The financial crisis which the United States is combating today, in many aspects resembles the characteristics and consequences which were the outcome of the Great Depression lasting from the time period 1929 till 1933 (Great Depression).
The Great Depression of earlier times and the financial crisis of the current times from 2003-2008 will be studied in depth in the following research work in order to bring out the similarities and differences the United States faced during these two times of financial turmoil.
Particular highlighted areas would comprise of government bond rates, Gross Domestic Product rates, Interest rates, money supply, and the major stock price trends in both these time periods along with a special analysis of the reactions of Congress will be looked at to try an estimate their impact.
The major impact which the financial turmoil has brought is visible in areas such as Government Bond rates, Gross domestic product of the times, Interest rates, Money supply and Major Stock Prices. The gross domestic product is one of the most crucial indicators to measure the country’s economy and progress rate. GDP represents the total dollar value of all goods and services produced over specific time duration. The Great Depression time period had left a mark which is clearly visible even after 80 years since its conception, the current financial crisis situation is almost similar, though not the same intensity and as grave as it was before but still the savers can do nothing but watch their money disappear as the banking system weakens and financial institutions fail.
GDP is represented as a comparison to the previous quarter or year. A significant change in GDP has a considerable impact on the stock market, and a bad or regressing economy means lower stock prices as in the current times and the Great Depression of 1929.
Government bonds and interest rates are different sides of a coin, when the output is on the rise, the bond prices sweep down and vice versa. (Farell C, 2008). Government bonds and interest rates are methods of providing liquidity in the open market and increase or decrease the quantity of money; hence their comparison is of utmost importance to study the past and the present market liquidity position.
To judge the expansionary and contractionary economic policy, Government Bonds are the best indicators. Interest rate helps in judging the economy maximum sustainable growth rate. On the other hand stock market prices indicate the global risk diversification opportunities available, stock markets are also important economic growth indicator as it aims to increase the liquidity of financial assets, promotes wiser investment decisions, it is a common place where the corporate control mechanism works.
If we compare the economic conditions in 1929 and 2008, then the unemployment rates in 1929 before the crash was between 5 percent and 7 percent and by 1933, the jobless rate augmented to almost 25 percent (Moreschi A, 2008) whereas in 2008 Unemployment fluctuates at around 6.1 percent, highest in the last five years. The homeownership in 1929 was approximately 49 percent which dropped to 44 percent in 1940 whereas in 2008, a record 68 percent was achieved when Americans were found with possession of their own homes. But a wave of foreclosures is certainly going to affect the percentage on the whole Calbreath D, 2008).
The financial sector in 1929 was much stronger than it is today. No major financial institutions collapsed before the stock market crashed but almost 9,000 banks failed during the 1930s, the current times in 2008 (Bruce A, 2008) renowned banking and investment institutions as Washington Mutual, IndyMac, Countrywide, Wachovia, Lehman Bros., Merrill Lynch and Bear Stearns have actually failed with almost 150-200 banks in a dire critical state but still are in a position to cope up Calbreath D, 2008). The stock market in 1929 from a record high of 386 points on Sept fell 49 percent to its interim low of 198 points on Nov. 13 and did not revive back until 1954.
On the other hand in 2008 Dow fell a record high of 14,280 on Oct. 5, 2007 to a low of 10,267 on Monday, before gaining a little to Friday’s close of 10,325. The stagnant incomes in 1929 observed a 4 percent drop in inflation-adjusted disposable income of agricultural workers whereas the top bracket class observed a steady gain whereas in 2008 (Waggoner J, 2008), inflation-adjusted income for middle-class workers dripped by 1 percent. The concentration of wealth in 1929 was mainly in the hands of stock speculators (Tomkins L M, 2008) whereby the richest 1 percent of Americans owned approximately 40 percent of the country’s wealth.
However the current figures reveal that in 2008 the richest 0.1 percent of Americans constitutes only 11.6 percent of the total nation’s income (Calbreath D, 2008). As per the information given by Amity Shale’s in her “The Forgotten Man: A New History of the Great Depression”, November 1933, figures reveal that the unemployment rate had increased to over 23% whereas in the current times it’s just 5%.
Government bond rates
Stocks performed very badly during the Great Depression but on the contrary government bonds did fairly well. During depression Bond prices did rise tremendously as bond yields came down sharply. For example, the prime corporate bond output level fell from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond output further deteriorated to 2.94%. Bonds returned 6.04% during the 1930s (Farell C, 2008).
The statistics reveal that From October 1926 to November 2001, the U.S. economy was under expansion to almost 80 percent of the time and under contraction for remaining 20 percent of time, the current expansion began in December 2001 , out of the past 14 recessions, government bonds out to have outperformed cash and stocks.
