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ECONOMIC DEPRESSIONBY M. N. KhanMEANING

In economics, a depression is a sustained, long downturn in one or more economies. It is more severethan a recession, which is seen as a normal downturn in thebusiness cycle. A depression ischaracterized by abnormal increases in unemployment, restriction ofcredit, shrinking output andinvestment, numerous bankruptcies, reduced amounts oftrade and commerce, as well as highlyvolatile relative currency value fluctuations, mostly devaluations. Price deflation orhyperinflation arealso common elements of a depression.

LIST OF PREVIOUS DEPRESSIONS

GREAT DEPRESSION

The most well-known depression is the Great Depression that affected most of the economiesin the world throughout the 1930s. The depression began during the Wall Street Crash of 1929, andthe crisis quickly spread to most national economies. Between the years of 1929 and 1933, GDPdecreased by 33% and unemployment rates increased to 25%. Possible causes for the GreatDepression include the stock market and the bank panics of October 1930.

A long-term effect of the Great Depression has been the departure of every major currency fromthe Gold Standard.

PANICOF 1837

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People standing in que for food to be served

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The Panic of 1837 was an American financial crisis, built on a speculative real estate market. Thebubble burst on May 10, 1837 in New York City, when everybankstopped payment in gold and silvercoinage. The Panic was followed by a five-year depression, with the failure ofbanks and record highunemployment levels.

LONG DEPRESSION

The Long Depression, known at the time as the "Great Depression", lasted from about 1873to 1896. It affected much of the world and was contemporaneous with the Second IndustrialRevolution.

CURRENT DEPRESSION FROM LATE -2000S

In 20082009 much of the industrialized world entered into a deep recession sparked by a financialcrisis that had its origins in reckless lending practices involving the origination and distribution ofmortgage debt in theUnited States. Sub-prime loans losses in 2007 exposed other risky loans andover-inflated asset prices. With the losses mounting, a panic developed in inter-bank lending. The

precarious financial situation was made more difficult by a sharp increase inoil andfood prices. Theexorbitant rise in asset prices and associated boom in economic demand is considered a result of theextended period of easily available credit, inadequate regulation and oversight, or increasinginequality. As share and housing prices declined many large and well established investment andcommercial banks in the United States and Europe suffered huge losses and even faced bankruptcy,

resulting in massive public financial assistance. A global recession has resulted in a sharp drop ininternational trade, rising unemployment and slumping commodity prices. Social unrest andpolitical changes have appeared in the wake of the crisis.

In December 2008, the NBERdeclared that the United States had been in recession since December2007, and several economists expressed their concern that there is no end in sight for the downturn andthat recovery may not appear until as late as 2011. The recession is the worst since the GreatDepression of the 1930s. The unemployment rate has been increasing since September 2008. For April2009 alone, a net total of 539,000 jobs have been lost in the United States. The unemployment rate inthe United States is currently at 8.9%. The IMF has warned about "worrisome parallels" between thecurrent global crisis and the Great Depression, despite the unprecedented steps already taken by central

banks and governments worldwide.

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People on street unemployed

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INDICATIONSBEFORETHEPRESENTECONOMICCRISIS

COMMODITY BOOM

The decade of the 2000s saw a global explosion in prices, focused especially in commodities

and housing, marking an end to the commodities recession of 1980-2000. In 2008, the prices of manycommodities, notably oil and food, rose so high as to cause genuine economic damage, threateningstagflation and a reversal ofglobalization.

The decade of the 2000s saw a global explosion in prices, focused especially in commodities andhousing, marking an end to the commodities recession of 1980-2000. In 2008, the prices of manycommodities, notably oil and food, rose so high as to cause genuine economic damage, threateningstagflation and a reversal ofglobalization.

HOUSING BUBBLE

By 2007, real estate bubbles were still under way in many parts of the world, especially in theUnited States, United Kingdom,Netherlands, Italy, Australia,New Zealand, Ireland, Spain, France,Poland, South Africa, Israel, Greece, Bulgaria,Croatia, Canada, Norway,Singapore, South Korea,Sweden, Argentina, Baltic states, India, Romania, Russia, Ukraine and China.[citation needed] U.S.Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth'(in the U.S. housing market) it's hard not to see that there are a lot of local bubbles". The Economistmagazine, writing at the same time, went further, saying "the worldwide rise in house prices is the

biggest bubble in history". Real estate bubbles are invariably followed by severe price decreases (alsoknown as a house price crash) that can result in many owners holding negative equity (a mortgage debthigher than the current value of the property).

