Monday, August 26th, 2019

The Chilling Ways The Current Global Economy Echoes The 1930s Depression Era

Published on February 21, 2016 by   ·   No Comments

John Coumarianos,/ MarketWatch.com,

One view of what caused the Great Depression in the 1930s is that the Federal Reserve failed to prevent a collapse in the money supply.

This is the famous thesis of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, 1867-1960, and it was, more or less, the view of Ben Bernanke when he was chairman of the Federal Reserve.

The global economy today resembles that of the 1930s in several ominous ways.

Financial author Edward Chancellor recently called attention to a paper written by Claudio Borio, head economist at the Bank of International Settlements (full paper below), that provides a fuller picture of the causes of the Great Depression. The paper also draws parallels between global economic conditions that led to the rise of protectionism in the 1930s and our situation now.

The paper’s thesis is that “financial elasticity” characterizes both the pre-Depression global economy and today’s global economy.  Elasticity refers to the buildup of capital imbalances such as money flows into emerging markets because of low rates in developed markets.

Free flowing capital to emerging markets

As Chancellor tells it, the gold exchange standard established in the 1920s allowed U.S. and U.K. bonds to be used together with gold in exchange transactions among central banks. This arrangement encouraged growth in foreign lending.

Specifically, the U.S. lent money to emerging markets in Latin America and Central Europe. Investors in the U.S. enjoyed higher returns for seemingly little extra risk as defaults were initially low.

However, lending standards began to loosen, and American investors brought their dollars home after the Fed hiked rates in 1928. Money flowed into U.S. stocks, among other things, which, of course were poised for a crash.

Capital flow reversal

This reversal of capital flows, combined with a drop in commodity prices, destabilized the emerging markets by 1929, sending their commodity producers into bankruptcy. In 1930, several South American countries devalued their currencies and defaulted on their debt.

The crisis spread to Austria, Germany, and eventually to Britain, a heavy lender to Central Europe. Britain eventually devalued its currency, but in the U.S. the Fed actually raised rates in late 1931 to stem gold outflows. A banking panic ensued, as the U.S. finally “felt the full force of the world depression,” according to Chancellor.

The result of these debt problems was the institution of capital controls. Capital no longer flowed freely among countries. International trade slowed due to tariffs, and foreign debts were not repaid. Economist John Maynard Keynes himself favored the move away from globalization, and Chancellor quotes him as writing, “Let goods be homespun, and, above all, let finance be primarily national.”

Today’s similarities with the 1930s

Now, as in the 1930s, the global economy is stretched. A low interest-rate regime in the developed world has encouraged lending to emerging markets. Additionally, China’s and Europe’s banking systems are burdened with bad debts.

Moreover, last year, as Chancellor reports, emerging markets experienced their first capital outflows in nearly three decades, and that movement of capital appears to be continuing in 2016. Ratings agencies have downgraded South Africa and Brazil sovereign debt, while commodity prices continue to plunge.

Read More HERE

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