posted March 31, 2010
Epic Recession: Prelude to Global Depression, Part 2 (The History)

2010 will be remembered as the year in which politics began to catch up to the continuing economic crisis.

In January, in the Senate election in Massachusetts, working and middle class voters emphatically registered their growing impatience with the $2.3 trillion in bailouts to bankers, insurance companies, big corporations, and wealthy investors—who quickly resumed giving themselves record bonuses once again. They expressed their anger with bankers getting free money from the government at 0% interest rates—just as quickly used to speculate in foreign currencies, stocks, and properties abroad—while they, working and middle class households, cannot get their mortgage loans modified, cannot obtain student loans at anything but exorbitant market rates, or are increasingly denied bank loans to keep their small businesses from collapsing. They recorded their disgust with credit card companies thwarting even timid Congressional efforts to place a lid of 34% on card charges and fees. They expressed their distrust with the promise of a health care reform bill that morphed daily into a health insurance industry subsidy bill—giving insurance companies tens of millions new customers at taxpayer expense while workers with health insurance largely pay for it all. They noted their discontent with revelations that giant companies like AIG and Goldman Sachs got reimbursed 100% by the U.S. Treasury for their speculative bets and loans while they, the working and middle class, continued to lose their own homes in rising millions each year or, in the tens of millions, were forced to watch as their home values collapse below mortgages owed. Not least, they recorded their rage with the nearly $500 billion of the 2009 $787 stimulus package spent by Congress in tax cuts and subsidies that have yet to even ‘trickle down’ to produce jobs.

An amazing 31% (roughly 50 million) of the 150 million U.S. labor force found themselves unemployed at some point in 2008-2009. Youth, minority, and high school educated workers suffered depression level unemployment rates of 30%, 40% and more. True jobless at year end approached 23-25 million. Adding insult to injury, the unemployed are repeatedly told not to expect lost jobs to come back to previous levels until 2016 at the earliest and not until after 2020 by some estimates. Meanwhile, those desperately seeking jobs today at the ground level know joblessness is not abating, despite government figures. To the extent business began to hire at all at year end, it was hiring hundreds of thousands of temporary workers and part-timers who will be shed once again at the slightest indication of downturn. To the extent the unemployment did not rise further at year end, it is because additional hundreds of thousands were giving up finding work and leaving the labor force; and because the U.S. labor department continued to insist on making false statistical projections of new business formation and hiring in order to offset continuing real job losses. Readers should make no mistake. Real joblessness is still rising. It’s not the official 10% and stagnant, but 17%-18% and rising.

Simultaneously, on the housing front, a record additional 2.4 million homes went into foreclosure last year—more than 6 million since the housing crisis began in 2006. Ten to fourteen million of the 53 million outstanding residential mortgages are projected to foreclose during the current crisis. Between a third and a half of all mortgages are projected to be ‘underwater’ at some point. The promise of housing recovery late last summer is beginning to fade once again, as new home sales, new home construction, and home prices began to retreat once again in the closing months of 2009.

As this writer has been forewarning for more than a year, there can be no sustained economic recovery so long as there is no fundamental solution to the continuing loss of jobs, to the continuing housing foreclosure problem, and so long as there is no fundamental readjustment to the continuing rise in income inequality in America. Along with rising consumer debt, growing income inequality is a major cause of consumption fragility. The average consumer’s debt today is still 130% of his real disposable income. And his real income continues to drop. In 2009 the decline in wages and earnings continued for more than 100 million working and middle class Americans. According to recently released government data, real wages and benefits fell another 1.3% in 2009. Workers actually earn less today than they did in 2001.

Jobs, foreclosures, earnings decline, unavailability of credit—all have meant a continuing fall in consumption demand which comprises 71% of the economy. A sustained economic recovery—still very much lacking to date—simply cannot occur without a turnaround of consumption. And the longer the turnaround is delayed, the more likely a second ‘dip’ of the economy becomes and even a subsequent second financial crisis. And should the latter occur, a trajectory to depression is on the agenda. Today’s Epic Recession becomes the prelude to global depression.

