One view of what caused the Great Depression in the 1930s is that the
Federal Reserve failed to prevent a collapse in the money supply.
This is the famous thesis of Milton Friedman’s and Anna Schwartz’s
A Monetary History of the United States, 1867-1960, and it was, more or less, the view of Ben Bernanke when he was chairman of the Federal Reserve.
The global economy today resembles that of the 1930s in several ominous ways.
Financial author
Edward Chancellor recently called attention to a
paper written by Claudio Borio,
head economist at the Bank of International Settlements, that provides a
fuller picture of the causes of the Great Depression. The paper also
draws parallels between global economic conditions that led to the rise
of protectionism in the 1930s and our situation now.
Now, as in the 1930s, the global economy is stretched. A low
interest-rate regime in the developed world has encouraged lending to
emerging markets. Additionally,
China’s and Europe’s banking systems are burdened with bad debts.
Moreover, last year, as Chancellor reports, emerging markets experienced their
first capital outflows in nearly three decades, and
that movement of capital appears to be continuing in 2016. Ratings
agencies have downgraded South Africa and Brazil sovereign debt, while
commodity prices continue to plunge.
Protectionism is in the air
with the European Union and the U.S. imposing tariffs on Chinese steel.
Also, anti-immigration sentiment is rising.
Although the additional restrictions imposed by a gold standard don’t exist today,
the peg of Chinese yuan to the U.S. dollar
DXY, +0.05%
is unsustainable in Chancellor’s opinion, as may be the euro
EURUSD, -0.1617%
So much elasticity or
the buildup of imbalances can be painful during the process of restoring
balance. Therefore, regarding monetary policy, it’s important,
according to Borio, to lean “against the build-up of financial
imbalances even if near-term inflation remains low and stable.”
Borio’s paper was written in August 2014, so it’s difficult to know what
advice he’d have for the Federal Reserve today. But in his paper, he
notes that the imbalances that low rates and elasticity produce may
“return us to the modern-day equivalent of the divisive competitive
devaluations of the interwar years; and, ultimately, [trigger] an
epoch-defining seismic rupture in policy regimes, back to an era of
trade and financial protectionism and, possibly, stagnation combined
with inflation.”
Read more: Chilling ways the global economy echoes 1930s Great Depression era - MarketWatch
