Thinking outside the 1930s box
- 7 October 2011
- From the section Business
There are two kinds of people at present: those who know in a vague way that the 1930s was a bad time, and those who have studied the detail and understand the economics of why it went bad.
The latter are now getting publicly terrified because they can see, very clearly, the danger of doing it all again.
They include Sir Mervyn King on Sky last night: "This is the most serious financial crisis at least since the 1930s, if not ever." And Barack Obama, whose comment "Europe is scaring the world" hit the nail on the head.
But even as people dig out their old books about that concatenation of accident, stupidity and miscommunication that caused the Great Depression, I want to throw in another thought: it could be worse than the 1930s if we let it happen.
I suspect this is what was in the back of Mervyn King's mind when he added that "if not ever" comment. To understand why, here is a brief reminder of what happened:
1. From 1929 to 1932 the main government in the firing line - America - operated a pro-cyclical policy of deflation: that is, making the downturn worse in the belief that it would "cleanse the system". This caused a debt-deflation spiral in America that infected the rest of the world.
2. By 1931 the stress in the global system was about to take down institutions at the opposite end to America: Credit Anstalt bank in Vienna sparked the 1931 banking crisis, which quickly spread to Bank of the United States (see my October 2009 film on 70 years after). Deflation took hold in many countries.
3. Adherence to an unsustainable currency union - the Gold Standard - then forced governments to continue deflation-worsening policies, provoking social unrest and inter-country tension over unpaid debts (in this case war reparations, but still debts).
4. As I've said repeatedly: those who came off Gold first recovered first - but the exception proves the rule of why. Germany continued with austerity policies for a year after it came off Gold and did not recover in time to stop its politics degenerating into street fighting and fascism.
5. Both Japan and Germany then switched to deficit-financed, infrastructure-led expansion; Britain to a housing-led expansion, and America in 100 days of Franklin D Rooseveltturned its economy towards demand managed recovery, creating 12 million jobs in five years (to give you an idea of how, 40,000 of them were state employed actors and theatre directors).
6. The cost was the world economy disintegrated into near hermetically closed trading blocs, militarised politics, traumatised civil societies; with most politicians fearful of taking any pre-emptive action against the growing threat of Nazi Germany, and the majority in most democratic countries supporting appeasement and pacifism.
7. Then, after the double-dip of 1937, it was re-armament and war.
You may ask how it could possibly get worse than this.
In the first place, because we are a highly financialised world economy, in which the destabilising role of finance - when it goes wrong - is in proportion to its highly stabilising and dynamic role when it works right.
To read the account of the banking crisis of 1931 is to read a kind of analogue, pipe and slippers version of what could happen if we get another Lehman this time around, with a combination of sovereign and banking debt crisis.
Secondly because of globalisation. Globalised production lines, globalised labour markets, commodity markets, culture - all this acts like social superglue preventing any politician from even contemplating an overt protectionist or state-capitalist response.
While it was possible - just - for the Conservatives to admit defeat in 1992 and leave the ERM, it has become impossible for European and US politicians to defend anything other than the brittle front line of globalisation. Thus, lacking any ability to conduct a mobile or flexible defence, a controlled retreat, they risk the whole thing smashing open.
Third: there are no coherent alternatives. There are panic driven crisis plans - like the one the EU/IMF and EC are supposed to draw up, to recapitalise the European banks and stabilise country finances. But because there is no belief that, for example, a nationalised bank can do anything but harm, there is never any "germ of the new" inside the measures proposed.
This is in marked contrast to the 1930s when Keynes, Hjalmar Schacht (Hitler's Keynes) and Korekiyo Takahashi (Japan's finance minister) all understood how deficit financed growth could work inside economies fighting for their lives using trade and currency competition, and sealed off from the collapsing global finance system.
Social unrest is different this time. As I've reported from Greece it is "anomic" - that is, there is a tendency for societies to become listless, lawless, with low level social conflict and breakdown.
Such Communist parties that still have mass support - Portugal, Greece - do not want to take power; the hard right parties, such as LAOS in Greeceor the True Finns in Finland, want to be power broker, not prime ministers. That aside, in a Greek poll this morning, the leaders of the far left (SYRIZA) and the far right (LAOS) were the most popular politicians, each with 38%.
So if we look into Mervyn King's eyes and wonder what his nightmares might be, and indeed our own, it could be this: a situation where politics, economics and social unrest prove incapable of making the kind of switch that happened between 1931 and 1934.
Let me be clear - I am not advocating such a switch, but exploring the reasons why it is not going to happen, and what the alternatives are.
So then, in the absence of decisive policy action, you get a sequence that goes: crash (2008); stimulus (2009); failure of stimulus (2011); second crash (2011/12); deflation; involuntary collapse of globalisation. In that situation, which I profoundly hope does not happen, every government becomes like the Brüning administration in Germany after 1931, still trying to make the old policy work in the new world, increasingly resorting to decree.
Is there a way out? It is not the journalist's job to propose one, but it is the politicians and economists' job to address things clearly. I think Mervyn King did that yesterday: he said the maximum he could say and he did the maximum he could do, given the circumstances.
If we now see a round of bank recapitalisations and long-term sovereign bond-buying by the ECB it will leave Europe at least in a state described by one of my City contacts thus:
"I think that we face the quite real prospect that the market is removed as the determining mechanism for setting the price of capital within the eurozone at the sovereign level."
That is, Europe, through emergency, ad-hoc fiscal union, effectively removes its sovereign debt from the influence of market forces. If, in the process, the national states (backed by the IMF and EFSF) take major ownership stakes of recapitalised banks, you then also get the beginnings of state-directed lending, says my interlocutor:
"This would put internal credit creation back under the control of the state," they say, even if it only took the form of SME lending targets, credit easing and some infrastructure programmes.
Once you consider the enormity of this - a situation that many in modern politics, finance and economics might regard as the definition of "unfreedom", you understand why it has become so hard for Barroso, Merkel et al to formulate a plan. The plan is also their nightmare.