The Meaning of the Massachusetts Election

The Republicans did not win the Massachusetts election. One candidate, clever enough to tap into rising populist anger, co-opted it. He ran more as a populist than as a Republican. The second, an elitist Democrat, was too aloof, overconfident, and unable to connect with working-middle class voters, and handed it to the Republican on a silver platter.

Attempting to put a conservative spin on the Massachusetts election outcome, Republican news outlets like Fox and Cable news channels have pushed the talking point that the loss of Massachusetts for the Democrats represents a retreat by independent voters from support for Democratic proposals for health care, economic stimulus, bank regulation and the like. But a poll conducted by the AFL-CIO immediately after the vote clearly indicated Democrats were rapidly losing support—not from independents but from working class and union voters. According to AFL-CIO president, Richard Trumka, in a publicly distributed communication to union workers nationwide immediately after the Massachusetts election, “Unless Democrats demonstrate that fixing the economy is their overriding priority, and begin to create more jobs for working Americans NOW, we’re going to see more results this November like the Massachusetts election?. Trumka went on to add that “working America is demanding major change NOW—not timid, go-slow, partial solutions?.

Unfortunately, ‘timid, go-slow, partial solutions’ have been the hallmark of Democratic Party leadership now for decades. Moreover, Obama and his advisors have acted, and continue to act, as if their number one legislative goal is to achieve bi-partisanship with the Republicans—and not jobs, health care, an end to housing foreclosures, or tax justice. Except for bailing out the banks and big corporations, Republicans have refused to agree to any Democratic proposals, no matter how ‘timid, go-slow, or partial’, to use Trumka’s phrase.

In response to the Republicans’ ‘just say no’ strategy, the Obama administration extended its hand in 2009 repeatedly to the Republican pit bull, only to have it consistently bitten upon each gesture. After a year of repeated injuries, the Democrats’ hand was finally severed with the vote in Massachusetts and the immediate collapse of health care legislation.

With but one hand left, Obama and advisors are still insistent, however, on reaching out with the remaining hand (undoubtedly the ‘right’). In one of the most bizarre political moves in recent years, within 48 hours following his State of the Union address in January, President Obama entered the dog pit of the Republican Party legislative caucus to once more try to reason with them. In a closed door meeting with the entire Republican opposition on January 29, Obama again asked them to please consider a bi-partisanship approach. But following the Massachusetts election debacle, what Obama’s futile gesture amounted to was a plea to the Republicans to suspend their ‘just say no’ strategy, which has proved politically as successful for them as the counter-strategy of ‘bi-partisanship at all costs’ has proven a disaster to the Democrats. So why should they change? With less than nine months to the November elections, the Republicans will no doubt intensify their rejection of all future overtures by Obama. One can therefore only wonder why Obama and his advisors cannot figure that out. Is it just naivete on their part? Or does Obama perhaps suffer from the tragic character weakness of wanting to be liked by everyone, even his avowed legislative enemies?

Whatever the cause for Obama’s continuing fixation on a failed strategy of bi-partisanship, it is not just the still deteriorating real economic conditions that has voters increasingly upset after one year of the new administration. It is the perception of Democrat wimpiness, of their inability to get anything done except bank and big business bailouts despite clear majorities in both houses of Congress. It is the perception of a President that is exceptionally good at ‘talking the talk’, but so far has been unwilling to even begin ‘walking the walk’.

Obama’s Historic Choices: 1934, 1994…or 1978

Unfortunately, this is not a new scenario. We have seen it before. It happened in 1994. After a devastating mid-term congressional defeat, Bill Clinton went into the Republican dog pit, promised to balance the budget to offset the then rising cost of bank and savings and loan bailouts, to cut welfare and social spending, to reduce taxes and push Free Trade, and thereby convinced his Republican counterparts he was, if not of canine geneology like them, at least a dog lover. In 1978, having failed to resolve the economic crisis of the 1970s, Jimmy Carter similarly extended both hands to his Republican opposition (in prayer?), and subsequently emerged from the dog pit a born again moderate Republican.

