The stock market crash of 1929 is generally taken beginning of the Great Depression. In fact, the stock market significantly recovered within a few months. The real problems started when consumer confidence failed in the early 1930s, leading to a downward spiral in consumption, production and employment.
There have been comparisons between 1929 and the current situation but there are very significant differences – particularly in Australia.
When there is a decline in confidence, three things need to happen to boost economic activity.
Firstly, consumer spending needs to be stimulated. The best way of doing this is by cutting interest rates. In 1930, Australia had no central bank capable of doing this.The government-owned Commonwealth Bank had been established in 1911 partly with the idea that interest rates could be controlled through the Commonwealth Bank – If the Commonwealth Bank cut interest rates, other banks would have to follow in order to remain competitive. The trouble was that in 1930-31, the Commonwealth Bank refused the cut interest rates unless the Government cut pensions. The Government refused. The standoff led to a vote of no confidence and the defeat of the Scullin government – and no interest rate cut.
In 2008, Australia had high interest rates of around 7% and a central bank able to immediately cut them.
The second thing that needs to be done in a downturn is stimulation of trade by devaluing the currency to make exports cheaper. In the 1930s, the value of the Australian pound was pegged to the British pound. There was no devaluation of the Australian currency to boost exports – and this caused the Depression to become particularly severe in Australia.
Since 1983, the Australian dollar has been allowed to float. Market forces have acted to devalue the Australian dollar by almost 30% from its peak in July 2008.
Finally, employment needs to stimulated. This is best done by undertaking major infrastructure projects. In the 1930s, the Australian Commonwealth and State governments were heavily in debt, mainly to the Bank of England, and had no funds or borrowing capacity to undertake infrastructure projects.
Now, the Australian government has no debt and a large surplus. in fact, he Australian Government Future Fund is one of the largest foreign wealth funds of any country – more than most of the oil-rich Middle Eastern countries. And the Government immediately announced that it would bring forward $4 billion in infrastructure development.
The situation in America is very different.
America has a public debt of more than $10 trillion and has little scope to reduce interest rates which are at around 2%.
When the American investment banks got into trouble, the Senate passed its "bailout" bill which many expected would boost the stockmarket. It didn’t – for the simple reason that it wasn’t intended to. The purpose of the bill was to placate America’s creditors – particularly China – and convince them not to withdraw their funds. That’s why the bill gives the Treasury the power to purchase, without reference to Congress, any assets (not just American ones) required to protect the interests of any investors (not just American ones). And it’s why George Bush called Hu Jintao just before he submitted the bill to Congress.
With this debt, America does not have the financial resources to quickly recover from this downturn. It’s only option is to trade its way out of trouble – a process which could well take a decade or more.
Periods of recession or depression lasting more than a decade have occurred in the past whenever an old technology has gone into decline before a new technology has become established. This occurred in the 1830s and 40s when steam trains replaced horse-drawn transport; the long depression in the 1870s to 90s happened when the electric telegraph, light and motor were introduced and the 1930s depression occurred when mass-produced cars and consumer goods started to become available. We are now experiencing the decline of the fossil fuel economy and have yet to develop the renewalable energy economy which will replace it.
However, it remains extremely unlikely that America will fall into a severe depression like the 1930s. The world now has far more sophisticated financial management, much better economic management tools and much better social welfare. The most likely scenario is a US recession lasting a year or two followed by a prolonged period of moderate performance before the American economy is booming again.
Currently, about 5% of Australia’s exports go to the United States – so a decline of even as much as 10% in American consumption could be expected to translate into a decline of only 0.5% in Australia’s exports. Similarly, it has been estimated that a 10% American decline would lead to only a 0.3% reduction in China’s output.
While Australia is likely to escape the worst of the current downturn, the economic disruption associated with the end of the fossil fuel age is unavoidable. Australia must use its current favourable position to move the economy off fossil fuels and onto renewables.