In 2008 the world dodged a second Depression by avoiding the mistakes that led to the first. But there are further lessons to be learned for both Europe and America

Jean-Claude Juncker, on the euro crisis:

"We all know what to do, but we don’t know how to get re-elected once we have done it"

Dear Sirs, I'm embarrassed for and disgusted at the Economist after reading this article. "American and European unemployment rates rose to barely more than 10% in the recent crisis; they are estimated to have topped 25% in the 1930s." I just finished reading a new article in Business Week moments ago explaining how the real unemployment is currently 21% or 22%. Your article makes no mention of this at all. I think I'll keep reading Business Week instead of the Economist. Based on your prescription for economic growth, every country will go the way of Greece and Italy. No thank you. Hopefully your British readers will take this article to heart and we Americans will read Business Week instead. Have a nice day.

A few observations:

The real issue is DEBT, PRIVATE DEBT. I am amazed at neoclassical economists’ belief that private debt is "okay" (Bernanke regards private debt as “simply a transfer of funds from one class of people [debtors] to another class [creditors]” so it was a mere retribution of a zero sum balance – ignoring this thing we call insolvency!), while a government in a fiat currency when it issues debt denominated in its own domestic currency cannot be insolvent. Today what is different from the 1930s is the COMPOSITION of debt: in the 1930s it was mostly with the business sector (commercial real estate). Today, it is with consumers (residential real estate). But in both cases, debts that can’t be repaid won’t be repaid. It therefore stands that debts should reflect the present value of these assets, not their former value. Resources should be freed and be geared toward more productive investment.

Indeed, one commentator has observed “the US was a creditor country so running up more debt did not open a dangerous dependency on possible rivals or even enemies, unlike today”. This is irrelevant. The only entity that can (legally) issue the US dollar is – wait for it – the United States government. The Chinese government does not “fund” anything. They simply choose to accept US debt because they value it, and the dollar is issued via a simply electronic transfer in a fed account. It is simply clicking a button. In a fiat currency the government is the monopoly issuer of its own currency and it is as simple as clicking a button. The US is not beholden to any foreign power. It is a proud, sovereign nation, unlike the nations in the Eurozone. Japan has been doing it for ages now – no one thought they would become insolvent. The same commentator observed “Hitler assumed the powers of chancellor in a democratic way” – of course, representative government it (be it via semi-Presidential system or the legislature) is not Democracy, it is not Switzerland, or Liechtenstein.

Also, namewithheld is correct: if you use the U6 measure of unemployment (a definition more analogous to the standards used by in the 1930s – every few years in the last two decade they redefine unemployment and eliminate people who have not been in the labor market for a year of no longer being unemployed). Under the U6 measure the unemployment rate is around 18%. That's a depression, but not as severe as the 1930s, despite quicker levels of de-leveraging.

Finally, Milton Friedman does not understand money. This is a man who thinks the money supply is exogenous. I'm sorry, but paper after paper has shown loans create deposits, deposits do not create loans. The Fed DID respond by increasing the monetary base, but people did not want to borrow. In other words, the money supply is endogenous. De-leveraging is taking place. No one wants to borrow. What distinguishes the 1930s and 2010 is government expenditure. No one has answered this question: why haven't we had massive economic disasters akin to the 1820s, 1840s, 1890s, and 1930s, emblematic of massive deflation and mass unemployment?

It is all dreadfully familiar (though no European country is about to elect another Hitler).

In fact no European country ever “elected Hitler”.

For the record:

1. at no time did the Nazi party ever win more than 40% of the vote in a free election. Its share of votes actually decreased in the last (November 1932) election before its seizure of power. Even after seizing power it achieved only 43.9% of the vote in the election of March 1933, and it failed to gain a majority of seats;

2. the Nazis’ seizure of power arose not from a popular vote but from the machinations of establishment politicians (notably von Hindenburg, von Schleicher and von Papen) attempting to maintain their privileged position through the abuse of executive powers;

3. it is true that there were three significant plebiscites under Nazi rule (none of them constitutionally binding) designed to legitimise Nazi rule after the event. However, the earliest of these was held a) more than a year after the Nazi regime had seized power, b) more than a year after opposition parties had been outlawed, and c) six weeks after the assassination of Hitler’s political opponents and the institution of a reign of terror. These plebiscites were a) ratification, after the event, of the combination of Chancellorship and Presidency in 1934, b) approval, after the event, of the remilitarisation of the Rhineland in 1936, and c) ratification, after the event, of the Anschluss in 1938;