Broad credit market was weakened due to the corresponding effect on the sub prime mortgage industry. Government Treasuries empowered the market in comparison to risky bonds and equities since July 2007, returning nearly 8% through December 2007 (Fund Evaluation Report, 2008)
Comparison between the purchase of 1929 and 2008 Treasury Bonds
The most talked about and in discussion area is the stock market ‘crash’ , if the figures are compared then one can figure out that during the depression phase, the Dow tumbled down to 90 this was as high as a loss of nearly 75% of its previous value. “according to the views of Miss Shale’s, member of Council on Foreign Relations, “In the Great Depression times, America underwent deflation where there was actually no money but the current times is just the opposite, today we are in the market inflationary phase rather than deflation.
From 1921 to 1929, there has been noticed a considerable rise in the stock market due to technological advances, The Dow which had fallen up to as low a price as of 63 during the panic of 1921 and increased to as high a figure as 386 in September 1929; that’s a splendid increase of almost 600 percent in just eight years. The Dow fell 42% from a time period from 9th Oct, 2007 to 27th Oct, 2008, almost similar to the situation which existed in 1929 (Meyer G, retrieved on 15th November, 2008). As per the statistics in 2006, two-thirds of all 401(k) plans were invested in stocks which is again similar to the earlier figures
The financial crisis earlier dealt with the overvaluation of stocks, and the government in their attempt to raise interest rates to balance off things actually overdid it. And what could have been just a normal recession turned into the Great Depression where the unemployment rates just peaked to as high as 25 percent in 1932.In the current times, leverage also being used to buy stocks which are traded on margin, just 10 percent down. Today, the volume of traded stocks is massive; just more than 2 billion are traded solely on the NASDAQ daily. The fluctutaions between 1927 and 1928 stock market is similar to that between 2007 and 2008 (Lafitte P, 2008).
Gross domestic product
Gross domestic product is one of the means to measure the economic growth of the nation; GDP is defined as the market value of the goods and services produced in a country. GDP is calculated by culminating and cumulating all the expenses incurred in the country. Maximum economic growth along with full employment is supposed to vary between a range of 2 percent and 2.5 percent. GDP needs to be adjusted and accustomed in accordance with the inflationary conditions prevailing in the market. The past and the current GDP status reveals that inn 1929 GDP in the US was just halved from $103bn to $55bn due to deflationary conditions in the market which ran at 10% per annum. World trade in unit terms fell down by 25 percent and in dollar terms by 65 percent (Clayton A, 2008). When we talk about the real GDP, the position in 2007, the position is certainly not very promising, yet the GDP did rise by 2.2% in 2007 and another 0.6% in the first quarter of 2008. Gross Domestic Product (GDP) was reduced by 0.5 per cent in the third quarter of 2008, compared with a 0.0 per cent movement in the previous quarter. Weaker service industries, construction and production output were the major areas responsible for the deceleration in growth. (National Statistics, 2008).
The consequences have been loss in jobs but that’s just a normal phase of the changing market trend. Unnoticed fact is that before January of this year, America had had positive job growth for 52 straight months (Stossel J, 2008). Third quarter 2007 GDP was measured at 4.9 percent following second quarter GDP of 3.8%. Fourth quarter GDP is anticipated to be less if consumption (C)+ Investment (I)+ Government Expenditure (D)+ Imports – Exports (I-E), all are taken into consideration. In recent years, the US economy had strong GDP figures, per capita rose by 2.2% in 2007 (2.9% for the European Union), 3.4% in 2006 (3% in the European Union), and 3.2% in 2005, however 2008 has upsetting figures (Lafitte P, 2008).
If we look at the Federal Reserve which was created in 1913, took the first step in spreading the policy of easy money in the late 1920s. Similar manner the newly created consumer credit has gushed in. For the first time in history, this easy flow of money has allowed the masses to purchase high priced products may it be automobiles or electronic appliances. The Construction and entertainment industries have simply been on their hilt.
The real cause of the problem today is considered to be the easy money policy which first allowed the economic and stock market to boom and worsened up the situation by tightening up the money flow. Greenspan’s easy money policy is also one of the causes responsible for directing the flow of money into overvalued real estate and other non-productive projects (Kleinman G. 2008)
Monetarists such as Milton Friedman and current Federal Reserve System Chairman Ben Bernanke hold a firm view that the Great Depression was caused by monetary contraction (Geller A, 2008). Friedman further augmented that the downward turn in the economy, starting with the stock market crash can shape up into just another recession. In earlier times Federal Reserve could not limit the decline of the money supply due to regulatory reforms which required partial gold backing of the stipulated credit amount. In 1929, federal expenditure was only 3 percent of GNP which tripled to three times in 1939 (Paul J, 2008).
During the Great Depression phase the safe interest rates such as the government paper dropped and people who possessed the stellar credit history had to pay much higher rates. This situation is almost similar when compared to the current trends as today, the credit markets and banking system have completely freezed up which in turn means less liquidity in the market.
