[Marxism] A second Great Depression is still possible

Louis Proyect lnp3 at panix.com
Mon Oct 12 07:17:44 MDT 2009

(posted to LBO-Talk by Ira Glazer)


Over the past year the global economy has experienced a massive 
contraction, the deepest since the Great Depression of the 1930s. But 
this spring, economists started talking of “green shoots” of recovery 
and that optimistic assessment quickly spread to Wall Street. More 
recently, on the anniversary of the Lehman Brothers crash, Ben Bernanke, 
Federal Reserve chairman, officially blessed this consensus by declaring 
the recession is “very likely over”.

The future is fundamentally uncertain, which always makes prediction a 
rash enterprise. That said there is a good chance the new consensus is 
wrong. Instead, there are solid grounds for believing the US economy 
will experience a second dip followed by extended stagnation that will 
qualify as the second Great Depression. Some indications to this effect 
are already rolling in with unexpectedly large US job losses in 
September and the crash in US automobile sales following the end of the 
“cash-for-clunkers” programme.

That rosy scenario thinking has returned to Wall Street should be no 
surprise. Wall Street profits from rising asset prices on which it 
charges a management fee, from deal-making on which it earns advisory 
fees, and from encouraging retail investors to buy stock, which boosts 
transaction fees. Such earnings are far larger when stock markets are 
rising, which explains Wall Street’s genetic propensity to pump the economy.

As for mainstream economists, their theoretical models were blind-sided 
by the crisis and only predict recovery because of the assumptions in 
the models. According to mainstream theory, it is assumed that full 
employment is a gravity point to which the economy is pulled back.

Empirical econometric models are equally questionable. They too predict 
gradual recovery but that is driven by patterns of reversion to trends 
found in past data. The problem, as investment professionals say, is 
that “past performance is no guide to future performance”. The economic 
crisis represents the implosion of the economic paradigm that has ruled 
US and global growth for the past thirty years. That paradigm was based 
on consumption fuelled by indebtedness and asset price inflation, and it 
is done.

There is a simple logic to why the economy will experience a second dip. 
That logic rests on the economics of deleveraging which inevitably 
produces a two-step correction. The first step has been worked through, 
and it triggered a financial crisis that caused the worst recession 
since the Great Depression. The second step has only just begun.

Deleveraging can be understood through a metaphor in which a car 
symbolises the economy. Borrowing is like stepping on the gas and 
accelerates economic activity. When borrowing stops, the foot comes off 
the pedal and the car slows down. However, the car’s trunk is now 
weighed down by accumulated debt so economic activity slows below its 
initial level.

With deleveraging, households increase saving and re-pay debt. This is 
the second step and it is like stepping on the brake, which causes the 
economy to slow further, in a motion akin to a double dip. Rapid 
deleveraging, as is happening now, is the equivalent of hitting the 
brakes hard. The only positive is it reduces debt, which is like 
removing weight from the trunk. That helps stabilise activity at a new 
lower level, but it does not speed up the car, as economists claim.

Unfortunately, the car metaphor only partially captures current 
conditions as it assumes the braking process is smooth. Yet, there has 
already been a financial crisis and the real economy is now infected by 
a multiplier process causing lower spending, massive job loss, and 
business failures. That plus deleveraging creates the possibility of a 
downward spiral, which would constitute a depression.

Such a spiral is captured by the metaphor of the Titanic, which was 
thought to be unsinkable owing to its sequentially structured bulkheads. 
However, those bulkheads had no ceilings, and when the Titanic hit an 
iceberg that gashed its side, the front bulkheads filled with water and 
pulled down the bow. Water then rippled into the aft bulkheads, causing 
the ship to sink.

The US economy has hit a debt iceberg. The resulting gash threatens to 
flood the economy’s stabilising mechanisms, which the economist Hyman 
Minsky termed “thwarting institutions”.

Unemployment insurance is not up to the scale of the problem and is 
expiring for many workers. That promises to further reduce spending and 
aggravate the foreclosure problem.

States are bound by balanced budget requirements and they are cutting 
spending and jobs. Consequently, the public sector is joining the 
private sector in contraction.

The destruction of household wealth means many households have near-zero 
or even negative net worth. That increases pressure to save and blocks 
access to borrowing that might jump-start a recovery. Moreover, both the 
household and business sector face extensive bankruptcies that amplify 
the downward multiplier shock and also limit future economic activity by 
destroying credit histories and access to credit.

Lastly, the US continues to bleed through the triple haemorrhage of the 
trade deficit that drains spending via imports, off-shoring of jobs, and 
off-shoring of new investment. This haemorrhage was evident in the 
cash-for-clunkers program in which eight of the top ten vehicles sold 
had foreign brands. Consequently, even enormous fiscal stimulus will be 
of diminished effect.

The financial crisis created an adverse feedback loop in financial 
markets. Unparalleled deleveraging and the multiplier process have 
created an adverse feedback loop in the real economy. That is a loop 
which is far harder to reverse, which is why a second Great Depression 
remains a real possibility.

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