4. none of the plebiscites was free or fair. This is evident from the impossibly high approval rates: 90% (of those voting), 98.8% and 99.75% respectively; and

5. amongst the techniques of intimidation used in Nazi plebiscites were a) the arrest of opponents before the vote and abrogation of their voting rights, b) the presence of party officials at ballot boxes who received the marked ballots by hand, and c) the use of numbered ballots (numbered with invisible ink) to identify voters.

A far closer parallel between now and the 1930s is European Council President Herman Van Rompuy’s “fast-track” fiscal compact that seeks to use executive powers to avoid ratification by parliaments or national referendums.

I was hoping for something better from the Economist. Instead, despite a very interesting re-cap of the historical details, the only conclusion is that ever central bank must print, print, and print money in order to buy all the bonds that any organization deemed too big to fail wants to sell. Cheap money and irresponsible lending by private parties got us into this mess, and I don't see how even cheaper money and even less responsible lending by governments via central banks will get us out.

Prior to the invention of fiat currency and central banking, investors generally earned around 6-8% interest on good loans. Current rates are less than half that. We were supposed to be stunned recently by Italy's having to pay 7% on a bond sale. By making money unrealistically cheap, governments are not saving us from a recession any more than autocratic governments saved their economies by providing insanely cheap subsidized gasoline or bread to their citizens. They maintained the subsidies as long as they could, in order to keep the peace, but were eventually forced to abandon them.

What we really have here, both in this article and in this recession, is the first real test of Keynesian economic theory. Until now, it's never been tried on a large enough scale to test whether it can succeed on its own, or it has merely bought sufficient time for some stroke of luck to arrive and bail out the government that tried it.

Perhaps we will now get to find out whether simply lending money cheaply is enough to save the economy. If not, it might be time to step away from the radiant aura of Saint Milton and see if there are some other issues that might be gumming up the economy. Off hand, it occurs to me that those issues might include demographics (too many unproductive and expensive old people), impatient greed (nobody wants to get rich slowly any more), resource depletion (everything that isn't grown is mined), and government regulations (hindering growth in some areas and fostering irresponsibility and instability in others).

The current development here in the U.S. and also the (pending) recession in the U.K. is strong evidence that governmental 'tinder' (stimulus) only works if there is enough 'combustible material' (in other words: a basically solid economy) to feed the 'flames' for a lastingly burning recovery. If this is not so, then the 'tinder' will soon puff out.

And exactly this, even more so than in the aforementioned economies, has happened to some of the peripheral eurozone countries: They have not enough 'combustible material', i.e. a basically healthy, competitive economy, so that a stimulus (the tinder) could lastingly ignite it.

These countries spent the bygone years of plethora with virtually 'burning away' their resources instead of building an economically solid basis for the 'rainy days' to come.

Now, they lack the 'combustible material' (i.e. a competitive economy) necessary for even the most charitable 'tinder' to 'reignite' their fire.

Insofar those are correct (e.g. Mrs. Merkel) who demand that these economies undergo the necessary reforms (i.e. make their economies competitive) at first, so that a tinder (stimulus) can ignite a long burning economic 'fire'. If this is not done first and foremost, all 'tinder fuel' from outside will fizzle out, resulting in an aid-fed economy in perpetuity without any lasting effect.

Of course, really extreme human hardship should be taken care of individually in a charitable way . . . if, finally, even the 'wealthy' of those countries evidentially can't provide for a national welfare scheme via e.g. higher personal property taxes, then - and only then - E.U. solidarity should be employed.

An E.U. 'Welfare Fund', as part of the topped up 'Cohesion Fund', could achieve this . . . under strict supervision, of course, of uncorrupted non-domestic bodies.

Great article.

Would also like to see an analysis of debt levels as % of GDP today compared to 1929 as there is so much more to learn from the roaring 20s than we are led to believe.

There are some very strong arguments for a debt deflation as a explanation of how we got here. It would be great if the Economist could explore this in addition to the standard analysis of what is going on.