On the other hand, Obama could eschew the Carter-Clinton approach and decide to become a dog trainer instead of a dog lover, like Franklin Roosevelt. FDR would never have met with the opposition to try to ‘reason’ them into cooperation. In fact, after they thwarted his policies in 1933-1934, FDR upped the ante and offered them his New Deal bone to chew on. FDR brought the dogs to heel. When they didn’t behave, after two years he tied them to a post in the back yard until they did. He gave people jobs when bankers and businesses wouldn’t. Banks that refused to lend were forced-merged into those that would. The Federal Reserve was sent into a corner to sulk for a decade. A Home-Owners Loan Corporation, HOLC, was created that took over mortgages under water and it refinanced the terms of mortgages, reducing rates and monthly payments. He earned their wrath but didn’t give a damn and turned to the people instead—not just in talk but action. FDR’s attitude to the intensifying anger of bankers, CEOs, mortgage companies, and wealthy investors was summed up in his declaration at the time, ‘They hate me, and I welcome their hate’. It was not an Obama-like attitude or response, intent on pursuing bi-partisanship at all costs—and in the process leaving the populist field of action to the exclusive use of clever Republicans, tea party radicals, and other right wing assorted goofus. FDR got to the ‘populist pass’ first, well ahead of the opposition.

So we know it won’t be FDR and 1934 after the coming Democratic Party rout in November 2010. It’s either 1978 or 1994. The historic question is whether Obama will become Clinton II or Carter II after the coming November debacle. The big difference in terms of outcomes between the latter two is ‘concessions and lose the election’ vs. ‘concessions to win the next election’. And my guess is it will be more like 1978 than 1994.

It appears an historical trend is re-emerging once again. Every time the Republicans make a mess of the economy—Nixon in the 1970s, Reagan-Bush in the late 1980s, and George W. Bush in the ‘oughties’—the Democrats get a brief chance to set it right. They invariably fail, however. The Democrat then rules for a mere two years, followed by a remarkable transformation as he morphs into a cross-bred Republican. A kind of canine. Perhaps not of exact canine genus and species, but sharing 99.9% common DNA.

Epic Recession Today: Type I (1907-1914) or Type II (1929-1931)?

It is becoming increasingly apparent Obama and his advisors do not adequately understand the fundamental nature of the current crisis. Today’s Epic Recession is not a normal recession. It is quite unlike any of the nine previous recessions that occurred in the U.S. from 1945-2001. On the other hand, neither is it unique. It has happened before. On several occasions in fact. Both in the 19th and 20th centuries. Both in the U.S. and elsewhere.

As explained in Part 1 of this article in last month’s issue of this magazine, as an Epic Recession the current crisis is neither a normal post-1945 recession nor yet a depression. With characteristics of both normal recessions and depressions, Epic Recession is an unstable hybrid condition. It typically transforms into either an extended period of economic stagnation that lasts for a number of years, sometimes as long as a decade; or else transitions to a classic economic depression. As measured by a number of quantitative indicators—i.e. GDP, industrial production, employment, exports, duration of decline, price trends, etc.—Epic Recession is more serious than a normal recession but not as serious as a bona fide depression. More important than just quantitative differences, however, an Epic Recession is a consequence of certain fundamental qualitative forces not at work in normal recessions. These distinguishing qualitative forces are shared, in part, with classic depressions but not as intensely. That is why Epic Recessions may, and sometimes do, descend and transition into bona fide depressions. But it is not guaranteed they always do so.

In the U.S., precisely the former, ‘Type I’ Epic Recession, occurred in 1907-1914 following the severe banking crash and financial panic of 1907. An equally severe contraction in credit and the real economy followed the financial crisis of 1907. The general economic crisis it provoked resulted in an eventual major restructuring of the banking system in the U.S., with the formation of the Federal Reserve, and led to the introduction of a permanent income tax for the first time. That is, fundamental changes in both monetary and fiscal policy at the time (neither of which have as yet occurred in the current Epic Recession).

