The specter of Depression looms over America: not as a clear and present danger, but as a vague and menacing fear.
Except for the vision of deeper economic aftershocks, most Americans -- even those who owned stocks and suffered severe losses -- might dismiss Wall Street's panic as a grotesque drama of high finance. But memories of the 1930s inevitably color the current crisis. They evoke misty images of bread lines and shantytowns. No one expects an economic collapse, but then again no one thought stocks could lose a fifth of their value in a single day. What's unsettling is not the certainty of doom. Rather, it's the sense that we're losing control. We think we understand the economy well enough to avoid disaster. Wall Street's panic has shaken that faith.
Is the anxiety warranted? Probably not. For all its flaws, the U.S. economy has an underlying vitality. It's rebounded strongly from recessions. Since 1982 it's created nearly 14 million jobs. Gross national product has risen about 20 percent. Government has adopted safeguards -- deposit insurance, unemployment insurance -- to prevent a depression. And yet, doubts linger. What's worrisome are parallels between now and the 1930s that go beyond the market crash. The world economy is out of balance. Cooperation among the great economic powers -- the United States, West Germany and Japan -- is shaky.
Wall Street's panic has inspired two predictable reactions. On the one hand, there are reassurances that all is well. Similar statements were made after the 1929 crash. "Things are better today than they were yesterday," said Henry Ford. At the other extreme are ritualistic denunciations of greed. "Wall Street had supplanted Las Vegas ... Monte Carlo and Disneyland as the place where dreams are made," wrote analyst Robert Reich of Harvard.
Both reactions reflect superficial truths. The stock market boom assumed, especially during the past year, an air of unreality. Stock prices rose relentlessly, ignoring any whiff of bad news. By their peak in August, they were roughly 22 times profits. Price-earnings ratios that high hadn't been seen since the early 1960s. Young investment bankers had earnings of six or seven figures -- obscene amounts. All the wealth inspired "the arrogance of confusing capital gains with brains," as Alan Abelson of Barron's writes.
By itself, though, the market's frenzy poses only limited dangers. Henry Ford's reassurances sound pious now, and so do their modern counterparts. But they're not as silly as they seem. The market crash of 1929 didn't cause the Great Depression, and it's doubtful that today's panic will cause a depression either. Perhaps a quarter of U.S. families own stocks directly (that is, not through pensions). The median investment was $4,000 in 1983; by 1987, that may have grown to $12,000. Even with recent losses, most long-term investors are ahead.
Some nervous consumers may delay spending, especially on cars or homes. Some businesses could postpone new investment. Might these reactions trigger a recession? Possibly. A depression? Hardly.
What caused the Great Depression were government blunders. The Federal Reserve didn't protect the banking system. Between 1929 and 1933, two-fifths of the nation's 25,000 banks failed. Consumer deposits were frozen or wiped out. Business loans were called. A downward spiral ensued. As credit contracted, bankruptcies and unemployment rose. Nervous bank depositors withdrew their money, squeezing loans further. The Federal Reserve didn't stop this spiral by providing banks with loans to meet customers' demands for cash.
A similar calamity now seems implausible. Federal deposit insurance up to $100,000 has forestalled 1930s-like bank runs. The Federal Reserve has acted to prevent major bank failures that might cause a flight among uninsured depositors -- mostly businesses -- and lead to a financial collapse. The most recent case was the rescue of the Continental Illinois Bank in 1984. Last week the Fed again affirmed its role as "lender of last resort."
But Wall Street's panic was more than a random spasm. Its larger economic meaning lies in fears about the global economy. World economic growth has been dangerously lopsided. Other countries grew by selling to the United States. In 1986 the U.S. trade deficit hit $156 billion. Anyone could see this pattern couldn't last. The inevitable result of spending beyond your income is debt. Even if the U.S. government continued to borrow heavily, consumers and businesses couldn't. People and firms grow leery of rising debt burdens.
What emerges is the risk of economic stagnation and political stalemate. The United States can't indefinitely continue as the world's engine of economic growth, and other countries aren't filling the gap. Ideally, foreigners -- Germans, Japanese, Koreans, Brazilians -- would increase spending while Americans slowed borrowing. The U.S. economy would be sustained by rising exports to other countries. Economic growth abroad would be sustained by higher domestic spending. But there's the rub. Export-led growth camouflaged economic weaknesses in Europe and Asia. Europe is suffocated by high taxes and rigid regulations. Growth in Japan has slowed sharply. Developing countries remain overburdened with debts.
Beneath the speculative froth, the 1980s' stock boom rested on two assumptions: low inflation and steady growth. By last summer, both seemed increasingly suspect. Fears mounted. Foreigners wouldn't continue to hold the dollars they received for their exports. The dollar would depreciate. U.S. inflation would revive because imports would be more expensive. Interest rates would rise. Export-led growth elsewhere would slow. Stock prices began to slip because investors couldn't see an escape from these contradictions. Every new trade figure or hiccup in the foreign exchange market became a test of whether the contradictions were being resolved.
It's here that parallels with the 1930s become relevant. The Great Depression was worldwide in scope, as economist Charles Kindleberger argues. Protectionism flourished. In 1930 Congress passed the Smoot-Hawley Tariff Act. Other nations retaliated. Being on the gold standard, countries tried to protect scarce gold supplies by maintaining tight economic policies that limited imports. International loans -- necessary for some countries to finance their trade -- evaporated. These steps devastated world trade. By 1933, it was less than a third of its 1929 level.
What are today's similarities?
First, the underlying economic situation isn't well understood. In the 1920s, countries didn't grasp the implications of the gold standard. Now, countries are confused by the nature of the imbalance in the world economy. Popular wisdom holds -- wrongly -- that the problem flows entirely from the "twin" U.S. budget and trade deficits. True, the United States should reduce both. But unless other countries speed up their economies, American efforts will be futile and self-defeating. Lower U.S. spending will further depress the world economy.
Second, economic nationalism is rising. Congress is considering the most protectionist legislation since Smoot-Hawley. Abroad, the nationalism takes the form of scapegoating the United States. By blaming all the world's ills on U.S. budget deficits, foreigners -- the Germans, Japanese and others -- avoid asking the difficult questions of why their economies can't grow faster and are so export dependent.
Finally, the Third World debt "crisis" remains unresolved. Developing countries run huge trade surpluses to meet the interest on their loans. In 1986 the collective trade surpluses of Argentina, Brazil and Mexico totaled $15 billion. These surpluses deprive U.S. exporters of healthy markets and require developed countries -- led by the United States -- to absorb huge imports to avert loan defaults.
The foundations for steady world economic growth are weak. Last week's global stock market panic doesn't signal an impending Armageddon, but it does more than confirm the truism that investors run in herds. Global markets moved in unison because major economies are linked. Maybe the turmoil will shock governments into shoring up the foundations.
What will be required are intricate and controversial reforms. In Europe, governments need to reduce the restrictive regulations and heavy taxes that suffocate growth. In Japan, the government needs to stop protecting inefficient farmers and high food prices, diverting more spending into housing, social services and cheaper food imports. A way needs to be found to reduce developing countries' debts and to reform their bureaucratic economies.
No one knows whether these changes can be made or, if they aren't, what will happen. Can we maintain control? The verdict has yet to be written. For now, though, the specter of Depression remains just that.