In the current times, Fed has cut interest rates nine times since the credit crisis began in September 2007 along with creation of various credit facilities, which has permeated financial institutions to exchange assets that they couldn’t sell otherwise for protective Treasury securities while during the depression phase in 1929 and 1930, the Fed actually raised interest rates and completely sapped liquidity from the system which worsened up the entire situation
Demand for goods and more unemployment. If we look at the Depression times, large “universal banks” were split up into separate commercial and investment banks which led to the establishment of Goldman Sachs and Morgan Stanley but the current economic crisis has given enough space whereby investment banks are being revived back into large commercial banks. (Blog, 2008). Globally Long-term interest rates are low because inflation expectations are passive and restrained due to non-inflationary monetary policies and real interest rates are low.
Major central banks around the world have reduced the interest rates to control the inflationary pressures. Aggregate savings ratio has decremented in the US, remained relatively stable in the Euro area and Japan, but increased sharply in rising Asia. This change in the global savings pattern is the real cause for the low long-term real interest rates as a large amount of Asia’s and Middle East savings are invested in US treasury bonds (Kuroda H, 2005).
Impact on congress
It is found that Hoover had enough surplus and left office with a substantial deficit due in great measure to out of control Congressional spending. Congress was responsible for huge spending on relief spending and Veteran’s bonuses that actually dripped down the budget from surplus into deficit.
In contrast to the Great Depression times when government took a backseat the present congressional time has been quite active trying its best to prevent an economic meltdown. Further Ben Bernanke and the Treasury Secretary Henry Paulson explained to President Bush, the severe extreme condition that may arise if proper actions were not taken timely, the President understanding the intensity of the situation put aside his instincts and agreed to bail out $700 billion and the fiscal stimulus checks to take a safeguard measure and intervene in the financial system to keep it afloat (Meyer G, 2008).
Unemployment insurance is another key innovative step on the part of Congress as in comparison to 1930s which has been specially drafted in order to prevent Americans from going homeless or hungry after losing their jobs. According to the new scheme, Congress promised to offers at least six months’ pay to jobless workers but revising off the current layoffs Congress extended the time period from seven to 13 weeks (Calbreath D, 2008).
It has been noticed that in 2008, Foreclosures and defaults of home mortgages have soared up, established firms and institutions in the financial industry are taken over or have turned bankrupt, and the government-sponsored enterprises are seized by the U.S. government (Tomkins L M, 2008). The Federal Deposit Insurance Corp also assures a bank deposit of $250,000 to float up and maintain the liquidity in the market (Calbreath D, 2008).
On the whole if differences between the Great Depression and current financial crisis are looked on, one can say that at the times of the development of the Great Depression the earlier government’s just adopted a wait and watch theory while today they seem to be proactive and doing every possible thing to avoid the chances of depression to occur again, the current 6 percent unemployment rate lies nowhere close to the great depression which accounted to a 25% decrease in job rates (Kleinman G. 2008).
Years backs there was no international cooperation and expansion of liquidity was a tedious exercise as most counties traded on gold which actually turned recession into depression but now there exists a coordinated policy among the countries for instance many of the world’s Central Banks including Europe, England, Canada, Swiss, Australia, South Korea, China and the US have lowered their interest rates (Kleinman G. 2008). Earlier fiscal conservatism and Keynesian philosophy were the best applied practices but currently Fed has eased up the difficulties by floating up enough credit to AIG and others to release the credit markets (Levitt P K, 2008).
Another remarkable point of difference is the difference in the kind of economy; in 1920s the economy was a manufacturing and agriculture economy while the current economy is service-based and international in scope which in itself turns out the market conditions of both times making it difficult for any comparisons on the whole.
On the other hand, if we point out some similarities with the Great Depression, the phenomenon is a worldwide crisis as before and there are many financial institutions in a difficult situation. In the 1930s, 7,000 to 9,000 banks shut down which is reflected in today’s time as well, though not to the same intensity and certainly the market has the potential to avoid it as well (Kanell E M , 2008).
Both economic downturns were followed by periods of extraordinary business investment, productivity growth, and economic booms with marked declines in business investment and stock values. Both phases followed years of exceptional productivity growth. Both the turmoil periods, 1929 and 2001 proved to be business investment recessions that followed periods of excessive investment (Econ, 2008).
Comparing the past and the current trends it can be said through we are approaching another depression in 2008 but still the general consensus and the market conditions support the fact that the current situation is not a recession and the downturn under no circumstances would reach the depths of the Great Depression when active intervention by the governments all over the world has been undertaken to combat the threat (Jack and Suzy, 2008). The situation would take time to revive but certainly is not uncontrollable and does have alternatives for putting things into place. Just similar to the period which one saw after Great Depression, the current financial crisis also needs to undergo a complete regulatory reformation.
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