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Increasing Oil and gasoline rates

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INFLATION

In February 2008, Reuters reported that global inflation was at historic levels, and thatdomestic inflation was at 10-20 year highs for many nations. "Excess money supply around the globe,monetary easing by the Fed to tame financial crisis, growth surge supported by easy monetary policyin Asia, speculation in commodities, agricultural failure, rising cost of imports from China and rising

demand of food and commodities in the fast growing emerging markets," have been named as possiblereasons for the inflation.

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Hike in housing Prices

World wide Inflation

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CAUSES

DEBATE OVERORIGINS

On October 15, 2008, Anthony Faiola, Ellen Nakashima, and Jill Drew wrote a lengthy article

in The Washington Post titled, "What Went Wrong". In their investigation, the authors claim thatformer Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary Robert Rubin, andSEC Chairman Arthur Levitt vehemently opposed any regulation offinancial instruments knownas derivatives. They further claim that Greenspan actively sought to undermine the office of theCommodity Futures Trading Commission, specifically under the leadership ofBrooksley E. Born,when the Commission sought to initiate regulation of derivatives. Ultimately, it was the collapse ofa specific kind of derivative, the mortgage-backed security, that triggered the economic crisis of2008.

SUBPRIME LENDING AS A CAUSE

Based on the assumption that subprime lending precipitated the crisis, some have argued thatthe Clinton Administration may be partially to blame, while others have pointed to the passage of theGramm-Leach-Bliley Act by the 106th Congress, and over-leveraging by banks and investors eager toachieve high returns on capital.

Some believe the roots of the crisis can be traced directly to subprime lending by Fannie Mae andFreddie Mac, which are government sponsored entities. The New York Times published an article thatreported the Clinton Administration pushed for subprime lending: "Fannie Mae, the nation's biggest

underwriter of home mortgages, has been under increasing pressure from the Clinton Administration toexpand mortgage loans among low and moderate income people" (NYT, 30 September 1999).

In a 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to1998 it was shown that $467 billion of mortgage credit poured out of CRA-covered lenders into low-and mid-level income borrowers and neighborhoods. (See "The Community Reinvestment Act AfterFinancial Modernization," April 2000.)

GOVERNMENT INTERVENTION AS A CAUSE

In 1992, the 102nd Congress and the George H. W. Bush administration weakened regulationof Fannie Mae and Freddie Mac with the goal of making available more money for the issuance ofhome loans. The Washington Post wrote: "Congress also wanted to free up money for Fannie Mae andFreddie Mac to buy mortgage loans and specified that the pair would be required to keep a muchsmaller share of their funds on hand than other financial institutions. Whereas banks that held $100could spend $90 buying mortgage loans, Fannie Mae and Freddie Mac could spend $97.50 buyingloans. Finally, Congress ordered that the companies be required to keep more capital as a cushionagainst losses if they invested in riskier securities. But the rule was never set during the Clintonadministration, which came to office that winter, and was only put in place nine years later.

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OVER-LEVERAGING, CREDITDEFAULTSWAPSANDCOLLATERALIZEDDEBTOBLIGATIONS

Another probable cause of the crisis and a factor that unquestionably amplified its magnitudewas widespread miscalculation by banks and investors of the level of risk inherent in the unregulatedCollateralized debt obligation and Credit Default Swap markets. Under this theory, banks and investors

systematized the risk by taking advantage of low interest rates to borrow tremendous sums of moneythat they could only pay back if the housing market continued to increase in value.

The average recovery rate for high quality CDOs has been approximately 32 cents on the dollar, whilethe recovery rate for mezzanine CDO's has been approximately five cents for every dollar. Thesemassive, practically unthinkable, losses have dramatically impacted the balance sheets of banks acrossthe globe, leaving them with very little capital to continue operations.

CREDIT CREATION AS A CAUSE

The Austrian School of Economics proposes that the crisis is an excellent example of theAustrian Business Cycle Theory, in which credit created through the policies ofcentral banking givesrise to an artificialboom, which is inevitably followed by abust. This perspective argues that themonetary policy of central banks creates excessive quantities of cheap credit by setting interest rates

below where they would be set by a free market. This easy availability of credit inspires a bundle ofmalinvestments, particularly on long term projects such as housing and capital assets, and also spurs aconsumption boom as incentives to save are diminished. Thus an unsustainable boom arises,characterized by malinvestments and overconsumption.

Other observers have doubted the role that the yield curve plays in controlling the business cycle. In aMay 24, 2006 story CNN Money reported: in recent comments, Fed Chairman Ben Bernankerepeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is nolonger a good indicator of a recession ahead.

