1937 redux?

Posted on Monday 4 January 2010


That 1937 Feeling
New York Times

By PAUL KRUGMAN
January 3, 2010

Here’s what’s coming in economic news: The next employment report could show the economy adding jobs for the first time in two years. The next G.D.P. report is likely to show solid growth in late 2009. There will be lots of bullish commentary — and the calls we’re already hearing for an end to stimulus, for reversing the steps the government and the Federal Reserve took to prop up the economy, will grow even louder. But if those calls are heeded, we’ll be repeating the great mistake of 1937, when the Fed and the Roosevelt administration decided that the Great Depression was over, that it was time for the economy to throw away its crutches. Spending was cut back, monetary policy was tightened — and the economy promptly plunged back into the depths.

This shouldn’t be happening. Both Ben Bernanke, the Fed chairman, and Christina Romer, who heads President Obama’s Council of Economic Advisers, are scholars of the Great Depression. Ms. Romer has warned explicitly against re-enacting the events of 1937. But those who remember the past sometimes repeat it anyway.
I love Paul Krugman, even though I sometimes want to argue with him. He assured us that we didn’t have an "oil bubble." He was into his green—oil-resources-are-finite—liberal mode [which is why I love him], but he was wrong as rain. We did have an oil bubble that was the straw that broke the camel’s back in 2008. He was all over Obama’s Stimulus Plan as too little, without acknowledging that Obama got the most possible at the time [after Bush’s trllion dollar give-away in his last days]. He’s gloomy about our recovery implying we could’ve done more. I think it’s fine for him to be gloomy, but it’s because we’re in a terrible Recession/Debt bind that we can’t do anything about right now – created by G. W. Bush and the Neoconservative Cowboys. But this time, in this article, Paul Krugman could not be righter.
… Which brings us to the still grim fundamentals of the economic situation. During the good years of the last decade, such as they were, growth was driven by a housing boom and a consumer spending surge. Neither is coming back. There can’t be a new housing boom while the nation is still strewn with vacant houses and apartments left behind by the previous boom, and consumers — who are $11 trillion poorer than they were before the housing bust — are in no position to return to the buy-now-save-never habits of yore.

What’s left? A boom in business investment would be really helpful right now. But it’s hard to see where such a boom would come from: industry is awash in excess capacity, and commercial rents are plunging in the face of a huge oversupply of office space. Can exports come to the rescue? For a while, a falling U.S. trade deficit helped cushion the economic slump. But the deficit is widening again, in part because China and other surplus countries are refusing to let their currencies adjust.

So the odds are that any good economic news you hear in the near future will be a blip, not an indication that we’re on our way to sustained recovery. But will policy makers misinterpret the news and repeat the mistakes of 1937? Actually, they already are….
Here’s what Krugman is referring to. On the left, the graph shows the Consumer Price Index during the Great Depression. For review, this is the cost of a standard package of goods over time. This crash in the CPI means that people are panicking and dropping prices to get rid of Inventory. It’s called a Deflationary Spiral and it’s the worst thing that can happen in a Capitalist economy. The graph on the right shows the Unemployment during the Great Depression. FDR was under the same pressure from the Republicans that Obama faces. He let up on the New Deal too soon and we headed for another round of Recession/Depression – saved by Pearl Harbor.
Although we’ve had cyclic Recessions since then, this current crisis is the first one that had the beginnings of a Deflationary Spiral!


The CPI in 2008 and the first 4 months of 2009

It’s what the Troubled Asset Relief Program and the American Recovery and Reinvestment Act helped us beat. Krugman is warning us not to make FDR’s mistake and back off too soon.
The Obama fiscal stimulus plan is expected to have its peak effect on G.D.P. and jobs around the middle of this year, then start fading out. That’s far too early: why withdraw support in the face of continuing mass unemployment? Congress should have enacted a second round of stimulus months ago, when it became clear that the slump was going to be deeper and longer than originally expected. But nothing was done — and the illusory good numbers we’re about to see will probably head off any further possibility of action.

Meanwhile, all the talk at the Fed is about the need for an “exit strategy” from its efforts to support the economy. One of those efforts, purchases of long-term U.S. government debt, has already come to an end. It’s widely expected that another, purchases of mortgage-backed securities, will end in a few months. This amounts to a monetary tightening, even if the Fed doesn’t raise interest rates directly — and there’s a lot of pressure on Mr. Bernanke to do that too.

Will the Fed realize, before it’s too late, that the job of fighting the slump isn’t finished? Will Congress do the same? If they don’t, 2010 will be a year that began in false economic hope and ended in grief.
The Republicans are in a bind here. If they force a cutback, the "1937" dip is inevitable. So it either has to be blocked or the consequences have to be clearly laid at their feet. The battle is going to be between Obama’s Pragmatism [will he stay the course?] and the Republicans’ blind ideology. [will they realize what they will do to the economy?]. If there’s a compromise, I don’t see it…

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