HIS 107 Readings

Economic Crisis of the Twenty-First Century

The collapse of the world economy and of the American economy in the Fall of 2008 was the most severe economic crisis since the Great Depression of the 1929-30s.

There were both similarities and differences between the two. Both originated in the United States and dramatically impacted the world economy. Both were precipitated by collapse of the leading sector of the U.S. economy; the stock market in the 1920s, and the housing market in the 21st century. Both occurred in economies where there were large maldistributions of wealth between rich and poor. Both were dependent upon mass consumption for the continuation of prosperity. Both suffered the consequences of a lack of government regulation of economic practices and lax enforcement of existing regulation. Both were accompanied by corrupt practices in the financial sector of the economy. In both instances, the attempt to use government action to introduce corrective measures was met with fierce resistance by political forces, which primarily represented wealthy, corporate, financial interests. In both circumstances those powerful interests dominated the political system and used it for their own private goals. Consider this comparison

A reasonable conclusion might be drawn that lessons of the past were ignored.

There were, however, numerous differences. The American economy of the 1920s was considerably smaller than it was in the 2000s. The United States was the leading creditor nation of the world in the 1920s with very little debt. In the 2000s, the U.S. had become the leading debtor nation of the world. This, in the 1920s, gave the United States an advantageous position from which to respond to economic crises, whereas its indebtedness in the 2000s made solutions more difficult. In the 1920s, the world economy was in an early stage of the fossil fuel era during which fossil fuel resources were tapped as the primary source of power fueling the economy. In the 1920s, the institutions associated with fossil fuels were growing rapidly with little resistance from established special interests. In the 2000s, the fossil fuel era was beginning to come to an end, but established interests fought with every means available including warfare, to maintain their positions of power, wealth and influence. In the 1920s, the American economy led the world and the U.S. government could act unilaterally to stimulate growth throughout the world. In the 2000s, the U.S. economy was still the single most influential economy in the world, but it shared responsibility with China, which had become the largest creditor nation, and with Europe.

In the 1920s, the prevailing economic theory for dealing with economic collapse was that the laws determining the business cycle were immutable, and governments could do little about it. Since then, Keynesian economic theory postulated that government or public spending can stimulate economic growth when the private sector fails to do so. A countervailing theory of the Chicago school of economics, which developed in the 1970s, claims that the private sector is the essential driver of economic growth. The government, through taxation and too much regulation, becomes a drag on the economy. These theories are not necessarily mutually contradictory.

During eras of prosperity, the private sector is the primary driver, while the public sector pursues long term objectives deemed to be in the public interest, at the same time, improving and maintaining the infrastructure. During such times, it is appropriate for the government to run a small annual surplus, pay down existing debt, or accumulate a reserve needed to meet an economic slowdown. During recessionary eras, however, it is desirable for the government to stimulate the economy by spending in excess of its income, in other words, by deficit spending. To achieve the proper balance under particular circumstances is a challenge.

Economic theory is always complicated by political realities. Private businesses and corporations have as their primary goal, to increase the growth and profitability of the business. These private goals may not support, and may possibly obstruct, the public interest. In a perfectly competitive, laissez faire circumstance there is the closest approximation between private goals and the public interest. Such a circumstance can never, in practice, exist. Private business will use their political influence to obtain subsidies and legislation favorable to themselves, but not to others. It is a part of the fundamental basis of capitalism to compete, both economically and politically, for individual advantage. Having achieved an advantage, each private enterprise will use it to further accelerate their advantage. Those enterprises and those individuals that have fallen behind will be driven into bankruptcy and poverty. The society will become divided between large enterprises and few very wealthy individuals on the one hand, and failed enterprises and a large poverty population on the other. If such a process were to continue indefinitely, the society would collapse completely, due to lack of a middle class and insufficient consumer demand. That point of complete economic collapse has never occurred because, in the circumstance of a depression, an increasingly desperate citizenry has demanded fundamental changes in the political leadership. Those changes may be desirable or they may be catastrophic, depending upon the political circumstances in different nations.

In the United States, the Great Depression assured a re-alignment of the political majority from the Republican Party to the Democratic Party. There was a stable political alternative which enabled the existing political structure to survive. The new leadership under President Roosevelt responded inadequately, but sufficiently, to economic hardship, to retain their mandate. They failed, however, to escape from the fears about debt accumulation. Experimentation with a variety of government programs to increase employment had to be carried out by deficit spending. Fears about the increasing national debt led to decisions to reduce government expenditures long before the depression had been resolved. The result was to bring about a decline in economic activities in 1937 and 1938. A renewal of deficit spending helped to stem the decline. The depths of the Great Depression were so profound, however, that there was not enough fiscal stimulus to bring recovery. It required unlimited expenditures by government, and unprecedented levels of deficit spending in World War II, to restore prosperity to the American economy.

In Germany, there was no stable, political alternative to the leadership of the German Social Democratic Party, when it failed to respond to the Great Depression. Its ability to respond was compromised by the prevailing “do-nothing” economic theory of the time. This was reinforced by the disastrous experience in the early 1920s, when increasing the money supply had resulted in hyper-inflation. Furthermore, the German economy was dependent upon investments by Americans. When the Great Depression began in the United States, those investments ceased. The circumstances of the first “Great War” had left Europe decimated and dependent on the United States.

