I'm going to say (before I start talking about the Depression) that while I feel we are currently in poor economic shape, both globally and nationally, and while I don’t see aggregate growth prospects making significant headway any time soon, I do not believe we are heading toward disaster - my justification for this reasoning is another article-in-progress.
Instead, I want to discuss the viability of what we can and cannot do to get us out of the financial hole we’ve dug for ourselves (and in many cases, continue to dig for ourselves). In particular, I’ll refer to the availability of three options that we used in the Great Depression, since this was a popular reference point for our current situation, despite the fact that we’ve had 8.5%-plus unemployment combined with negative GDP growth twice before (once in the mid 1970s recession and also in the early 1980s recession). The only new (and seemingly large) caveats to this been-there-done-that attitude are an incredibly higher national debt and the general consensus that we’re losing competitive ground globally to places like India and China. Let’s keep in mind, however, that the latter sentiment is one that’s been going strong now for about 30-plus years.
Anyway, here are three things we did in the 1930s and brief reasons of why I think these will or will not work (graded A-F on viability):
1. Deficit Spending (C+): FDR and his administration led the way on large increases in government spending throughout much of the Great Depression to fund his New Deal, among many other government purchases that at the time, we couldn't "afford." (See the change in "G" to the far right in the graphic below. Notice also the difference between the changes in investment "I" and that of G.)
Deficit spending entirely our way out of this recession is certainly not the way to go, as our national debt clock will tell you. We are currently just over 100% of our GDP with national debt, and while this hasn't been our highest debt/GDP ratio in our nation's history (it was ~120% during WWII), we don't have nearly the industrial competitive advantages that we had post-war to put us back in the black post-spending. This is not to say that we shouldn't spend - quite the contrary - we'll need to keep some amount of government spending in whatever plan of action we take, as I'll come back to later.
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Click to enlarge
2. Increase The Money Supply (NYSE:B): After the mistake of tightening monetary policy initially, the (still debated) easing of monetary policy that followed helped give liquidity back to the markets, including struggling businesses that were strapped for cash (see the monetary base graphic below. Note the initial fall in the money supply followed by subsequent increases).
Just like in 1932-1933, this move won't do much if we're heading slowly upward or in stagnation, since increased liquidity won't matter much if credit demand isn't a consequence of greater aggregate demand in the economy. Put another way, credit isn't as big of a priority when spending is being curtailed. However, if we are heading for another bust, the Fed will hold onto this move as its last resort, since this injection of liquidity will allow firms seeking desperate loans for funds to pay off their debts and their workers. In short, we hope it doesn't have to come to this, but we could see small increases (or one large increase) in the money supply if the Fed thinks we're heading further downhill. If no measures are taken here, we're probably heading up, however slow it may appear.
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Click to enlarge
3. Government Sponsored Employment Plan (B+): An integral part, both in size and stature, of FDR's New Deal was the Works Progress Administration (WPA), which led the way in creating new jobs, much of which was funded by the $30 billion ($500 billion adjusted for inflation) that the New Deal cost the American people. The plan put many people to work (employing more than 8 million people), and while the true effect of the WPA is debated, the administration without question aided the economy by fighting unemployment and increasing aggregate consumption (and thus earnings).
An employment program would be a solid idea at this stage, especially if we fund smaller businesses that are hurting disproportionately to larger businesses. By spending a stimulus-size package on medium- and micro-sized loans for micro-cap and small-cap businesses, then attaching employment incentives to these loans (such as increased funds to those firms who hire a greater amount of workers), we can increase employment by a much larger marginal amount, than, say, by funding larger corporations through tax breaks, many of which aren't nearly as strapped for cash.
Additionally, if we find that some of these smaller firms require additional liquidity down the road if demand relapses once more, then we can drop a smaller QE2 to release more capital to be loaned into the credit sector. This way, we ensure that any increases in the money supply don't lead to stagflation, since employment would have already increased (increasing earnings growth), and our government-loaning stimulus, which would ideally be attached with high long term interest rates, won't be in much jeopardy of default.
I realize that, as a Keynesian, I'm biased here. Still, my choice would be option No. 3.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.