Many believe that our economy is at a point of no return, and that we are heading into another depression. There are even predictions of another civil war in the U.S. due to the current economic situation. That is how negative of an outlook some of us have for the future of the U.S.
Only time will tell how telling such beliefs are. Myself being one that disagrees with these foretellings, I have a different prediction. I believe that people are confusing this certain interest that economists have in the Great Depression today to be something bad. Yes, it is true that economists have shown a great interest in studying the depression recently, but that does not mean what we are experiencing now is anything like the Great Depression. The study of the Great Depression is nothing more than a guide for policymakers to make sure that history does not repeat itself.
What happened during the depression of the 1930’s can be explained by the debt-deflation theory. This theory describes the effects of an unexpected fall in prices due to a decrease in the availability of credit, assuming that most demand prior to that point was created by debt. With this reduction in demand, there was less products and services being purchased, and businesses required less being produced. With this, less people were employed, and even less demand was the result of it, production was cut back by even more, more jobs were lost, and this cycle continued. This sounds like what is happening today, however it just isn’t. The depths of the Great Depression has it’s roots in how the Federal Government and Central Bank chose to react to it.
There are a couple of mistakes made in the 1930’s which helped further the depression. One of these mistakes was that of the Federal Reserve Bank allowing the money supply to fall by 25% from 1929 to 1930, then also allowing the money supply to decline even further each year following that. This continued decline in the money supply was the result of numerous bank failures. Banks during that time were allowed to fail, which in turn worsened the already falling consumption and investment rates (keep in mind that banks have the role of providing funds to those that need it when they need it). As a result, businesses and individuals in need of funds at the time had no access to it.
The Federal Government was also to blame, as they tried their best to maintain a balance budget, rather than save the economy. Though there were a number of programs that went into effect during the Great Depression to help relieve Americans of their struggles, such as public works and farm subsidies, this was accompanied by tax increases. The Revenue Act increased taxes on mostly lower and middle income consumers starting in 1932. Meanwhile the unemployment rate had just reached 24% that same year.
Today things are definitely different. When our major banks began to face insolvency in 2007, the government did not ignore it. These financial institutions were saved by the well known $800 billion bailout. Though too many people view the bailout as unjust, these very institutions today are providing liquidity to our economy to get it going again. The government had also taken it upon themselves to consider the needs of it’s citizens facing unemployment and smaller incomes with the $787 billion Stimulus Package that addresses everything from tax cuts to job creation. If you would like to track government spending as far as the Stimulus Package goes, you may visit www.recovery.gov . Based on this web site, the Stimulus Package has helped make the following possible:
- 640,329 jobs have been created
- $288 billion will be going to tax cuts, of which $92.8 billion has already been spent
- $275 billion will be going to contracts, grants and loans, of which $69.6 billion has already been spent
- $224 billion will be going to entitlements, of which $97.5 billion has already been spent
To add to this, the Federal Reserve Bank has kept a close eye on the money supply. So much so that they have not hesitated to open their discount window to financial institutions in need starting in 2007. In addition, they have even created new bodies to provide more liquidity to the institutions that need it in the coming days (note that this is possible due to the dollar becoming a floating currency; one that is not backed by commodity, unlike in 1929 when the dollar was backed by the gold standard and the money supply was limited). These newly created bodies include:
- Term Auction Facility
- Term Security Lending Facility
- Primary Dealer Credit Facility
- Interest on Reserves
- Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
- Commercial Paper Funding Facility
- Money Market Investor Funding Facility
It is true that the cost of living is going up, which include increases in State taxes. Some may argue that these rises in the cost of living will make the increase in government spending meager. So the question now is, will the rising cost of living offset the efforts of the Government and the Central Bank to prevent another depression? This is something I will talk more about in the next post.
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