Nevertheless, these basic changes in the banking and tax systems only served to prevent a deeper economic decline. They did not succeed in generating a sustained economic recovery. Only a leveling off of the economy without a real recovery. Things did not get worse. But neither did they significantly improve for more than a short period. After 1907 the U.S. economy essentially stagnated for six more years, from 1908 to 1914, neither capable of generating a long term recovery but preventing a continued long term collapse. Following the financial crash and initial economic decline, a brief and mild recovery of approximately 24 months occurred. It was followed in turn by another decline of 21 months, by a second mild recovery of 15 months and still another decline lasting 24 months—after which World War I intervened and provided a major economic stimulus. The two ‘short, weak recoveries’ and two ‘brief moderate declines’ averaged out to virtually no sustained longer term economic recovery. It was on average six long years of stagnation. It was, in other words, a ‘lost decade’. The long run stagnation that ensued was only resolved by a sharp acceleration of government spending—i.e. a massive fiscal stimulus—that marked the entry of the U.S. economically into World War I after 1915. Neither the bailout of the banks nor normal tax cuts or stimulus was able to generate sustained economic recovery. It was what this writer calls in his forthcoming book, Epic Recession: Prelude to Global Depression, a ‘Type I’ epic recession.

In contrast to 1907-1914 and its extended economic stagnation following the severe banking crisis of 1907, a ‘Type II’ Epic Recession occurred in 1929-1931. A ‘Type II’ is an Epic Recession in which the economy fails to even level out in an extended period of stagnation, but rather continues to decline in further stages and transitions into a bona fide depression. In a Type I, financial fragility and the collapse of the banking system is checked and contained, but consumption fragility continues to worsen, preventing sustained recovery. In a Type II, financial and consumption fragility continue to deteriorate, leading to a further fracturing of the economic system in stages and a series of further, deeper declines.

The first 24 months of the great depression of the 1930s was a classic ‘Epic Recession’ event, lasting from late summer 1929 through the summer of 1931. During that period, 1929-1931, the public consensus was not that the economy was in depression. It was a very serious recession, no doubt. But not yet serious enough to qualify yet as depression. Layoffs were significant but not disastrous. Manufacturing and construction had declined sharply, but not the entire economy. Banking was not yet in a freefall. However, unlike the 1907-1914 experience, the initial financial crisis (stock market crash of October 1929) and the credit contraction and real economic decline that followed October 1929, transformed into the great depression after mid-1931 instead of a period of extended stagnation, as after 1907. The rest of the economy joined manufacturing and construction, and the economy in general entered a period of more rapid decline. Unemployment rose sharply after mid-1931. And the banking system itself finally collapsed in dramatic fashion.

This different trajectory for 1929-1931 was initially due to the failure to stabilize the banking system as it progressively deteriorated between 1929-1931, i.e. as it grew progressively more ‘fragile’. The real economy and ‘consumption fragility’ additionally grew increasingly fragile from 1929-1931. Both fractured together in the summer of 1931. The financial system crashed for a second time in mid-1931, but this time the banks themselves instead of just the stock market. The event dragged down the real economy with it further and deeper in the second half of 1931. Part of the reason for the second financial crash in 1931 was the decision by the then Hoover administration to prematurely ‘balance the budget’ and for the then Federal Reserve to prematurely ‘raise interest rates’ in order to protect the value of the U.S. dollar in global markets—i.e. talk that has found an echo today in 2010. The Federal Reserve in 1931 thus chose to sacrifice domestic economic recovery to protect the investments of bankers, wealthy investors, and U.S. companies expanding abroad. With the first true banking panic in 1931, credit contracted sharply, businesses began defaulting and folding, massive unemployment ensued, price deflation and wage cutting followed, and defaults (consumer, business, and local government) rose rapidly.

This general scenario was repeated again twice more, in 1932 and in early 1933. By the summer of 1933, unemployment was 25%-30%, production down by more than half, more than 15,000 small banks had failed, the stock market had declined 89%, and the great depression was at its low point.

The great depression of the 1930s was thus not a simple, linear decline of the economy from 1929 to 1941. It was composed of several phases and multiple stages. The opening phase was an Epic Recession, 1929-1931, that was allowed to deteriorate and which consequently transitioned eventually into a series of subsequent contractions, ‘ratcheting’ down from 1931 to 1933. In 1933-34 the decline leveled off. FDR stabilized the banking system. But that stabilization, in itself, was insufficient to generate a sustained economic recovery. 1933-1934 was a period of real economic stagnation, although one during which stock prices and investments began to recover, creating the illusion that the recovery was well underway. But leveling off is not recovery, especially at the very low level to which the economy had fallen. In fact, on the ‘way down’ from 1929-34, there were no fewer than five stock market ‘recoveries’—i.e. periods during which the economy also appeared to have ‘leveled off’. But the appearance did not last, and subsequent declines set it, precipitated by the series of subsequent banking panics in 1931, 1932 and 1933.