OTHERCAUSES

Many libertarians, including Congressman and former 2008 Presidential candidate Ron Paul

and Peter Schiffin his bookCrash Proof, claim to have predicted the crisis prior to its occurrence.They are critical of theories that the free market caused the crisis and instead argue that the FederalReserve's expansionary monetary policy and the Community Reinvestment Act are the primary causesof the crisis. Alan Greenspan, formerFederal Reserve chairman, has said he was partially wrong tooppose regulation of the markets, and expressed "shocked disbelief" at the failure of the self interest ofthe markets. It has also been debated that the root cause of the crisis is overproduction of goods caused

by globalization (and especially vast investments in countries such as China and India by westernmultinational companies over the past 1520 years, which greatly increased global industrial output ata reduced cost). Overproduction tends to cause deflation and signs of deflation were evident in Octoberand November 2008, as commodity prices tumbled and the Federal Reserve was lowering its targetrate to an all-time-low 0.25%. On the other hand, ProfessorHerman Daly suggests that it is notactually an economic crisis, but rather a crisis ofovergrowth beyond sustainable ecological limits. Thisreflects a claim made in the 1972 bookLimits to Growth, which stated that without major deviation

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from the policies followed in the 20th century, a permanent end of economic growth could be reachedsometime in the first two decades of the 21st century, due to gradual depletion of natural resources.

EFFECTS

OVERVIEW

The 2008-09 recession is shaping up to be the worst post-war contraction on record:

Real gross domestic product (GDP) began contracting in the third quarter of 2008, andby early 2009 was falling at an annualized pace not seen since the 1950s. Capital investment, which was in decline year-on-year since the final quarter of 2006,matched the 1957-58 post war record in the first quarter of 2009. The pace of collapse inresidential investment picked up speed in the first quarter of 2009, dropping 23.2% year-on-year, nearly four percentage points faster than in the previous quarter. Domestic demand, in decline for five straight quarters, is still three months shy of the1974-75 record, but the pace down 2.6% per quarter vs. 1.9% in the earlier period is arecord-breaker already.

TRADEANDINDUSTRIALPRODUCTION

In middle-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by 50% in

one week, as the credit crunch made it difficult for exporters to obtain letters of credit.

In February 2009, The Economist claimed that the financial crisis had produced a "manufacturingcrisis", with the strongest declines in industrial production occurring in export-based economies.

In March 2009, Britain's Daily Telegraph reported the following declines in industrial output, fromJanuary 2008 to January 2009: Japan -31%, Korea -26%, Russia -16%, Brazil -15%, Italy -14%,Germany -12%.

Some analysts even say the world is going through a period ofdeglobalization and protectionism afteryears of increasing economic integration.

UNEMPLOYMENT

The International Labour Organization (ILO) predicted that at least 20 million jobs will havebeen lost by the end of 2009 due to the crisis mostly in "construction, real estate, financial services,and the auto sector" bringing world unemployment above 200 million for the first time. The numberof unemployed people worldwide could increase by more than 50 million in 2009 as the globalrecession intensifies, the ILO has forecast.

The rise of advanced economies in Brazil, India, and China increased the total global labor pooldramatically. Recent improvements in communication and education in these countries has allowedworkers in these countries to compete more closely with workers in traditionally strong economies,

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such as the United States. This huge surge in labor supply has provided downward pressure on wagesand contributed to unemployment.

FINANCIALMARKETS

For a time, major economies of the 21st century were believed to have begun a period ofdecreased volatility, which was sometimes dubbed The Great Moderation, because many economicvariables appeared to have achieved relative stability. The return of commodity, stock market, andcurrency value volatility are regarded as indications that the concepts behind the Great Moderation

were guided by false beliefs.

There were several large Monday declines in stock markets world wide during 2008, including one inJanuary, one in August, one in September, and another in early October. As of October 2008, stocks in

North America, Europe, and the Asia-Pacific region had all fallen by about 30% since the beginning ofthe year. The Dow Jones Industrial Average had fallen about 37% since January 2008.

The simultaneous multiple crises affecting the US financial system in mid-September 2008 causedlarge falls in markets both in the US and elsewhere. Numerous indicators of risk and of investor fear(the TED spread, Treasury yields, the dollar value of gold) set records.

Russian markets, already falling due to declining oil prices and political tensions with the West, fellover 10% in one day, leading to a suspension of trading, while other emerging markets also exhibitedlosses.

Political Communists and others rallied in Moscow to protest the Russian government's economicplans. Protests have also occurred in China as demands from the west for exports have beendramatically reduced and unemployment has increased.

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Unemployment graph showing increasing unemployment

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POLICYRESPONSES

NATIONALFISCALPOLICYRESPONSETOTHELATE 2000SRECESSION

The financial phase of the crisis led to emergency interventions in many national financialsystems. As the crisis developed into genuine recession in many major economies, economic stimulus

meant to revive economic growth became the most common policy tool. After having implementedrescue plans for the banking system, major developed and emerging countries announced plans torelief their economies. In particular, economic stimulus plans were announced in China, the UnitedStates, and the European Union. Bailouts of failing or threatened businesses were carried out ordiscussed in the USA, the EU, and India. In the final quarter of 2008, the financial crisis saw the G-20group of major economies assume a new significance as a focus of economic and financial crisismanagement.

