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Tuesday, October 07, 2008


1873 and our current failure of imagination

a brilliant article posted at the economist's free exchange regarding economic historian scott reynolds nelson's comparison of the current crisis facing western finance with what had been known, before the events of the 1930s, as 'the great depression'.

i've previously commented that our anchoring of "the worst case" upon the events which followed 1929 was a form of historical ignorance. multiyear deflationary events following hugely reckless credit booms are a regular feature of human societies. i said here:

it may not be 1929, surely. but on the other hand it may well be something very much like that -- or 1819, or 1873, or perhaps 1973 for that matter. and as the public grows ever more conscious of the validity of the comparison and what a massive debt unwinding awaits, the less measures like the proposed rate freeze or super-SIV will ultimately matter.

ah, remember the rate freeze and the super-SIV (though that last has apparently come back on steriods)?

anyhow, to nelson:

As a historian who works on the 19th century, I have been reading my newspaper with a considerable sense of dread. While many commentators on the recent mortgage and banking crisis have drawn parallels to the Great Depression of 1929, that comparison is not particularly apt. Two years ago, I began research on the Panic of 1873, an event of some interest to my colleagues in American business and labor history but probably unknown to everyone else. But as I turn the crank on the microfilm reader, I have been hearing weird echoes of recent events.

In fact, the current economic woes look a lot like what my 96-year-old grandmother still calls "the real Great Depression." She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.

it's become a touchstone of responsible economic analysis to say that, while things may be bad, "this isn't the great depression." and it isn't. what is also implied is that "things can never really get that bad again", because that was the result of "policy mistakes". that's become a statement that makes mainstream economists mainstream, and reflects the need of social acceptance (and employability) over forecasting accuracy.

but to say as much represents a profound failure of imagination. there is no heavenly law which says the limit of god's will to test us is a 25% unemployment rate or a one-third cut in real GDP. by many measures, the initial conditions from which we depart are significantly worse than they were in 1929.

moreover, it represents a kind of historical ignorance. there have been many great depressions -- and it is far from unlikely that we are embarking on another. asset price declines are a self-feeding phenomena, an example of reflexivity. house prices are likely, i think, to go further down than anyone is now willing to responsibly speculate. (though sir john templeton was willing.) if they do as this truly awesome debt bubble unwinds, depression is not only plausible but unavoidable as even early efforts at direct bank recapitalization will be found insufficient. and this would be merely a repetition of broken expectations in a pattern seen in every collapsing bubble -- where not only the optimists but the responsible pessimists are shocked at what comes.

moreover, as we are perhaps witnessing with the TARP, "policy mistakes" are often a result of a refusal in revision to acknowledge that no step could have been feasibly taken that would have resulted in a happy outcome. the paradigm which makes our current actions seem logical is, i suspect, fading away -- a shift is upon us that will lead to a new model, a new view, which will in time make the current actions of the federal reserve seem as quaint and misguided as those which myth has ascribed to the hoover administration or the ruling party LDP of early 1990s japan.

the clarity of relevant comparisons with the great depression of 1873 should help drive these points home. the big squeeze is on -- we are witnessing the early stages of the return of hardship.

UPDATE: wolfgang munchau via yves smith -- "policy mistakes" and plenty of them have already been made, here and in europe.

This was always a tough crisis to handle, but if we had responded to it in an appropriate and forceful manner, the worst could have been avoided. The problem is that we are making all sorts of policy mistakes now, very serious mistakes. Unless reversed with a weeks at the latest, they will lead to a situation that truly deserves the epitaph of a global meltdown. We would no longer be talking about the worst financial crisis since 1929. It would simply be the worst financial crisis.

UPDATE: thanks to barry ritholtz -- this 1911 new york times article by roger babson articulating the recovery from 1873.

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I just discovered your blog via "Vix & More".

Market-Historian Bob Hoye has also compared this current credit crisis to previous mass bubbles - including that of 1873.

I think you will find his articles (namely the "Signs of the Times" series) of interest.

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