What Matters: Getting history right

22 April 2010

Social enterprise: It takes a network

By Raj Kumar

In Social Entrepreneurs

22 April 2010

Teaching the world to change

By Dan Viederman

In Social Entrepreneurs

22 April 2010

Innovating at scale in the social sector

By Jonathan Bays and Marla Capozzi

In Social Entrepreneurs

13 April 2010

The economics of social progress

By Iqbal Z. Quadir

In Social Entrepreneurs

Previous: Ian Bremmer interview transcript

Next: Global sourcing in a world less flat

Getting history right

By Francis J. Gavin

31 March 2009

In an effort to make sense of the recent chaos and confusion on global financial markets, many have looked to the past for answers and insights. The economic crisis is often compared to the Great Depression, which began with the collapse of the American stock market in 1929, spread around the world, and did not end in the United States until the Second World War. In the aftermath of the stock market crash, nations became inwardly focused and international cooperation was almost impossible to achieve—exacerbating the world’s economic and geopolitical problems. Are we doomed to repeat the cycle of nationalism and antiglobalization? Furthermore, when searching for solutions to today’s crisis, analysts and policymakers have looked to the success of the Bretton Woods conference in August 1944 in restoring confidence in international development and in monetary and trade relations by laying down agreed upon rules of the road and creating powerful global institutions. How relevant is this history to our current dilemmas?

Many economists have already pointed out the economic differences between the interwar and current crisis. The magnitude of the Great Depression was unprecedented and unlikely to be repeated—the unemployment rate in the United States reached 25 percent, home foreclosures were an order of magnitude larger, and the gross domestic product fell by almost half between 1929 and 1933. Furthermore, our economic policymakers and politicians have not repeated the disastrous policies of the past, which included raising interest rates and hiking trade barriers.

But the key differences between the current crisis and the past are less economic than political. The Great Depression was the offspring of the killing fields of Europe: the First World War had destroyed trading patterns, undermined currencies, and produced massive public debts. Who would foot the bill for this catastrophe? The Americans had financed the British and French victories, and expected to be paid back in full. The British and French demanded that Germany carry the cost by paying reparations. Germany —which been victorious on their Eastern front and had prevented Allied forces from entering their territory—had agreed to end the war in part because of Woodrow Wilson’s promise not to impose a victor’s peace. When this promise was broken and massive reparations were imposed, a bitter decade-long battle over who would pay what ensued. From this toxic environment of distrust and enmity emerged a series of unsustainable deals, whereby America financed Germany’s reparations to Britain and France, which were recycled back to the United States in the form of war debt payments. If American financing dried up – which it did during the late 1920s—the whole scheme would collapse, taking the international monetary system with it.

The political dimension of the interwar crisis was demonstrated when the largest bank in Central Europe, the Vienna-headquartered Creditanstalt Bank, failed in May 1931. While its balance sheets were troubled, the real cause of its collapse was the Bank of France’s withdrawal of support, initiated to protest a proposed customs union between Germany and Austria. France feared this free-trade agreement would lead to the eventual political union of the two German-speaking nations, tilting the military balance of power in Europe permanently against France. This collapse led to a crisis at the Bank of England (whose rescue attempt of Creditanstalt was overwhelmed) and the suspension of the pound sterling’s convertibility into gold. In other words, a bad economic situation was turned into a global catastrophe because of the unresolved geopolitical tensions in Europe.

Today, most of those long simmering geopolitical disputes have been resolved, and there is virtually no danger of a major war on the Continent. The European Union—for whatever its faults—pushes the nations of Europe to go beyond a purely nationalistic perspective and view the crisis through a regional and even a global lens.