When you borrow from the future, you are essentially forgoing future consumption. ECB debiting their accounts and buying up all this debt will not solve the crisis but allocate the cost of bad capital allocation onto the prudent, typically savers. The ones let off the hook are free to get us into the next mess.

I find your leading sentence quite strange. The mistakes that led to the 20th Century's Great Depression are the same mistakes that led to this one: Unrestrained greed--unrestrained by Glass-Steagell (sp?), etc.

The mistakes that made that Great Depression worse than it might have been are not the mistakes that led to it.

Thanks, though, for letting us know what the thinking is of those who are watching these aspects for all of u.

Strange that the author should neglect to mention that the event which reflated the economies and restored full employment was World War Two. How convenient then that China should choose this moment to threaten it's neighbours in the South China Sea. From the US point of view, a limited war is SEAsia might be just the ticket: all those arms manufacturers hiring like crazy, and all those boys in basic training....uemployment? What unemployment?. Dangerous times indeed.

So you are saying "austerity will make it worse." You may be right but there is one big difference between the US back then and the US today: The US was a creditor country so running up more debt didn't open a dangerous dependency on possible rivals or even enemies, unlike today. Ironically, Germany is in the exact opposite position yet it is the one pushing for austerity. But how else would it make Southern Europe change its ways?

I believe Keynes was basically right but more spending by the US government might just make the trade deficit balloon again and if Germany played "friendly" why would Greece and Italy not go back to "business as usual?"

Agreed that the ECB must start buying lots of govt bonds to prevent the crisis from getting worse.

But, as part of a longer-term solution, it must set a relatively high inflation target in order to cushion the impact of wages and prices in the periphery readjusting with levels in the core countries. If this doesn't happen, the staying in the euro will be intolerable for Club Med.

As the leader of one of the biggest parties in the legislature, Hitler assumed the powers of chancellor in a democratic way. I seem to remember that you don't consider parliamentary democracy real democracy but I think it is the better model on offer. (Which leads me to say that the Wiemar Republic was not a real parliamentary democracy but rather what is known as a "semi-presidential" system.)

But hard as times may be, it is difficult to imagine any Western European country abolishing democracy as the system of its government. The greater threat to democracy today seems to be that the EU will have such wide-raging powers over national budgets that democratically elected legislators will answer to unelected civil servants. This makes me very uneasy. I think it is simply wrong to do things this way.

I understand that every fiscal response post-WWII was "Keynesian". My point is that every other test was much more localized, either by geography or by economic sector, than the current situation, and was thus more likely to see the troubles ended by fortuitous external circumstances.

Where I must largely disagree with you is on your assessment of real estate. The recent misallocation of large amounts of capital towards real estate was simply a matter of supply and demand. Thanks to artificially cheap "government" money and the government's willingness to assume the risk of bad home loans, capital was misallocated into ever-higher house prices. This benefited everyone in the industry -- developers, builders, agents, and financiers -- but it distorted the apparent demand for the actual product. As a blunt instrument of bludgeoning real estate speculation to death, a heavy land tax might do the job, but rather than using one misguided government intervention to cancel out another misguided government intervention, a more sensible option would have been to unwind all the mortgage subsidies. If there is any moral basis to them at all, it's that it's somehow more noble for people to own houses than to rent them. That itself is hard to support in a general sense. More significantly, heavy land taxes, when tried, force land owners to maximize the revenue they can get from their property, which in turn usually distorts the markets and damages the environment. An owner of a couple low-rent houses along a busy highway may find himself forced to build a strip mall or upscale condos. An owner of farm land may be forced to plant the highest-value crops and push the land to maximize yields. An owner of timber land may be forced to log it. In short, a heavy land tax may have almost the same end result as subsidized mortgages -- over-development.

The aspect of stimulus I wish was addressed here is the Law of Diminishing Returns.

This was raised briefly during The Economist’s debate on Keynesianism back in March 2009 (here and here).

There is a useful distinction to be drawn between:

a) "automatic stabilisers" (the reductions in tax and increase in welfare payments that arise automatically during a recession); and

b) what might be called "discretionary stimulation".

It may be expected that the more discretionary stimulation is employed, the lower will be the marginal return on it. During any recession a reallocation of resources is required . . . and that takes time. The pain of reallocation may be ameliorated, but the process cannot be speeded up by pouring money on to it.

