THE BEAR'S LAIR
Creating a great depressionBy Martin Hutchinson
Financial downturns are unpleasant, but they do not need to turn into the Great Depression, which historians now agree was the product primarily of a number of egregious policy mistakes. For almost 80 years, we have thus felt safe from a recurrence of the "Great Depression" phenomenon, primarily on the basis of "we have learned from those mistakes - nobody would today be so stupid."
Sadly, recent events suggest that this optimism may have been misplaced and that politicians, never the most economically intelligent of mankind, may be working towards the considerable feat of constructing a Great Depression - Mark II.
The bull market before 1929 was sold for a generation as unprecedented in size, representing an apogee of speculation that had never been seen before and would never be seen again. We now know that to be rubbish. Radio Corporation of America, the Google or Microsoft of the period, never sold for more than 28 times earnings, a generous valuation to be sure but nothing compared with the stratospheric prices reached by the more fashionable dot-coms in 1999-2000.
The stock market capitalization to US gross domestic product ratio peaked in 1929 at 75%, above the long-term average of 58%, equal to the 1966 peak, but less than half of the 185% it reached in 1999 and still substantially less than the 105% of GDP at the end of 2007. Then there was housing, which in the 1920s enjoyed no great boom outside Florida (partly because mortgage finance was then very conservative) and so did not represent a giant overhang of overpriced assets ready to crush the economy when markets turned.
While the asset bubble awaiting deflation in 1929 was smaller than those of 2000 or 2007 (or that in Japan in 1990) the global economy of 1929 had other weaknesses. The world payments balance had not recovered fully from World War I, so continental Europe was dependent on loans from the New York money market, as was much of Latin America. US and most European tariffs were much higher than currently, while the British Empire was running an entirely self-defeating unilateral free trade policy, with a currency that was linked to gold and considerably overvalued - thus Britain had largely failed to share in the US boom of the 1920s. ......(more)
The complete piece is at:
http://www.atimes.com/atimes/Global_Economy/JJ01Dj02.html