What about the calls for a new Bretton Woods system? The meeting of world leaders in the New Hampshire resort in August 1944 sought, among other things, to rewrite the broken rules of international monetary relations. The conference did lead to the creation of the International Monetary Fund and World Bank. But the new international monetary rules were flawed from the start. Economists now recognize that countries can have two but not three of the following: national independence to set monetary policy, free capital flows, and fixed exchange rates. By trying to build a system that included all three, Bretton Woods system was unsustainable from the start. What emerged was an awkward system of fixed exchange rates, capital controls, and national autonomy marked by currency crises. Looking back, we tend to forget that growth in the developed world after World War II was the less the product of globalization than the recovery of war-devastated economies, the one-time productivity increases from the so-called green (agricultural) revolution, and preferential trade regimes like the European Economic Community (today’s European Union).

Despite these flaws, the postwar economic order had an important geopolitical logic. For example, the success of the European Union may have hurt American trade and capital, but this was a price well worth paying to bring peace and stability to the war-torn continent and to create a powerful counterweight to the Soviet Union during the Cold War. This logic also explains why we encouraged Japan to recover behind trade barriers, capital controls, and American military protection. The United States and other nations were able to put aside short-term interests for longer term political and economic gains that accrued to an entire region rather than a single country.

Why does any of this matter today? Because it is as dangerous to misread the past as it is to ignore it. The current financial crisis is serious and could get worse. There are valuable lessons from history that can be applied to policy today. But we should keep in mind we also have important advantages our forebearers did not. Most fortunately, we live in an era when the threat of a great power war in the developed world is remote. The major players may have their political differences, but nothing approaching the bitterness and distrust that marked international relations in the last century. In addition, the greater interconnectedness of the world that has grown up over the past 20 years will act as a counterweight to the tendency to pursue purely self-interested policies. This backdrop will make continued cooperation much easier, and should make another Great Depression far less likely.

Comment [9]

Agree? Disagree? Let us know what you think. Please include your full name with your comment. Comments may be edited.

Very interesting analysis. You argue that comparing today’s crisis to the Great Depression is misleading since the political situation between today’s major powers is nowhere as poisonous as it was in 1929.

While I agree with the facts that you summon to make your case, I disagree with your optimistic analysis of the threat of protectionism. Yes, the European Union has achieved full integration and yes, supply chains have become increasingly global. Nevertheless, the threat of protectionism is very real. Only last year, British Prime Minister Gordon Brown called for British jobs for British workers. In the same vein, the US Congress inserted the insidious ‘Buy American’ clause into its Recovery Bill, which further prevents companies receiving government assistance from hiring US-trained foreign students. No, the ghost of protectionism has not been exorcised.

Your analysis also makes the tacit assumption that the major powers in 1929 are the same players in today’s global game. This is clearly not the case. With India, China, Russia and Brazil on the global stage, do today’s political dynamics resemble those of 1929? What, for example, will happen to the global system if China or India implodes in today’s crisis?

While today’s crisis has not (yet) resulted in as precipitous a decline in world output as occurred during the Great Depression, its lessons are still relevant in dealing with the current crisis.

Posted 30 April 2009, 07:13 by Onajomo Akemu
Interesting article, but it reminds me of a remark by J.K. Galbraith. This sort of argument, he said, remains attractive because “it is simple, and exonerates both the American people and their economic system from any substantial blame”. Whereas, he argued, depression was a home-grown consequence of bad banking structure, bad distribution of income, bad economic intelligence and the dubious state of the foreign balance (though no mention of reparations). As for the state of corporate structure, he says (in The Great Crash), “The fact was that American enterprise in the twenties had opened its hospitable arms to an exceptional number of promoters, grafters, swindlers, impostors and frauds. This, in the long history of such activities, was a kind of flood tide of corporate larceny.”

So maybe there are some parallels with the current crisis after all.

Posted 27 April 2009, 11:17 by Peter Littlechild
In my opinion repeating the cycle of nationalism and antiglobalization would be an axiomatic denial of world economic growth and financial evolution since the Great Depression.
Understanding the main reasons of this Global Financial Crisis would help us maintain perspective and not following reactionary models and solutions. In order to avoid nationalism and antiglobalization, institutions having a direct impact in the financial global structure like the IMF, World Bank and some others responsible for delineating the world commerce like the WTO, need to reform the regulatory system in its entirety allowing free and capital markets absorb some of the pressure caused by market instability. In the same manner these institutions need to consider not only a new frame of monetary policies in which lower interests, better financial instruments and international trade is promoted, but also the entrance and participation of emerging economic regions like Asia, Middle East and South America.

