Leo Tolstoy famously wrote, ‘Happy families are all alike; every unhappy family is unhappy in its own way.’ Applying this line from Anna Karenina to economic booms and busts may be a stretch. Not all periods of prosperity are alike. But economic busts vary greatly, so as we slide into one, a brief history is useful.
Current problems stem from the collapse of an asset price bubble. For several years running, house price increases outstripped growth in incomes and general price levels. In several regions, house price increases were particularly sharp, with values doubling in just a few years.
Some observers also see a bubble in stock markets, with prices rising faster than warranted by the underlying fundamentals, but there is no consensus on this.
In any case, in 2006-2007, house prices leveled off and then began to slide. New construction shrank and existing homes became hard to sell. Increasing numbers of homeowners defaulted on mortgages. The economy has now tipped into recession.
This resembles the late 1920s, except that era’s bubble largely was concentrated in stocks. Real estate prices had increased, but were a much smaller factor in that collapse. The economy continued to boom through much of 1929. When stock markets began to crumble in late October, however, generalized slowing quickly set in.
The downturn was not instantaneous. After initial sharp declines in October, stock prices stair-stepped downwards for four years as output shrank and unemployment rose. Full recovery did not come until 1940.
In the 1980s, Japan experienced a bubble that many compare to ours. There were marked increases in both real estate and stock prices. But Japan’s increases were even more extreme, especially in housing. At the end of 1989, stock prices began to fall, dropping 50 percent in 10 months and then sliding further. Almost two decades later, they remain 68 percent below 1989 peaks.
The slide in Japanese real estate prices was at least as severe, particularly in metropolitan Tokyo. The economy slowed markedly by Japanese standards and unemployment rose. Despite vast government stimulus packages and money growth, Japan still has not recovered the economic dynamism it had enjoyed for four decades.
Often an economy slows without any prior bubble. This was true in the relatively mild eight-month recession that began in mid-1990 and in similar ones in 1957 and 1960.
Sometimes deliberate government policy actions tip an economy into recession. The U.S. economy was in recession for 22 months in 1980-1982, largely because of Federal Reserve policies led by Chairman Paul Volcker, to end the inflation that had become endemic in the 1970s.
President Andrew Jackson’s 1832 veto of a bill to re-charter the Second Bank of the United States, a private institution with special monopoly powers, tipped the country into a sharp slowdown. Historians note, however, the bank’s deliberate contraction of credit to intimidate the government also played a role. Related problems of excessive credit growth precipitated a harsh recession from 1837-1843.
In 1925, Winston Churchill, then Chancellor of the Exchequer, revalued the British pound by returning to the gold standard that had been abandoned during World War I. The rise in the value of the pound abruptly made British exports more expensive, including coal, textiles and ocean shipping. Thousands lost their jobs and output stagnated.
Abrupt cuts in government spending also can slow an economy. This happened in the United States in 1918, 1945 and 1953 at the end of World Wars I and II and the Korean War, respectively, as military spending plummeted.
It often is difficult to distinguish between the fundamental root causes of a recession and some specific incident that sets it off. The 1873-1879 depression was one of the most severe in U.S. history. The proximate cause was the failure of the Jay Cooke bank, which had heavily speculated in railroads, in September 1873. But the deflationary return to hard money after the printing of millions of greenbacks during the Civil War played a role. So did a bubble in stock prices engendered in great part by politically corrupt financing of over-hyped transcontinental railroad deals.
Some argue that a return to the gold standard would solve all our problems. They need to study history more closely. A gold or silver standard does not guarantee stable prices.
The U.S. experienced sharp inflation in the 1850s simply because gold discovered in California effectively boosted the money supply. Spain had roaring inflation in the century after 1540 because of the influx of silver from its American colonies. And variances in the relative values of gold and silver bedeviled economic policymakers repeatedly in the 1800s. People rushing to exchange silver for gold touched off a severe recession in 1893.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.