Now all the “tinder” (to borrow la.výritý’s expression) has been used and panicked governments are switching back to austerity instead.

How different things might have been if that scarce stimulus had been rationed more carefully as suggested by some at the time.

"A far closer parallel between now and the 1930s is European Council President Herman Van Rompuy’s “fast-track” fiscal compact that seeks to use executive powers to avoid ratification by parliaments or national referendums."

I don't know the details of this proposal but I think you may be right. It is greatly disconcerting how uninterested European leaders are in making sure the EU becomes more democratic as it becomes more of a federation. I really find it problematic. Of course, politicians find elections "troublesome." Who, after all, likes to risk being fired from a prominent position every four or so years. Democracy, or rather the rule of law, may also be having trouble in the US (which does not, of course, excuse any tendency to abolish democratic control of the entity, state or union, that controls budgets and thus has the power of the purse)

Democracy is under pressure in its heartlands for the first time in at least two generations:

http://andrewsullivan.thedailybeast.com/2011/12/the-end-of-america.html

Firstly, I would disagree THIS recession then is THE test for Keynesianism, at least in Europe given several countries are not operating in fiat currencies (Keynes came to be sympathetic with endogennous money and Abba Lerner's "functional finance"). Australia and China would be better examples - as the government (certainly in the latter) are not constrained ideologically.

Secondly, it was indeed a matter of supply and demand: credit expannsion (which you yourself note) created illusionary demannd for a finite resource (land). Rents result. In fact, you seem to have rephrased exactly what I said: "Thanks to artificially cheap government money and the government willingness to assume the risk of bad home loans, capital was misallocated into ever-higher house prices. This benefited everyone in the industry -- developers, builders, agents, and financiers -- but it distorted the apparent demand for the actual product". In other words, a blending of the Austrian and Georgist schools of thought. Where I differ is that it is relevant whether it is "government money" the Melbourne Land Boom of the 1890's (Australia's biggest depression) occured in the most free market banking system in human history. If the money supply is endogenous, that does not stop financially innovator acts from being, well, innovative, and finding ways to fund rent-seeking projects.

Thirdly, we also differ is a heavy land tax (a form of tax with no so-called 'deadweight loss'). Land itself is ALWAYS valuable because of the unearned increment i.e. if schools, roads, new infrastructure are laid out, it will always emit a positive price signal which will cause banks to lend money (as we have noted they do so endogenously) - if land is rising in value - due to positive expectations (which may or may not be justified e.g. "population growth", "zoning", "new infrastructure" etc), then people get suckered into the winner's curse. So mortgage subisidies are irrelevant: we have had land booms without them in 1798 (settlement speculation), 1819 (turnpikes), 1837 (canals), 1857 (railway), 1873 (railways), 1893 (silver, agricultural and railways), 1929 (commercial property), 1973 (commercial/residential property boom), 1989 (commercial property boom) etc. Note that all material progress, all advances in science, technology, in infrastructure create an externality: a rise in land values. So I do not accept your one-dimensional solution. Land is sui generis because it more than capital tends to appreciate due to exogenous forces (population, urbanization, advances in technology).

You are correct heavy land taxes force land owners to maximize the revenue - it forces the monopolist, particularly in suburban areas to be put to its most productive use (for the interim) - for jobs, for investment, for production (efficiency) as well as promoting equity (bringing unused, empty homes onto the market so families can move into them). It does not distort the market; it frees the market as it allows labor and capital to find their feet. As for the envrionemnt, I would argue the opposite: it stop urban sprawl because the vacant land INSIDE urbanised regions must FIRST be put to use before speculators 'leap frog' on the edges of a city.

"An owner of a couple low-rent houses along a busy highway may find himself forced to build a strip mall or upscale condos". So what? If the property has a 'higher' (more efficient) use (measured by higher demand or innovation), then so what? Although I would question this claim and extreme scenario. Hong Kong, Signapore (which derive 40% of their revenue from land) actually did NOT suffer during the Asian Financial Crisis (unlike regions with vacany rates of 50%). Why might it not result in "overdevelopment" in a large country?

* Because several properties are already developed, but idle - so if the family is moving into the home, or a vacant building is put to use there is nothing to "develop". The land is already developed. If it does lead to "overdevelopment" it may simply be fixing dilpihdated buildings, until some other viable opportunity homes along.