Unlike the crisis of the Great Depression, where much of the financial instability involved geopolitical issues, the crisis of our times involves not only insolvency of major banks around the world, but also important issues that if the new system fails to address successfully, the consequences are of great magnitude. Issues such as, alternative energies, natural disasters – raising the cost of basic consumer products like rice- and high costs of healthcare not to mention terrorism, are key factors of success to be considered in implementing a comprehensive financial solution for the current crisis.

I don’t think there will be another Great Depression. The leaders, institutions, and governments, who are tackling this current crisis, need to do it in a genuine, creative and wisely manner, not forgetting previous mistakes from history and intercalating new approaches to mitigate new challenges.

Posted 1 April 2009, 16:12 by Eric Regalado
I agree with Tom Concannon that our current crisis stems from the collapse of key US financial instruments that led to increased multiplication of capital. The fundamental principles for redistribution of risk are still sound business practices, but mispricing and limited views into the details of the new instruments led to poor decisions and disastrous consequences. Markets and regulators nearly always overreact to crisis situations, and our current situation will certainly lead to new paradigms of regulation and new instruments to enable investment capital.

One factor you left out of your analysis of the interwar environment was the collapse of the German monetary and credit market with 10^6 monthly inflation in 1923, which paved the way for a new currency model and much tighter credit controls. France and UK both considered monetary expansion, but in the end opted for more conservative policies with the effect of dramatic recessions in the early 1920s. As you note, America’s decision to call the loans used to finance retribution payments helped lead to global economic collapse in the 1930s.

Politically, the Left of the 1920s sought to resolve the postwar recessions with large federal deficits, wage increases, and tax increases on the rich, and the maintenance of low federal bond rates. The Right preferred a broad-impact tax policy with higher sales (VAT) taxes, and reduced government expenditures.

While there are many parallels between this period and today’s financial crisis, no major economy is close to the collapses of the 1920s and 1930s. Protectionism and populism are clearly increasing, but the tariff wars of the interwar period were far more vicious than the behaviors of today’s government leaders. Hopefully, we have learned this lesson from history.

Posted 1 April 2009, 11:25 by Jose Tormo
True, the origin of the historical depression was more political.

Present financial fiasco is the result of failure of artificial intelligence. Human brain driven by greed and deceit, deceived the thinking machines and asserted its superiority.

The fact remains, even today with machines, thinking at the speed of light and capable of processing mammoth data with in seconds, man was able to cook books and sweep it all under the carpet.

Basically it is smartness of some and folly of all in the end.

Posted 1 April 2009, 10:29 by SUDHIR JAIN
While the facts cited are not in doubt the third dimension of history is fiction. I find a complacency at the heart of this article which echoes that in the economic prophesies of only 6 months ago. The idea that war in Europe is now unthinkable is dangerously absurd. Voices throughout history have proclaimed war impossible. Yugoslavia was not merely interconnected with itself by strands of fibre optics and trade agreements. This last war in Europe was only 18 years ago. Russian domestic affairs are chronic. Ukraine is strategically important. Panic serves nothing save disaster, but complacency courts it.

sincerely
robin
http://www.phoenixchange.com

Posted 1 April 2009, 09:37 by Robin Greaves
I hope we are less bitter and better connected, but whether this is true and whether it will carry the day is quite another question. Bitterness from long before WWI has recently risen to confront us. But while that hangs over us and causes defense spending, it does not pose a depression threat.

Much of the other discussion seems irrelevant. Economic collapse seems possible due to entirely different reasons than those that caused the “Great” depression.

Though defense spending is a part of the problem, it seems insignificant in relation to the core cultural problem that seems to have led to our present economic crisis.

