Hamish McRae: It's bad, may get worse, but it's no Great Depression

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The Independent Online

The world's monetary authorities are at last really trying to reassert their power over the financial markets. They have not yet succeeded and they will have to do more, maybe much more, but eventually they will win. Or at least they always have in the past 75 years. You have to think that the world is facing something akin to the Great Depression of the 1930s to believe that they will fail.

For a start, the fire-power of the world's central banks, particularly when acting together, is huge. They can flood the world with money almost without limit, hence reinforcing the changes in interest rates such as they agreed on yesterday. Central banks don't act in concert very often. The last time I recall was a pact in 1985 to support the dollar. This time there will have to be more interest rate cuts around the world, but one of the messages yesterday was that there will be. This is the start of global interest rate disarmament. It was also great in show-biz terms to get the Chinese on board, since the Chinese economy has become the principal source of growth in the world.

The second way in which the authorities are taking charge is by supporting the banks. The response has had to come from governments and it has been pretty mixed. You would expect that. Governments had to make it up as they went along.

Not all have succeeded. The wooden spoon clearly goes to Iceland but the US has done none-too-well either. Continental European governments have done rather better with their bank rescues and this latest British plan makes a great deal of sense because it goes to the heart of the problem. It will give the banks access to whatever capital they need to keep functioning. You cannot do this well for that is not in the nature of the beast, but the British authorities are doing it better than most.

Getting the world's banking system moving again is a necessary precondition to averting a serious economic slump. There was always going to be some sort of global slowdown but the loss of confidence in the financial markets has made matters worse, potentially much worse. Markets reflect what they think will happen to the economy, but also help shape it. The markets are now in blue funk mode, signalling they believe that the forthcoming downturn will be serious indeed. They are not in the utter despair of the mid-1970s, the feeling that governments have lost control over monetary policy, their budgets, everything.

But the negative response to the British bank rescue plan and to the global interest rate cuts is undoubtedly troubling. You could say that what they are suggesting is that this downturn will be similar to that of the 1990s, a nasty but "conventional" post-war recession. That may happen, though my own view is that the UK may pull through in somewhat better shape than it did then. But could it be worse still – something more akin to the 1930s Depression?

I can think of at least half-a-dozen reasons why the present situation is quite different to that after the 1929 share price crash.

First, what is happening now follows a long period of rising prosperity, the longest such period the world has ever known. In the 1930s the world was still recovering from the destruction of half the accumulated wealth of the 19th century.

Second, there were deep rivalries and even hatreds between major nations that made economic co-operation virtually impossible and encouraged the rise of trade barriers and competitive devaluations. As a result world trade halved, making recovery very difficult.

Third, the US allowed many banks to go bust, leading to a breakdown in commercial activity. The US has a deeper recession than any other major nation. This time, pace Lehman, it will patch things up.

Fourth, countries followed what they thought were sound fiscal policies, trying to balance their budgets, cutting spending as their tax revenues fell. This time budget deficits will be allowed to rise.

Fifth, price levels in the 1930s were falling, so even very low nominal interest rates were high in real terms and investment funds were therefore expensive. Now prices are rising so low interest rates are more likely to boost investment.

Finally, global demand will be maintained by China, which in the 1930s was not a force in world trade. Now it is probably the world's third largest economy, so though much of the developed world may go into some sort of recession, we are not talking a decline for the world as a whole.

So yes, maybe something like the early 1990s, though that is not at all certain, but the 1930s? Unless something unspeakably dreadful happens in the coming months, absolutely not.

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