The Great Depression Comparisons Are Way Off

Sunday, February 13, 2011

Bank runs, financial meltdowns, and ultimate crisis measures have investors on edge. The media is doing its part by playing on those fears, producing headlines that lack permissible context. September 29th's headlines said it all, with every news outlet shouting about the Dow Jones industrial Average's largest point decline in history! Never mind that it was only the 17th largest ration decline (which is still bad, but not "crash" bad), the media is trying to parlay fear into increased concentration and viewership.

All that fear is pushing many habitancy to ask the question, is a depression ahead? The runs on Wachovia and Washington Mutual were stark reminders of that seemingly, but uncomfortably too real, long-gone era. If fear is adequate to collapse the largest thrift in the country, what else is vulnerable?

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Lost in the shuffle of doom-flavored noise, as websites spring up over night touting lists of bank failure predictions, are some huge basic differences between then and now.
There are two major distinctions, unchecked systemic fear and deflation. A closer look at the two will assuredly demonstrate why a depression is not even a remote possibility.

First, bank failures in the early 1930s were both numerous and paralyzing. Many habitancy think the collapses of IndyMac, Wachovia and Washington Mutual are end of the world scenarios. But seeing back, from the end of 1929 straight through 1933, 35% of all bank deposits were lost or withdrawn. The bank runs of that era were unchecked.

In 1929 banks were typically one-town thrifts, operating one or two branches. There were a few larger banks, notably in New York City. When the stock market crashed and the real estate bubble burst it caused a panic in the New York banks, some of which failed. Depositors in those failed institutions lost everything, as there was no Fdic. That knowledge caused a few local bank runs, as habitancy feared losing their whole life savings.

So, without any safeguards, bank runs spread throughout the country. Good institutions failed as much as bad ones. All it took were rumors. Because these small banks were like islands they had no way of paying a run of deposit withdrawals - they could not call in mortgages, nor could they sell them since no market existed. When the vault cash was gone the bank sought protection and concluded its doors, commonly for good. Depositors who missed getting their money out lost everything.
Could a cascade of bank runs happen again? Not likely since the Fdic guarantees up to 0,000 in deposits at a single bank. And, in fact, despite the well-publicized troubles on Wall street only twelve banks have failed this year. While some habitancy may fear a shaky bank, that guarantee is adequate to keep 98% of depositors safe according to the Aba's April bank survey. In the cases of Wachovia and Washington Mutual, no depositor lost any of their money. Their accounts were plainly transferred to dissimilar banks with no delay in way - Citigroup has taken and guaranteed all Wachovia's depositors while Jp Morgan has guaranteed Washington Mutual's accounts. Current Federal preserve statistics show that the money supply and total deposits at banks are still growing (one full year after the crisis began) not declining dramatically.

Deflation is the real imagine there was a Great Depression. The contraction in the banking theory created the deflationary pressures that turned a severe stepping back into a depression. When you step back and think about money in its most basic terms, in increasing to being a store of value it is also a medium of exchange. You work at a job in change for money that you, in turn, change for the basic things you need. You save money to change for basic needs at a later date. If your savings and your revenue are both threatened, without any immediate alternative source of cash, you are forced to use an additional one medium of exchange.

What happened in 1930 and 1931 was exactly that. Without the ability to make more money (rising unemployment) and a loss of savings (bank failures) habitancy were forced to use other assets in change for basic necessities. Mass selling and bartering of household goods and assets reduced the prices on all goods and assets in the economy. In response the cheaper had to dramatically ageement to reflect lower pricing of both assets and the profitability of conducting business.

The deflationary spiral became self-sustaining. Those who had no money had to keep exchanging at lower and lower prices. Those who did have money held on to it out of fear and prospect of still lower prices. The net influence was a nearly unblemished halt in economic activity.
From 1929 straight through 1933 the broad price level of the cheaper fell 25%. Those price declines were broad-based, an correct reflection of every economic sector.

The duplicate whammy of the credit shock from bank failures (including 10,797 banks that went out of business) plus deflation caused an improbable 45% decline in Gdp over that same period. Projecting that onto today's economy, we would have to see a .4 trillion decline in economic action over a four-year period.

There are serious problems in the financial system, and a stepping back is already under way in this first full year after the crisis began. But this contraction will not be nearly as severe as the 9% decline in 1930 (the first year of the depression) or the 13% decline in 1932 (the worst single year of the depression). The banking theory will not suffer double-digit declines in depository inventory levels, even if there are more large financial failures. That should be the headline for newspapers and 24-hour news channels, not the end-of-the-world hyperbole.

The Great Depression Comparisons Are Way Off

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