*Development would only result if it is viable to develop - e.g. on the edges of cities and the like.

* Empirical evidence where small land taxes have been applied so a building burst, but not a boom. The logical reasons why LVT does not result in overdevelopment is discussed here:

http://books.google.com.au/books?id=IcRmvWDmrp8C&pg=PA24&dq=land+tax+equ...

As such, your views are dismissed, and from being criticisms explain exactly why a land tax is useful.

“What we really have here, both in this article and in this recession, is the first real test of Keynesian economic theory. Until now, it's never been tried on a large enough scale to test whether it can succeed on its own, or it has merely bought sufficient time for some stroke of luck to arrive and bail out the government that tried it”

Not true. It was tried after the post-war (every fiscal response after WWII was described as “Keynesian”) and the “first real test of Keynesian economic theory” worldwide (but particularly in the US) was the 1973-75 recession:

http://sydney.edu.au/business/__data/assets/pdf_file/0019/71443/Paper_on...

I second the stuff on Milton, although note that no one has tackled the big cause of business cycles/depressions: credit expansion and rent-seeking behavior (particularly in real estate sector), which mis-allocates resources like capital (i.e. empty homes and buildings, demand for which never materializes) and thus labor (job losses in construction sector, manufacturing which relies on construction sector etc) - a heavy land tax would eliminate privatizing rent-extraction (the state collects the rents, but frees labor and capital) and thus the violent booms and busts would be largely mitigated (except for extreme exogenous shocks).

PS I just had a conversation with a friend and raised your concerns, and he agreed with me that:

1. To the extent that LVT encourages more development closer to the
CBD (by forcing idle land to come into use - something you concede it does do), it reduces the pressure to develop further out.

2. If the govt gets revenue from land values, it has an incentive to maximize the total value. And there's a certain optimum amount of open space / parkland that maximizes the total: "too little" open space damages values of developed land because nobody wants to live in a concrete jungle. "Too much" open space damages synergies that depend on proximity.

3. Overdevelopment can be in the "eye of the beholder" (is Hong Kong "overdeveloped" given its large population and small size? Is Singapore "overdeveloped" given its finite area on a small? And in any event, the over-development issue involves zoning approvals and the like). See also
http://www.grputland.com/2011/11/why-renters-are-vermin.html

Aren't we popping the corks on the champagne a little too early? This economy is one predicated upon central banks paying interest on bank deposits, what I call printing profits. With high unemployment, the Eurozone self-destructing, and the US economy ready to tip back into recession, we are not out of the woods. In fact, Bernanke's program may cause a deep depression because the Regressives want to impose austerity which will most assuredly cause a serious recession. They want to act like the worst is over and now we must solve our fiscal crisis with austerity.

To avoid a depression, we need to provide sufficient stimulus and except for a few people like myself and most of the economics profession, no one else wants to hear about it. Put your glasses away because you are about to toast the beginning of the real depression, the first recession was just a warm-up.

Mike Ballantine is a US Presidential candidate for the Green Party

Furthermore, your accusation of "overdevelopment" faces other problems (beside moral - i.e. the land is already developed and can be used by people who actually want to use it - and empirical - i.e. that it actually does do so). It shows a failure to understand that economic rent reflects potential for optimum not maximum use and that some land bears little or no economic rent (cf. CBD and the middle of Lake Eyre).

Instead of overdevelopment, we would see a more compact development (by removing leap frogging and putting land to its optium use - yes that includes those plazas and condos!) as well as a *wholesome* reduction in the number of vacant and underused lots in urban centres and a country side not eroded by urban sprawl. This compact pattern of development would cut the cost of public services and 2.5 hrs trips into Sydney. And, of course, the heavy land tax is intended to abolish/eliminate taxes onn labour (payroll, income) and capital (capital gains, sale taxes etc). So your criticisms are actually virtues (yes, it may cause dilaphidated buildings to be repaired!) and won't result in "overdevelopment" that is random, but measured precisely because the enterprise forces one to ask: "who in this local area with make use of this? Is this the optimum, as opposed to merely maximum function ,this land serves?".

You're alternative: more land hoarding and depressions. You fail to appreciate the unique power of land and the endogenous nature of the money supply.