The increasingly desperate economic circumstances facing the people of Germany, and the lack of rational political alternatives, led to the rise to power of Adolf Hitler and the Nazi Party. The new leadership ignored economic concerns about a debt, repudiated the international debt obligations, and engaged in deficit spending to rearm Germany in preparation for a new war. Economic recovery, coupled with nationalist propaganda about restoring the greatness of Germany, gave the regime popular support. The accompanying designation of imaginary enemies as the source of their difficulties, made this regime dangerous and irrational.

Economic depression leads to desperation and, sometimes, irrational “solutions”. A particular dilemma faces world financial leaders, governments, and the people in the early 21st century. On the one hand, over-consumption based on borrowing, reckless and corrupt financial practices, and lack of effective regulation by government, coupled with costly, unnecessary wars, has created high levels of debt, both public and private. These policies and practices have gone on for 50 years or more. The problem of indebtedness has developed over a long period and can only be resolved gradually over a long period.

On the other hand, the economic depression, which began in 2008, led to a near collapse of the private sector. In order to create jobs and revive the economy, the government undertook to stimulate the economy with a variety of spending programs coupled with selective tax decreases. The stimulus helped to stem economic collapse but was insufficient to restore a robust economy. At the same time that the Federal government engaged in deficit spending, state and local governments, operating under constitutional requirements to balance their budgets had to reduce spending and lay off workers. The net result was a minimal stimulus. There were opportunities for some investors, but there was stagnation, and chronic high unemployment rates. At this point, the Republican party, newly rejuvenated by a populist "tea party" movement, claimed that the stimulus had failed, and that government was an obstacle to growth in the private sector. The opposite argument was that the stimulus had been inadequate and that the government had to take direct action on a larger scale, and engage in more deficit spending. Failure to do so would result in continued high unemployment and a low tax base, which would only exacerbate the debt. The alternative of reducing government spending to deal with the debt would continue the downward spiral of a declining tax base, and assure that the long-term debt problem could not be resolved. Thus, the political paralysis adds great uncertainty to the probability of reaching a solution. Consider what economist Robert Reich has to say.

Furthermore, the approach of “peak oil” marks the beginning of the end of the era of the fossil fuel energy economy. Nuclear energy, because of its horrendous safety and related cost problems, is not a viable alternative. The transition to a renewable energy economy will require time and heavy investment. The short-term, “bottom line” motivation of the existing private energy industry opposes this transition, and is engaged in increasingly costly and risky endeavours to prolong the fossil fuel era. Offshore and Arctic drilling for oil, mountaintop removals for coal, fracturing of rock for additional sources of oil and gas, and failed efforts to render nuclear energy safe, are all examples of the desperate efforts being undertaken. The financial costs and the long term toll upon the environment of continuing on this unsustainable path will assure failure.The solutions depend upon government leadership, involving an immediate fiscal stimulus coupled with wise, long-term investment to grow the economy, and to restructure for a new, cleaner future.

As of the year 2011, the political trend, the impetus to cut spending in the midst of economic decline, will assure a rush to the bottom. Will the concern for the long term debt problem prevent the application of Keynesian techniques that are necessary to solve the immediate problem of economic depression? Will there be sensible, rational political leadership, or will there be catastrophic political, economic, and environmental consequences?

International Economics

The economy in the 21st century is, more than ever, a global economy. In 1945, at the end of world War II, the United States dominated the global economy to such an extent that economic ministers at the Bretton Woods conference of 1944 established the American dollar as an international currency along with gold, with the value of the dollar fixed at $35 per ounce of gold. The United States government could, at that time, easily support that exchange rate. This dominant position was the result of the destruction of the European and Asian economies by the war, while the war had greatly stimulated growth in the U.S. This was a circumstance that could not last as the European and Asian economies gradually recovered. The overseas commitments of the United States and the growing volume of imports by the U.S. caused a long term imbalance of payments. When the United States became a net importer of oil in 1970, the U. S. balance of trade became negative. It was no longer possible for the Unitd States to support the fixed exchange rate with gold and the U.S. government announced that it wouild no longer do so.

The economics ministers of the leading nations agreed a year later to a new system, which retained the dollar as the international currency but allowed its exchange value to fluctuate with respect to gold and to other currencies in accordance with supply and demand. The exchange rate by the year 2011 was more than $1600 per ounce of gold. This reflects the reduced role of the United States economy in the world economy. Consistent unfavorable balance of payments by the United States has changed the position of the United States from the largest creditor nation to the largest debtor nation in the world. American consumers have been enjoying a large share of the produce of the global economy, which has stimulated growth abroad and is gradually balancing the position of the U. S. economy in the global economy. Economies are being lifted elsewhere, while the U.S. economy is becoming increasingly indebted. The U.S. negative balance of trade is unsustainable, but is difficult to correct. U.S. exports are restrained by the higher labor costs in the U.S., while imports grow to maintain consumption levels.

These circumstances complicate the efforts of the U.S. government to stimulate the economy. When the government follows Keynesian techniques, increases spending, and creates jobs, there is a multiplier effect as increasing numbers of workers create more demand which leads to more spending and the creation of more jobs. This multiplier effect, however, is minimized if the new demand is for products from abroad. That creates jobs overseas, but not in the United States. Consequently, any stimulus has to be larger than otherwise.

At the same time, multi-national corporations have been shifting their production facilities overseas in order to take advantage of lower labor costs. In other words, more produce is imported, while jobs are exported thus adding to the imbalance of payments. This has been partially counter-balanced by the development in the United States of new technology and new innovations which temporarily have given the U.S an advantage in trade.