UNITED STATES POLICY RESPONSES

The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps onSeptember 19 to intervene in the crisis. To stop the potential run on money market mutual funds, theTreasury also announced on September 19 a new $50 billion program to insure the investments,similar to the Federal Deposit Insurance Corporation (FDIC) program. Part of the announcementsincluded temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups tomore easily share funds within their group. The exceptions would expire on January 30, 2009, unlessextended by the Federal Reserve Board.

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Tokyo share market falling down

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MARKET VOLATILITY WITHIN US 401(K) AND RETIREMENT PLANS

The US Pension Protection Act of 2006 included a provision which changed the definition ofQualified Default Investments (QDI) for retirement plans from stable value investments, moneymarket funds, and cash investments to investments which expose an individual to appropriate levels of

stock and bond risk based on the years left to retirement. The Act required that Plan Sponsors move theassets of individuals who had never actively elected their investments and had their contributions in thedefault investment option. This meant that individuals who had defaulted into a cash fund with littlefluctuation or growth would soon have their account balances moved to much more aggressiveinvestments.

Starting in early 2008, most US employer-sponsored plans sent notices to their employees informingthem that the plan default investment was changing from a cash/stable option to something new, suchas a retirement date fund which had significant market exposure. Most participants ignored thesenotices until September and October, when the market crash was on every news station and mediaoutlet. It was then that participants called their401(k) and retirement plan providers and discovered

losses in excess of 30% in some cases. Call centers for 401(k) providers experienced record callvolume and wait times, as millions of inexperienced investors struggled to understand how theirinvestments had been changed so fundamentally without their explicit consent, and reacted in a panic

by liquidating everything with any stock or bond exposure, locking in huge losses in their accounts.

LOANS TO BANKS FORASSET-BACKED COMMERCIAL PAPER

During the week ending September 19, 2008, money market mutual funds had begun to

experience significant withdrawals of funds by investors. This created a significant risk because moneymarket funds are integral to the ongoing financing of corporations of all types. Individual investorslend money to money market funds, which then provide the funds to corporations in exchange forcorporate short-term securities called asset-backed commercial paper(ABCP). However, a potential

bank run had begun on certain money market funds. If this situation had worsened, the ability of majorcorporations to secure needed short-term financing through ABCP issuance would have beensignificantly affected. To assist with liquidity throughout the system, the US Treasury and FederalReserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Windowusing ABCP as collateral.

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LEGISLATION

The Secretary of the United States Treasury, Henry Paulson and President George W. Bush

proposed legislation for the government to purchase up to US$700 billion of "troubled mortgage-

related assets" from financial firms in hopes of improving confidence in the mortgage-backedsecurities markets and the financial firms participating in it. Discussion, hearings and meetings amonglegislative leaders and the administration later made clear that the proposal would undergo significantchange before it could be approved by Congress. On October 1, a revised compromise version wasapproved by the Senate with a 74-25 vote. The bill, HR1424 was passed by the House on October 3,2008 and signed into law. The first half of the bailout money was primarily used to buy preferred stockin banks instead of troubled mortgage assets.

In January 2009, the Obama administration announced a stimulus plan to revive the economy and tocreate more than 3.6 million jobs in two years. The cost of this initial recovery plan was estimated at825 billion dollars (5.8% of GDP). The plan included 365.5 billion dollars to be spent on major policy

and reform of the health system, 275 billion (through tax rebates) to be redistributed to households andfirms, notably those investing in renewable energy, 94 billion to be dedicated to social assistance forthe unemployed and families, 87 billion of direct assistance to states to help them finance healthexpenditures ofMedicaid, and finally 13 billion spent to improve access to digital technologies. Theadministration also attributed of 13.4 billion dollars aid to automobile manufacturers General Motorsand Chrysler, but this plan is not included in the stimulus plan.

GLOBAL RESPONSES

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MONEYMARKETCHART

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Responses by the UK and US in proportion to their GDPs. Most political responses to theeconomic and financial crisis has been taken, as seen above, by individual nations. Some coordinationtook place at the European level, but the need to cooperate at the global level has led leaders to activatethe G-20 major economies entity. A first summit dedicated to the crisis took place, at the Heads ofstate level in November 2008 (2008 G-20 Washington summit).

The G-20 countries met in a summit held onNovember 2008 in Washington to address the economiccrisis. Apart from proposals on international financial regulation, they pledged to take measures tosupport their economy and to coordinate them, and refused any resort to protectionism.

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Global economy spending policy

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