class worker improved more than during any other period in history.

Fast-forward to today. At the outset of the Great Recession, our immediate focus was to prevent the pain of the Great Depression from happening all over again. And we did, for the most part. We stepped in and saved the biggest of banks – the pillars of the global financial system – while letting thousands of smaller ones fail. These measures averted panic. Unemployment rose, but not as badly as during the 30s. After a few scary months, the financial system returned to business as usual. Since then, unemployment has slowly but steadily recovered.

Now we are entering uncharted territory. This is where the paths of the Great Depression and the Great Recession diverge. We prevented the wave from wiping out the big banks, and yes, this partially averted a global tragedy. But by doing so, we also prevented the wave from flushing away the financial excess and disparity – two significant contributors to the crisis. Not only did we preserve the system and the institutions that led us here, but we kept them essentially in tact, if not made them bigger. There’s been no change in leadership. Only minimal new regulation. The message we’ve sent is: “don’t worry, this wasn’t your fault.” We have allowed, if not encouraged, those institutions to resume what they were doing before, attitudes unchanged.

By preventing this tragedy from painfully washing over all of us, we’ve also prevented it from flushing away the source of our infection. I fear we’ve merely bandaged over our problems. They’re still there, festering under the surface, potentially fomenting a greater tragedy for our future. And I don’t mean after another 80 years of prosperity – I mean, within the next decade. Or maybe tomorrow.

Think about it. Nothing has changed, really. So why should we expect the macroeconomic outcome to be any different?

(I guess I’m feeling awfully Austrian today).

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One Response to “Uncharted territory”


  1. I think you got it right in your first post on this subject: Keynes is right, and the Austrians are also right.

    https://iamnottoosure.wordpress.com/2010/07/14/keynes-is-right/

    The problem seems to be that the people in both of these camps have trouble keeping two thoughts in their heads at the same time.

    The comment I want to make here is that both of these theories could have been used to predict the so-called “financial crisis” of 2008.

    From the Keynsian perspective, the crisis was a reaction to massive overspending in the preceding years. This led to a crazy level of inflation, which ended up primarily hitting the real estate market, thanks to the ongoing globalization of the world economy and limitless supply of cheap Chinese labour.

    From the Austrian perspective, the crisis was the outcome of too much money flowing into unproductive “investments”: Things that gave Americans short-term enjoyment instead of enabling them to solve more problems in the long term. Houses instead of highways. Factories in China instead of in America. Gambling and speculation, instead of real long-term investments. Wars instead of education. Debt instead of capital.

    Maybe I’ve got it wrong. I’m not an economist. But I think that both of these perspectives describe the same reality, and that you are right to warn against just kick-starting the economy while it’s still pointing towards the precipice. All those failed investments have given us what I consider to be a deep structural problem. People have trained for the wrong professions. Money has been poured into the wrong holes. Just look at Spain, where tens of thousands of youths spent years mistakenly learning how to put up luxury houses that nobody now needs. Turning all this around is going to take time. The reason I support Obama is that I believe that the economy behaves very much like a boat: It can’t be steered unless it’s moving, and you there’s no way you can get it moving if you have first steered it (or let it drift) onto the rocks. Then you basically had to do what they did after the Great Depression, which was to build a completely new economy round the biggest public works project of all times, which was the second world war.


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