Business and banking interests vigorously opposed FDR’s initial recovery program in 1933, except for the bank bailouts and stabilization measures. This was not unlike the present situation in 2009-2010. The stock market made a modest recovery in 1933-34. Financial interests were satisfied all that should be done had been done, despite the rest of the real economy continuing to languish in depression, and advocated strongly for no more stimulus measures. The relative stagnation of 1933-1934 did not end, however, until FDR decided in 1934, after nearly two years in office with no recovery underway, to dramatically shift policy and oppose business interests more directly and aggressively. It was at this point the ‘non-bank’, non-business programs of FDR’s ‘New Deal’ began to take form. In 1935-1937, as a consequence, the remainder of the real ‘Main St.’ economy began a moderate partial recovery as well.

But Roosevelt’s moderate ‘New Deal’ programs of the mid-1930s proved insufficient to engineer a sustained economic recovery. Moreover, business interests in Congress, the Courts, and media launched a political counter-offensive to begin dismantling key elements of the ‘New Deal’. To them the depression was over, with stock prices now rising briskly and corporate profits returning. In their view, there was now no need to continue fiscal spending on jobs, housing, and other measures benefiting workers and small businesses. Balancing the budget once again became the policy mantra. Therefore by 1937 stimulus spending was consequently reduced. Taxes raised.

The retreat from fiscal stimulus predictably meant the economy quickly fell back once again into depression by late 1937-1938. Panicked by the evidence of what they had done, Congress in 1938 restored some of the spending. But it returned as well to a focus on Federal Reserve monetary policies, which took precedence once again over fiscal. But the new policy focus still could not generate a sustained recovery. By early 1941 there was still 15% unemployment.

The great depression of the 1930s, of which the Epic Recession of 1929-1931 was the ‘anteroom’, or preliminary phase, did not conclusively end until the entry of the U.S. into World War II, when massive government spending rapidly rose from previous 15% to 40% of annual economic production, or GDP, in 1942 and to 70% at one point in 1944. Thus sustained recovery from depression and ‘Type II’ Epic Recession was possible only as a result of massive fiscal spending by the government—as was also the case in 1915-1918 which finally ended the ‘Type I’ epic recession of 1907-1914.

This fundamental latter point does not mean that War per se is the only solution to Epic Recessions, or their more severe successors, classic depressions. It does mean, however, that only massive government spending in some form has historically proved the necessary solution to achieve a sustained economic recovery once extraordinary economic contractions like Epic Recessions and depressions occur. Not increases of 5% of GDP, such as occurred in early 2009 with the Obama $787 billion stimulus I package. But stimulus packages consisting of 15%-20% of GDP, or, in today’s terms equivalent to $2.5-$3 trillion. (It is perhaps useful to note that only one major economy in response to the current global epic recession launched a stimulus package quickly in response to the crisis that amounted to approximately 20% of its GDP. That country and economy was China which, by all accounts, quickly returned to prior levels and rate of economic growth by 2010).

The Lessons of Past Epic Recessions

If one wants to adequately understand the trajectory of the current Epic Recession, 2007-2010, in the U.S. it is therefore necessary to understand the fundamental causes and dynamics of those two prior similar Epic Recession events in U.S. history, 1907-1914 and 1929-1931. Instructive as well is the Epic Recession that was experienced by Japan from 1991-2002, clearly also a ‘Type I’ event. Other similar experiences have occurred as well in Latin American economies in the past several decades.

‘Normal’ recessions, such as have occurred nine times in the U.S. since 1945 do not provide appropriate lessons for how to contain and recover from Epic Recessions. In fact, they are grossly misleading. Normal recessions are not precipitated by severe financial and banking crises; Epic Recessions and subsequent depressions always are. It is thus important to understand first and foremost what causes the financial crises. It is equally important to understand how severe financial crises precipitate deep declines in the real economy and set in motion certain qualitative changes that prevent containment and sustained recovery. And how that consequent real economic decline in turn eventually precipitates second and subsequent financial and banking crises.

