Will there be a depression in the wake of the stock market collapse last month? No worry looms larger in the minds of Americans.
The depressing answer is that it is too soon to tell. True credit collapses take a year or more to develop after a financial panic. We will have to bite our nails for a while.
In 1929, it was not the crash alone that set off the full force of depression. Stocks fell as far as they did because maniacal speculation had pushed them up so high. But stripped of that drama, it's possible that the 1929 drop anticipated what could have been a normal, cyclical recession.
Industrial production -- especially autos -- was on a downswing even before the Great Crash. Consumer spending dropped because of jobs already lost in industry as well as the loss of stock market wealth. Business spending declined and recession followed.
Just such a recession is on the way today, arriving sometime in the next 12 months. The current business recovery is five years old -- a senior citizen by economic-cycle standards. Business and consumers should be taking whatever defensive moves they normally do in advance of a business slowdown.
But it's a long way from slowdown to depression. What set this country on that path 60 years ago was not the crash itself (although it had a role), but economic and political decisions made before and after.
There were five key failures -- a rerun of which you should be watching out for today:
An unstable credit system. Vast sums of credit had been diverted into the securities industry. After the crash, that credit froze, says Charles Kindleberger, author of "Manias, Panics and Crashes." New credit also vanished for financing imports and other business activities as older loans soured under the impact of falling prices.
The spread of panic to other countries -- initially from a futile attempt to maintain unrealistic currency-exchange rates. International lending declined and trade collapsed. The United States, then a trade-surplus country, put up tariffs to stop the trade-deficit countries from exporting to us -- thus denying them the growth they needed to pay off their debts.
A deflationary shrinkage in the supply of money, which threw the economy into a tailspin. One school of critics blames this on the Federal Reserve, which tightened credit after the crash to ward off misplaced fears of inflation. Another school says it wasn't the Fed's fault: Consumers lost confidence and refused to spend.
A fragile banking system. When a few banks fell under the weight of bad loans, Americans rushed to rescue their savings from the remaining banks. Even sound institutions couldn't meet the demand and were forced to close. This reduced money and spending even more. With the collapse of the banking system, the true crash arrived.
No "lender of last resort" stepped up to rescue the world's essential financial institutions until it was too late.
There are obvious parallels today. Japan is the major creditor nation resisting imports. Nations have been struggling to maintain an international dollar system that is no longer working. America's debt position is far more fragile than it was in the 1920s, both in the public and private sectors.
Today, corporate America has a higher level of indebtedness, relative to the nation's gross national product, than it did in 1929, says Benjamin M. Friedman, professor of economics at Harvard University. In the 1950s and 1960s, 15 cents of every dollar of pretax corporate earnings went to finance debt. Now, it's more than 50 cents. So there's almost no cushion.
Still ... does this mean a depression is around the corner?
Probably not. Thanks to federal deposit insurance, banks shouldn't collapse. The FDIC is effectively insuring even huge depositors to prevent them from zapping their capital out of weaker big banks. And American purchasing power is supported today by unemployment insurance, Social Security, welfare and other programs.
Our risks, however, come from the global connection, beyond the imagination of those who drew up protective legislation in the 1930s. What if a sudden loss of confidence interrupts the international computer system that swishes money around the globe at the rate of $600 billion a day? That could squeeze the money supply beyond the Fed's ability to correct. And whose job is it to rescue international banking organizations if it were needed overnight?
With any luck, these questions won't need answering. But as long as the pols keep fiddling in Washington, Bonn and Tokyo, it won't hurt to repair your storm cellars, just in case