How bad is the current recession in the centres of the global economy? Some pundits have claimed that it is the worst shock since the Great Depression of the early 1930s. They point to a lethal cocktail of a burst housing bubble, a credit crunch, and an explosion of energy and food prices. The prospect is for an ‘inflationary recession’ of devastating proportions.
Up to now any comparison with the 1930s is hysterical, rather than rational. The Great Depression was triggered off by a collapse of agricultural and commodity prices: today the prices of energy and foodstuffs are still rising, to the benefit of their producers, including Russia. In the Great Depression output in the main industrial countries fell by between 10 and 20 per cent. Today the worst we are promised is a slowdown in GDP growth. In 1929 Wall Street collapsed, and thousands of banks went bust. Today, after a ‘blip’, stock markets are up, and there has been only one bank failure in the USA (Bear Stearns) and another in Britain (Northern Rock) It seems likely that America has weathered the storm, and if America stops hiccupping, the rest of the world can breathe easier.
Why has the threat of disaster receded? First, the structure of the world economy is more stable than in the past. Rapidly falling transport and communications costs have created a single world economy. The world economy has absorbed three billion extra consumers, chiefly from China and India. Financial liberalization has spread risk, bringing down the cost of borrowing. Government spending everywhere is a much higher proportion of GDP than it was in the 1930s. Finally, we live in a world of paper money. This is bad for inflation, but it does give governments and banks unprecedented power to rescue their financial systems. An important cause of the severity of the downturn of the 1930s was that central banks in Europe ran out of gold.
Secondly, .there had been a very strong policy response, especially in the United States. So far the Bush tax cut has put an extra $150bn. into the pockets of the American consumer, with $150bn. to follow. The banking system has been refinanced. The dollar has been allowed to depreciate, reviving American manufacturing exports, and reducing America’s trade deficit.
A slowdown in global growth is still likely over the next few years. The huge fall in house prices in parts of the United States (in California, Florida, and Nevada) is bound to slow down consumer spending as households rebuild their wealth. The shrinkage of the US trade deficit will remove its stimulating effect. Europe will therefore grow more slowly.
China and India cannot de-couple from rising food and energy prices, which will retard their development. The best outcome for the energy summit at Jeddah on 22 June would be a credible plan to boost the supply of oil and reduce its demand, but this is too much to expect.
George Soros is quite right to say that de-regulated financial markets are bound to be much more volatile than regulated ones. But one of the lessons of the present crisis is that the links between the financial sector and the real economy are weaker than has hitherto been supposed. It may be that financial markets function as shock absorbers, dampening down business fluctuations.
There are still serious downside risks. Slowdown in US growth will weaken Europe. Rising food and energy prices will weaken China and India, which will in turn weaken demand for American and European good. The risk is of a series of slowdowns feeding back on each other. But let us banish further talk of another Great Depression. It will not happen.
Robert Skidelsky 