To date the Obama administration has addressed the current crisis as if it were a normal recession. They have bailed out only part of the financial system and thus temporarily prevented its further collapse. But a banking stabilization can, at best, produce only an extended period of economic stagnation. It cannot generate a sustained recovery. But Obama’s whole strategy in 2009 was predicated on the assumption that bailing out the banks would ‘get credit flowing again’, as he and his advisors said time and again. But it hasn’t. The record is now clear that the banks will not lend—at least to small and medium businesses that need it most. They will continue to speculate globally, seeking quick and fast speculative profits. It will take a fundamental banking system restructuring to change this. Just as other fundamental restructuring of the U.S. economy will be necessary to ensure a return of households to consumption.

To put this all in terms expressed in the book, Epic Recession: Prelude to Global Depression, the administration’s policies to date have staved off a further collapse of the banking system and ‘financial fragility’. But it has done little, on the other hand, to address continuing ‘consumption fragility’. Having blown trillions of dollars bailing out banks and big companies (like GM, who are now investing feverishly in China and elsewhere instead of the U.S.), consumer and household debt levels still remain at dangerously high levels. Meanwhile, the average household’s real disposable income continues to fall in general due to unresolved massive unemployment, continuing wage and earnings cuts, progressive benefits declines, deteriorating retirement income, various negative wealth effects, and a host of other forces.

The flood of publications on the economic crisis now appearing from various ‘pop-econo journalists’ are content to merely describe and narrate and therefore cannot fundamentally explain the current crisis. Because they cannot fundamentally explain, they cannot predict. And because they cannot predict, they cannot provide solutions to the crisis. Similarly, mainstream economists in most cases are unable to explain the trajectory and evolution of Epic Recessions and depressions. Their problem is somewhat different: the use of conceptual tools, models, and analyses that have been developed to explain the quantitatively and qualitatively different ‘normal’ recessions since 1945. That is, models and tools that fare poorly in analyzing and predicting Epic Recessions.

Unlike normal recessions, Epic Recessions are relatively unresponsive to traditional monetary or fiscal policy measures. Such was the case after 1907, in 1930-1931, in Japan after 1991, and elsewhere. Massive injections of liquidity into the banking system following the initial financial crisis that precipitates epic recession may, at best, succeed in only temporarily stabilizing the banking system; but it does not result in a return to credit and lending necessary to generate a sustained economic recovery. A floor may be placed under the financial crisis, preventing its further collapse. But typical central bank (i.e. Federal Reserve) policy interventions are incapable of engineering sustained recovery. For ‘recovery’ is not simply a stabilizing of the banking system. Nor is it even a return of GDP levels to positive growth. GDP is a tool and concept for measuring normal recessions, but grossly inadequate for measuring trajectories of Epic Recessions or depressions. Normal fiscal policy responses—i.e. moderate tax and government spending programs—are likewise insufficient in generating a sustained recovery and, at best, succeed in placing a floor under the collapse of consumption and business investment.

Like aging, one-eyed generals, Obama and his policy advisors—retreads from the Clinton years who no doubt think this is 1992-1994 and recovery can be engineered today as it was from the recession in 1990-1991—are all intent on fighting the new economic war with weapons of the preceding conflict. But the outcome in 2010 of their policies will more likely mimic 1978, not 1994. And that may well mean not only a midterm election debacle in November 2010, but a subsequent possible repeat politically of 1980 in 2012. A thought as chilling as it is unnecessary.

Obama and his administration, Congress and the Democratic party, and the welfare of tens of millions are thus at a crossroads in 2010. Does Obama have the strategic foresight and personal fortitude to make a turn to an FDR-like populist program—not only in ‘talk’ but in the ‘walk’? Or will he continue with another token jobs program, a tweaking of an already timid housing recovery program, and a lot of tough talk about bankers but little else? This writer’s view is that he will play it safe and consequently seal his fate in November and after. The next 60 days will tell if his proposals for 2010 continue to be ‘too little too late’. A thorough analysis of those proposals—and this writer’s comprehensive Alternative Program—are the subject of Part 3 of this article to follow.

Jack Rasmus

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