Greatly oversimplified, we simply expect to get what we want, and because of this we fell victim to a banking system that found easy victims for loan sharking. Plenty of willing opportunists jumped in to create an avalanche of money rolling into many pockets and a flood of cars and houses that we are pleased to consume. We came to believe that something about the American Dream meant we were entitled to big houses and cars, and it was somehow socially undesirable to look for ways to consume less. Prices exploded to levels that exceeded what could be sustained on current incomes, and now that the dust has settled some, it looks like we do not know how to make products that are more realistically suited to our needs and incomes.

Whether or not there is a collapse depends on whether we can adjust fast enough to reality to get production going again. We seem to have trouble realizing that very different kinds of cars are needed; and perhaps we can make do with very different kinds of houses.

As it is, it looks like the means of production are getting into a frozen condition. Housing production seems to show that state and auto manufacturing seems to be headed to a similar fate.

The personal credit card crisis has not even hit us yet. The illulsionary world enabled by credit cards still seems to be floating along, and I hear that junk credit card debt has been “packaged and securitized” to be sold to unwitting investors looking for high returns. When this shoe drops, as it must, the remaining market for goods would seem to be headed for collapse as well.

It seems like the problem has not been shown to us in history. We are on our own here, and we might actually have to think our way through it unguided by anything except what good sense we can muster.

Posted 31 March 2009, 14:50 by Jim Bullis
Excellent commentary – the new regulatory environment that emerges from the chaos of the present will likely have to deal with the opposing tensions between free and open capital markets and restrictions on rapid repatriation of “hot money.” In the end, the IMF and World Bank will take on a greater role as financial markets coordinator. These are interesting times.

Posted 31 March 2009, 14:43 by Frank DuBois
I agree that a Great Depression is much less likely today than in the interwar period of history. Thank you for highlighting some historical trigger events not often included in the capsule analysis of most articles on this subject. My view is that the USA still has much to account for to the rest of the world for the current financial crisis. This crisis bears some striking similarities to the events that occurred from 1929 through 1931, but the differences are even more striking.

The current global financial crisis stems from a pure failure of financial instruments. These instruments were not symptomatic of any underlying economic distress, such as the war devastation of the leading economies of Europe in the 1920’s, but rather these instruments caused the distress solely and completely. I believe that the USA owes all of its global financial trading partners a vigorous prosecution of all perpetrators of the financial fraud that is the cause of this crisis. But I also believe that this is unlikely to happen for some easily understood reasons.

An acute danger of economic protectionism exists at this moment in history. Absent of any obvious signal that the US is pursuing convictions of the perpetrators, other nations of the world will continue to distrust us. The US Congress is anxious to divert attention from their complete complicity in the perpetration of this fraud and as a result they are stoking political fires about, “buying American”. This political effort is enhancing the feeling of distrust abroad and has already led to calls for retaliation against the USA. Could it be as bad as the 1930’s? No, I don’t believe so, but we are definitely not out of the woods yet.

Posted 31 March 2009, 14:41 by Tom Concannon

Commenting is closed for this article.

Previous: Ian Bremmer interview transcript

Next: Global sourcing in a world less flat

Send an e-mail to let us know how we can make our site better.

Will globalization be derailed by the world financial crisis?

Follow the opposing views presented by our two debaters, then make up your mind and join the conversation

Comment on the debate

The new normal
The business landscape has changed fundamentally; tomorrow’s environment will be different, but no less rich in possibilities for those who are prepared, argues McKinsey's worldwide managing director Ian Davis.
China takes aim at dollar
The Wall Street Journal reports on China's call for a new currency to replace the dollar as the world's standard.
Zhou Xiaochuan's speech
The full text of the essay by Zhou Xiaochuan, China's central bank governor, in which he calls for a new world currency, is available here.
A New Deal for Globalization
Rising wage inequality in the U.S. is threatening a protectionist backlash that will hurt everyone. The best way to avert the problem, argue Kenneth Scheve and Matthew Slaughter in Foreign Affairs, is by instituting a New Deal for globalization -- one that links engagement with the world economy to a substantial redistribution of income. (Article requires registration)