This crisis doesn't yet have a name. It has all the hallmarks of a depression, but people are understandably reluctant too use the D-word. So let me suggest one: The Great Collapse, since this was both a financial collapse and an ideological one.
This great collapse doesn't have to be a second Great Depression – if government does nearly everything right, and soon. And when we come out the other side, we could have a more decent and sustainable society.
But if government doesn't do more, and fast, this could be worse than the 1930s.
Why? Three big reasons:
Finance: A Doomsday Machine.
The financial system is in far worse shape than it was when the stock market crashed in October 1929. In the 1920s, we had a stock market bubble, mainly because people could play the market "on margin," borrowing to invest in stocks. There were also scams like the original Mr. Ponzi's. Like the present decade, the Federal Reserve helped to enable the game, with low interest rates and few rules.
But today, thanks to "securitization" of loans and the ability of insiders to create exotic and unfathomable financial instruments, the current speculative system makes buying stocks on margin look like child's play. In the aftermath of the crash of 2008, the process of sorting it all out and getting banks functioning again is something that markets simply cannot do.
We are not even clear who owns what. The wise guys on Wall Street invented a doomsday machine from which there is no market escape.
In 1929 when the stock market crashed, the banking system was relatively healthy. Bank customers played these speculative games and took the losses, not banks. This time, the banks drank their own Kool-Aid.
It took until the awful winter of 1932-1933 for the general depression to fully infect the banking system. Over 4,000 banks failed in that winter alone. But Roosevelt's cure -- deposit insurance and a temporary bank holiday to sort out good banks from bad -- quickly got the financial system up and running again. There were fewer bank failures after 1933 than in any year during the 1920s. Today, by contrast, the banking mess is still dragging down the real economy, with no effective cure in sight.
Collapsing Wealth, Dwindling Demand.
The economy now bears all the hallmarks of a depression. Between the housing collapse and the stock market crash, American households are out several trillion dollars (in the 1920s, there were no 401 (k) plans and less than 2 percent of Americans owned stock).
When people are suddenly out a lot of money, they spend less. Weak demand in one sector cascades into other sectors. People spend less on autos, air travel, hotels, restaurants, clothing -- any optional purchase. Business sales and profits are down, which causes other layoffs, and the cycle deepens.
Between 1929 and 1933, the stock market lost 89 percent of its value. This time, stocks are down about 50 percent from their 2007 peak. Worse is very likely to come, because stock values are based on two things -- corporate profits and expectations of future gains. Profits are continuing to slide, and few analysts expect a return to a bull market anytime soon. So there are more sellers than buyers.
As stocks slide, the values of retirement accounts diminish, and people feel even poorer, reducing their inclination to spend. That's why declining stock prices and collapsing demand feed on each other -- and why a dramatic increase in government demand is the only available cure.
Roosevelt was said to be a big spender, but his biggest peacetime deficit was only about 6 percent of gross domestic product. This year, the deficit will exceed 11 percent, and the recession will deepen all year. It took the truly massive deficits of World War II -- nearly 30 percent of GDP -- to finally end the Great Depression.
A Debtor Nation.
America in 1929 was a major international creditor. Today, we are the world's biggest debtor. The financial bubble of the past decade, puffed up by foreign borrowing, created the illusion of prosperity.
During the bubble years, the borrowing from overseas disguised domestic weaknesses, such as our much diminished manufacturing sector and the fact that wages for most Americans were not keeping up with inflation. Households, like Wall Street, became overly reliant on debt. For now, foreigners are still willing to lend us vast sums, but that may not continue indefinitely as nations like China invest more in their own internal development.
In 1933, we could go off the gold standard, not hold the dollar hostage to international currency trading, and concentrate on domestic recovery. If foreign currency traders feared that deficits would cause a drop in the value of the dollar, they didn't matter because we didn't owe them anything. This time, we have to worry about keeping their confidence. (The only reason why the dollar is holding its value is that the euro, for now, looks even shakier, and the Japanese and Chinese are resisting letting their currencies appreciate -- but that could also change.)
All of these economic calamities have solutions, but each is more radical that what's currently on offer. The government will have to temporarily nationalize major banks, sort out good assets from bad ones, and then return banks to responsible private ownership. To cure the housing collapse, government should directly refinance mortgages, rather than trying to bribe banks to ease terms.
Deficits will have to be a lot larger before they can get smaller. That should not require a war; this is just as grave a national emergency. Those deficits could purchase much broader prosperity, just as the World War II deficits did. If foreign borrowing dries up, we may need to sell massive amounts of recovery bonds to Americans, just as we relied on war bonds rather than borrowing from abroad during World War II.
If government is spending upward of a trillion dollars to stimulate demand, those dollars can be used for social investments that we should have had all along -- things like decent early childhood education and comprehensive health insurance and clean energy. The government needs to view these investments not as a one-shot but as an ongoing commitment to a just society.
President Obama needs to grasp just how radical a set of solutions we need. Then he needs to use his gifts as teacher-in-chief to persuade the public and the Congress to follow his lead.
Can America recover from a Great Collapse? Can we avert a second great depression? To coin a phrase, yes we can. But we need the right strategies and we don't have much time.
A shorter version of this article appeared in The Boston Globe.
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