Lessons from history

Oct 13, 2008 Editorial

As the shockwaves from the meltdown in the financial world radiate from its epicentre in the United States, there are growing concerns, even in backwaters such as ours, about the intensity and possible duration of the economic slowdown that is already evident in widely diverse countries and economies.

The earlier precursors of bank failures in Britain and Germany, the quick pileup of goods in China and the “Eastern Tigers”, the drop in the flow of remittances from the developed countries to the homelands of the immigrants, and even the drop in the price of petroleum are all proffered as signals of the inter-relatedness of the world economy wrought by “globalization”.

While all of these observations are undoubtedly valid, there is a danger in evaluating the unfolding drama as a sui generis, unique event for which there have been no precedents from which we may derive lessons. This conclusion would be unwarranted.

While Karl Marx may have been the most trenchant critic of the economic system that evolved after the onset of the “Industrial Revolution” a couple of centuries ago, even those who reject his analysis have been forced to deal with the observed periodic rises and falls, even collapses, occasioned by the workings and apparent inherent logic of the “capitalist mode of production”.

The most dramatic crumbling of the system has been the “Great Depression” of the 1930s, to which the present crisis is being increasingly compared.

It is a fact, however, that the world came out of that depression and the system went on to greater successes; and in line with Marx’s prediction, to further subsequent cyclical behaviour. What lessons can we glean from that experience?

The Great Depression was preceded by the decade that saw an enormous increase in manufacturing output in the United States without a commensurate increase in real wages for the workers – who are the eventual consumers of much of that production.

The discrepancy resulted in record profits for those who were the owners of the corporations and the professional strata. These profits were ploughed back into increased asset ownership, reflected in an ebullient stock market, fuelled by speculation that hit a historic peak in 1929.

When volatility increased, speculation quickly morphed into fear, and the bubble popped: the wealthy cut back spending, the poor’s credit-supported spending was undercut. Demand plummeted, production followed suit, unemployment skyrocketed, and borrowers defaulted.

As ruined erstwhile millionaires plunged from the windows of skyscrapers, the policy tools that were crafted formed the basis of the modern interventionist governmental response to recessions or recessionary fears.

The US Government attempted to increase the availability of credit by lowering the reserve requirements for banks and benchmark interest rates. Fannie Mae and Freddy Mac were born to stabilize the housing free-fall through issuance of mortgages.

These proved inadequate to the crisis, and the recession spread across the world. In Guyana, the slowdown in demand for sugar forced wages in the industry to starvation levels.

These precipitated riots across the region, culminating in the Leonora strike and killings of 1939, which led the Moyne Commission that was taking evidence in Guyana on the situation of the sugar industry to propose far-reaching reforms, not only in the industry but in the governance structures of the colonies. The universal franchise was introduced.

However, it took WWII from 1939-1945 to pull the world out of the Great Depression. The cure almost killed the patient.

Since then, we have had several major scares – notably the Japanese property bubble crisis of the 1980s, from which Japan never really recovered. Japan had acquiesced to US demands to allow its currency to appreciate, leading to a sharp drop in exports.

The Government followed the standard recipe to lower interest rates, which encouraged borrowing, which precipitated speculative consumer and housing splurges. Sounds familiar? When the bubble burst after the Government predictably increased interest rates, deflation just as inevitably stepped in, which then triggered another round of lowered interest rates that just did not have the predicted effect. Japan remains mired in its “stagflation”.

We will return to some further lessons, but it should be quite apparent by now that new policy instruments will have to be forged to address the present crisis.

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