Lords of Finance by Liaquat Ahamed (Part II of II)

After the stock market crash, came the recession that turned into the depression that became the Great Depression. This time around (2007-2009), the central bankers headed up by Dr. Ben Bernanke (who in my opinion has done a remarkable job) learned much from the mistakes of this earlier period and, indeed, avoided a catastrophe.

BABSON STATISTICAL ORGANIZATION (sounds similar to Morningstar today) provided charts and information on the markets based on two laws:

(1) The economy has ups and downs that operate according to definite laws

(2) Emotions are the most important factor in causing the business cycles

The Federal Government represented only 2.5% of GDP in 1929 (much nearer to 25% in 2009) and though they decreased taxes by 1% across the board it had little effect on the Wall Street collapse. The Fed reduced interest rates from 6% to 2.5% but again, too late to be effective.

During periods of investor fear, capital searches for security.

However, the banking system was allowed to fail and there was no FDIC insurance. In late 1931, Germany declared bankruptcy and refused to pay its debts to the world, the Bank of England dropped the gold standard and the Federal Reserve increased interest rates to 3.5%.

Production was down 50% (and some industries experienced capital utilization of as little as 12% of available capacity) in the U.S. and this was driving prices down at the rate of 7% per year. Can you say deflation unlike anything we have experienced in this 2009 calamity?

In 1933, as President Roosevelt took over the reigns from President Hoover, he closed all banks in March and when they finally reopened half had gone bankrupt and the average saver lost their savings. This did not happen in our economic crisis today thanks to FDIC insurance.

RECOVERY BEGINS

(1) When banks were reopened in 1933 deposits were guaranteed up to $2,500 stabilizing the banking industry
(2) Government salaries were cut 15% and all government department's budgets were cut 25% reducing government costs until the New Deal was to begin

And, most importantly:

(3) The U.S. abandoned the gold standard and devalued, therefore, the dollar by 40%
(4) This devaluation lifted prices, increased production and the real cost of borrowing plummeted. Stocks doubled in three months. The Great Depression was on the mend.
(5) GDP and prices went up on the average about 10% per year stopping deflation in its tracks

The last problem to go, unfortunately, was unemployment which was still high even as late as 1936.

IN COMPARISON TO TODAY

"In the 1930's, most depositors had to line up physically outside their bank to get their money. Now massive amounts of money are being siphoned off with the click of a mouse."

"In the current (2007-2009) crisis, central banks and treasuries around the world...have reacted with an unprecedented series of moves to inject gigantic amounts of liquidity into the credit market and provide capital to banks..."

I enjoyed this book and its viewpoint and now I am even more convinced that a repeat of the Great Depression with 25% unemployed and significant drops in production and prices is less likely with the safeguards now in place. Economic disasters may come but the recovery may come sooner too.