This isn't new Great Depression – and it mustn't turn into one

Published on Tuesday 7 October 2008 21:37

IT HAPPENS that every man in a bank hates what the bank does, and yet the bank does it. The bank is something more than men, I tell you. It's the monster. Men made it, but they can't control it."

If John Steinbeck's great novel The Grapes of Wrath encapsulates the prevailing view of banking and finance in troubled times, it also offers some much needed perspective on the scale of the current financial crisis. Comparisons between the Great Depression (which effectively lasted from 1929 until the onset of the Second World War) and the credit crunch that began last autumn are overdrawn. In historical terms, what we are living through is small beer.

After the Wall Street crash of October 1929, tens of millions of people around the world were left jobless, homeless and hungry. By 1933, unemployment in the United States was running at 25 per cent; those lucky enough to have jobs were forced to take pay cuts and work fewer hours. In the four years after 1929, the entire US economy shrank by more than a quarter. In Britain, unemployment soared to 20 per cent by the end of 1930, although economic activity fell by significantly less than in America.

By contrast, unemployment in the US today is 6.1 per cent, while in Britain it is a little under 6 per cent. Annual GDP in both countries is still positive – just. And while many millions undoubtedly face financial hardship, there is no sign of the social unrest that plagued the 1930s (when the US Congress met in December 1932, police armed with tear gas and guns lined up on the steps of the Capitol to deter rioters).

Also, the sequence of events differs. It was a downturn in the US economy that caused the speculative share bubble of the late 1920s to burst, while the subprime tail is now wagging the economic dog.

That is not to say there are no parallels, nor that today's more globalised economy will avoid spiralling downwards into a deep and damaging recession as toxic debts kill off more banks.

The responses of US and European governments and financial authorities – the rescues of Fannie Mae and Freddie Mac and the major investment banks, apart from Lehman Brothers; the $700 billion bailout; the forced merger of HBOS and Lloyds TSB; and the relaxation of state borrowing rules – are borne of a fear of repeating the errors of the 1930s. Yet, as this week's continued market turmoil testifies, our politicians and central bankers still have a long way to go to be sure of avoiding catastrophe.

To modern eyes, the most notable feature of the Great Depression was the lack of action taken by governments. According to figures from the US Bureau of Census, 659 American banks failed in 1929, followed by 1,352 in 1930, 2,294 in 1931 and 4,004 in 1933. Yet fear of the kind of rapid inflation that had cut a swath through central European economies – Weimar Germany's in particular – in the 1920s deterred governments from injecting cash into the system.

The prevailing economic orthodoxy played its part too. Herbert Hoover, the US president, accepted the arguments of economists such as the Austrian migr Joseph Schumpeter, who insisted that depression was the only way for the economic system to purge itself of poisons.

Deficit-financing was heresy; balanced budgets were the order of the day. The British economist Lionel Robbins observed: "Nobody wishes for bankruptcies. Nobody likes liquidation as much … (But] when the extent of mal-investment and over-indebtedness has passed a certain limit, measures which postpone liquidation only tend to make matters worse."

With the US presidential election between John McCain and Barack Obama next month, it is worth remembering that the Great Depression cast Hoover and the Republicans out of office and shattered the economic consensus.

Much as with Obama, there was little in Franklin D Roosevelt's policy programme to suggest that he would extricate the US from the slump, but the president who became famous for his fireside chats with the American public, broadcast on radio, showed great leadership. Before he took the oath in March 1933, he ordered that every bank in the country be closed on the day of his inauguration.

With his famous "brains trust", he gradually worked his way towards a solution of sorts. His New Deal recognised what would become Keynesian economics – government intervention to bolster employment and thus the economy – although it would be the 1950s before Wall Street regained its pre-crash heights.

It is remarkable that, after the crash of 1929, the Federal Reserve Banks did cut interest rates, but too slowly to have any discernible effect. As they meet tomorrow to decide whether to cut rates, members of Britain's monetary policy committee, all of whom will be well versed in the history of the Great Depression, may well find themselves reflecting on that lesson. Surely the only issue will be by how much.

Equally, as a corrective to the prevailing wisdom surrounding Hank Paulson's $700 billion bailout, it is chilling to reflect that when the Federal Reserve eventually began pushing cash into the banking system under Roosevelt, the banks hoarded the cash for the day depositors came to get their money out. It took the creation of the Federal Deposit Insurance Corporation, which guaranteed bank deposits, to kick-start the system.

The scale of the banking crisis was responsible for the depth of the Great Depression and its longevity. It was, therefore, an underlying cause of the rise of fascism and the Second World War.

The onus on our politicians to ensure history does not repeat itself is enormous. They made this crisis; can they control it?

&#149 Paul Riddell is a journalist and author.