Great Depression and Global Economic Recession - Essay Example

?Federal Reserve Actions during the Great Depression in 1929 and 1930, and the Global Economic Recession of 2008 and 2009 Introduction The global economy has changed in various periods in history. Changes in global economy are interesting since they affect different continents in the world. The main reason for this is due to the circulation of goods in different continents. Besides, effects of commerce are experienced on a global scale. Therefore, an economic slump in the US will also be faced in Europe and the Far East. There are two critical periods in history whereby the global economy has slumped markedly, affecting millions of people around the world. The first is the Great Depression of the late 1920’s and more recently, the Global Economic Recession of the late 2000’s. Various factors have been implicated in these notable economic slumps in history, but these vary widely according to many economists, pundits and authors of economics books all have given their opinions on what may have caused the Great Depression and the Global Economic Recession. This essay analyses the Great Depression and the Global Economic Recession in detail by analyzing the causes and the role that Federal Reserve Actions played in the economic slumps. The paper also describes opinions concerning the economic slumps from four economists. The first two are Jeremy Attack and Peter Passell, authors of the book, “A New Economic View of American History: From Colonial Times to 1940”. The other authors are Jonathan Hughes and Louis Cain, authors of, “American Economic History”. In order to understand arguments put forth by these authors, it is important to analyze the Federal Reserve System and the two economic slumps. The Federal Reserve System Federal Reserve actions have been the countermeasures after the Great Depression and the Global recession of 2008. The Federal Reserve is an independent central bank that works in an independent manner since its actions are not ratified by the Congress or President. The Federal Reserve System was established in 1913 by Congress and its role was to supervise all banking operations in the US by raising or lowering interest rates, and to shape the US economy through institution of various economic policies1. As much as it is independent, this body is still answerable to Congress on various issues. The Federal Reserve System comprises seven Board of Governors members and 12 Federal Reserve banks that are distributed in various cities of the US. The Federal Open Market Committee (FOMC) is the policy maker of the Federal Reserve System and it affects monetary policy through many ways, some of which are; Open market operations; altering of reserve requirements and adjusting discount rates. These three tools are used to expand or tighten money supply. An example of this is in inflation. In case the FOMC wants to control inflation, it can restrict and control the US government’s money supply through selling of government securities and increasing the amount of money which banks need to use for reserve requirements2. These two actions by the FOMC remove money away from circulation, hence inflation would be controlled. This is because, a lower supply of money leads to less spending, and hence, there will be lower prices. As a result of these, economists argue that Federal Reserve actions are entirely responsible for economic slumps since they control inflation through their actions. Furthermore, the FOMC is able to amplify interest rates for purposes of controlling inflation. This is because, by raising rates of interest, this would make it expensive to borrow money; hence, consumers would find it easier to save money instead of spending it. The result of this is that prices of commodities would be lowered. With time, the initial roles of the Federal Reserve System have expanded due to the changing economic realities. Foe example, the Great Depression changed the manner in which the system operated so that future economic slumps would not be the case. However, this was not the case, because economic slumps happened years later and in 2008, the greatest of them all happened, and this shook the whole world. In a nutshell, the task of the system is to control employment levels, maintain price stability, and moderate interest rates through regulation of monetary policy. Currently, the Federal Reserve board supervises various entities; state member banks, bank holding companies, agreement and edge corporations, agencies of foreign banks operating in the US and all employees of the aforementioned entities. As a result of this, the Federal Reserve System has statutory authority to take any form of enforcement actions against all these entities. By so doing, the Federal Reserve System is seen to control the economy, and in case there is economic slump, it is entirely to blame since it should have put measures of preventing such actions. In case of economic slump, the system is better placed to establish measures that control economic issues like inflation and unemployment3. Generally speaking, the Federal Reserve is responsible for taking enforcement actions against the aforementioned entities in case there is violation of regulations, rules and laws governing or unsound financial practices. The Great Depression opinions by Jeremy Attack and Peter Passell According to Attack and Passell, The Great Depression represented a collapse in US Capitalism during the late 1920’s and early 1930’s. The authors explain that, the prosperity of the 1920’s ended with the stock market crash of 1929. The stock market crash signaled the zenith of the Great Depression. The economic slump witnessed during this time was so devastating that the federal government was unable to maintain the working of the country economically speaking. During this difficult economic period, the American public witnessed adverse economic misery. The harsh economic realities were not only witnessed in the US, but they also spread to other continents. A large population of people lived in poverty, with difficulty in finding food, shelter or clothing. Unemployment levels were extremely high during this time period, and this was felt for almost a decade. From the authors own words; ‘’Millions lost their livelihoods and eventually their self respect. In 1929 only 3.2 percent of the labor force was unemployed….by 1933, 21 to 25 percent of the labor force was unemployed4.’’ Attack and Passell view The Great Depression as seen as the worst form of economic slump in history. According to economists, depression is worse than recession in that recession is the process whereby economic activities are receding or falling. Depression on the other hand refers to an economic state that is fallen below the required level. Therefore, the Great depression of 1929/1930 was worse than the just witnessed Global Economic Recession of 2008. From the book, we learn that The Great Depression had two phases. The first phase began at around August 1928, about two months before the stock market crashed. This first phase ended in March, 1933. During this first phase, the value of goods and services alike fell by about 42%5. The recovery that followed these tough times took four years, but it was not complete before the start of the second phase of the depression. The second phase of the Great Depression lasted from May 1937 to about June 1938, a total of 13 months. In this second depression, output declined by about 9%. These harsh economic periods are seen as those with optimal business failure. The failure rate during the Great Depression was about 130 for every 10,000 businesses. Net exports were affected by the events of the Great Depression. The net exports in 1928 were at a level that was highest since 1921. At this time, American goods were valued at $4 billion and exports were worth $5 billion implying that foreign trade contributed $1 billion into the US economy. However, net exports plummeted greatly after the depression, and in 1936 they reached an all time low. Exports exceeded imports by over $33 million. The economic recession had begun in Western Europe, and this had reduced the demand for American exports6. Amazingly, the banking industry was not hard hit by the Great Depression. From the authors, we learn that the first banking crisis was between October 1930 and February 1931, while the second banking crisis was between March 1931 and August 1931. However, public confidence in banks was eroded during these crises. Some banks were only closed temporarily; however, the total number of these banks fell by about a third as a result of mergers, failure or liquidation. Federal actions also had their role to play in the banking crisis. The authors assert that; the international crisis deepened in the wake of President Hoover’s moratorium on intergovernmental debt repayment and pressure on commercial banks not to seek repayment on short term credits. There was loss of external confidence in the US dollar and this further drained confidence in national banks. This notion was reinforced by the Federal Reserve action in response to the external drain. The Federal team introduced the sharpest increase in rediscount rates, which was the highest in American banks’ history. The effect of this was that bank assets were reduced in value and it became expensive for banks to borrow from the Federal banks7. President Roosevelt intervened in order to avert the banking crisis of the 1930’s. He declared a banking holiday; hence, no bank was opened between March 6 and March 13, 1933. However, this did little to enhance depositor confidence in banks. Bank suspensions were high and one action by the Federal government was to reduce banking suspensions in 1934. This it successful accomplished through enactment of new banking policies and establishment of new legislations to govern banking8. The authors also assert that the Great Depression led to major political changes in the US. Between the Civil War and the Depression, the Republicans enjoyed high control in the government. They dominated the House of Representatives, Senate and Presidency. In the 1930 elections Democrats took over the control of the House of Representatives, and in they 1936 elections they really outnumbered the Republicans. It is during this period that Roosevelt was overwhelmingly elected beating Herbert Hoover by about 7 million votes in the 1932 elections. This changed American politics. Attack and Passell assert that, the change in political events in America after the recession affected the establishment of countermeasures to the Great Depression. Federal Measures established by the new government were aimed at regulating banking activities in the US and enhancing employment opportunities through enactment of legislations governing economic operations of the state9. These economists, in their book, have also asserted that the Great Depression was more than an American Affair. The authors have mentioned that other countries also experienced the same economic slump as the one witnessed by the US, though not in the same degree. For example, from the book we learn that Britain was worst hit during the third quarter of 1932 while France reached the lowest point in April 1935. The authors argue that, since the effects of the depression affected America and Europe alike, countermeasures put in place by President Roosevelt’s administration would not only improve the US economy , but also the global economy. Another global measure that various nations put forth including the Federal government of the US was imposition of tariffs, raising of existing tariffs and introducing quotas on all foreign imports. The overall aim of these was to protect domestic production. However, as the authors argue, all these changes were aimed at reducing international trade volumes. They succeeded in that by early 1933, global trade had been suppressed by almost half since every country put measures of ensuring that there was no importation of foreign goods10. This was a short time remedy but it had more serious consequences as the two authors argue. By reducing global trade, it encouraged another global crisis since global finance was greatly affected. As a result of this, inflation soared since commodities were rare. This may be seen as the genesis of the second round of the Great Depression. Jonathan Hughes and Louis Cain Views on the Great Depression The book ‘’American Economic History’’ analyses various economic issues in American history and how these have shaped current events. The authors have analyzed the prosperity of the 1920’s and how this was brought to a halt by the recession. Hughes and Cain argue that the Great depression was caused as a result of imbalances and underlying weaknesses in the US economy. The authors state that; after the 1929 crash, the economy began a long descent, year after dismal year…nine thousand banks failed, unemployment rose to a quarter of the labor force, millions could find no work11.’’ All these imbalances and economic weaknesses had been obscured by the 1920’s’ euphoria and the boom psychology. The Great Depression exposed all these weaknesses. From the author’s assertion, we learn that in times before the recession, governments had been lax in dealing with business downturns. Instead, governments during this time relied on impersonal market forces for economic corrections. Market forces alone were unable to bring about recovery during the first phase the Great Depression12. The period between 1929 and 1932 witnessed a gross decline in gross private investment. The authors claim that there was net disinvestment in the country’s stock between 1932 and 1934. Net investment fuels economic growth; hence, investments in the 1930’s were not sufficient to regain the remarkable economic growth of the 1920’s. We are also told that business confidence in the Hoover administration was extremely flattened. Even when President Roosevelt took over leadership, nothing much changed to regain business confidence. ‘’FDR’s vigorous characterization of his opponents in the business community as economic royalists hardly built confidence13’’. As a result of this, fundamental changes were introduced in the US economic structure. Some of the federal actions put in place after the Great depression comprised of government action in the form of taxation, public works, industrial regulation, social insurance, deficit spending and social-welfare services. All these measures ensured that there was economic stability in various industrial nations. The Global Economic Recession of 2008 and Actions of the Federal Reserve The Global Economic Recession of 2008 was an economic slump that was felt globally beginning from the second part of 2008 into 2009. Various factors have been implicated in the recession. For one, prices of oil surpassed the $100 per barrel, and these were triggered by geopolitical factors, stock market collapse and oil production cuts by the OPEC body. Secondly, escalation of staple food prices, above 15% was instrumental in the recession. This was as a result of an effect that is referred to as “second round”. Enhanced inflation rates reaching 6%, and enhanced foreign debts were other factors that caused the 2008 economic recession. Interest rates by the European Central Bank increased by about 4.56% during the last quarter of 2008, and this compounded problems for the already fragile global economy. The aim of this was to reduce the marked inflation in the Euro zone. At this time, inflation in this zone was about 5% and the Euro Central Bank hoped to slash it to zero. Finally, the end of 2008 witnessed unemployment rates soaring to above 12.5%, which coupled with the other factors led to the worst economic slump after the Great Depression of 1929/193014. The Global Economic crisis experienced in 2008 and 2009 is thought to have been caused by enhanced borrowing as a result of easy and cheap credit, hence the excessive borrowing increased risks in the US global financial system. In the wake of the recession in 2008, the Federal Reserve System came up with quantitative measures whose aim was to ease the tough economic realities in the global economy. These forms of quantitative easing by the Federal Reserve System had their own repercussions, and they have an effect on future financial markets and on the global economy. The first reserve action was introduction of higher equity prices, which many believe has led to lower unemployment rates. Economists base their reasoning using the economic theory, “the wealth effect”. This theory postulates that any form of enhanced spending enhances the amount of perceived wealth. In this respect, in case the stock market rises, consumers are bound to feel wealthier, hence, they will increase their level of spending. The effect of this is that the economy will be boosted, and more jobs will be created, thereby decreasing unemployment rates15. Therefore, this quantitative reserve action in the wake of the 2008 Global Financial Crisis was a way of controlling the economic slump through creation of more employment opportunities. Rising stock prices normally has a psychological effect on consumers and investors at the stock market or even to those who do not own any holdings at the stock market. Therefore, a rising stock market has been seen to enhance customer confidence increasing their spending power. This may also cause businesses to be more confident in terms of economy; hence it will trigger them to hire a higher number of workers. However, such enhanced market confidence will only be realized if the rise in stock market is sustained over a long period of time. The effects of this Federal Reserve action are yet to be realized fully since it is only about 4 years since recession hit global financial markets. However, these actions will go a long way in preventing future recurrences of the problem. Economists have argued that using the Federal Reserve System to build confidence among consumers and businesses is not really going to work since it will not achieve the full employment mandate. An example is in Zimbabwe. In 2008, this inflation ravaged country gained 30,000% in terms of its stock market, but this did not restore confidence in the country’s economy. Regardless of this, no one would dare say that this rise was an efficient and effective index of economic health. Therefore, use of rising stock market as a barometer of economic improvement is flawed and defunct because the Federal Reserve System’s actions move the market higher instead of concentrating on noteworthy fundamentals. Another action of the Federal Reserve System after in the wake of the global recession of 2008 was lowering of interest rates in the hope that this would stimulate economic growth. In the recent economic crisis, financial markets underwent massive deleveraging whereby, there was drastic selling of assets in order to enhance core capital ratios. As a result of this, this caused a reduction in risks in the system. However, policies put in place by the Federal Reserve System created strong incentives for various institutions so that their risk level would be increased16. As the Fed team lowers interest rates through the buying of Treasury bonds, it reduces the incentive for investment in these bonds. In order to control these effects, the Federal Reserve has enhanced the incentive when placing funds in investments that have a higher risk. This causes money to flow into US equities and the related markets as well. Therefore, the Federal System is fuelling and encouraging risky trade as a way of combatting the effects of the global recession. However, this has its negative effects since it is has also enhanced financial market risks, and this is increasing the possibility of a crisis that mirrors the one witnessed in 2008 due to deleveraging. The same policies that caused the Global Economic Recession of 2008/2009 are again being reverberated into the current financial operations in the US, and in other countries around the globe. Therefore, deleveraging that was applied by the Federal Reserve team has had its short term effects of bringing the economy back to normal, but this is a blessing in disguise since it seems that the crisis may recur if the Federal team continues applying these policies. Another action by the Federal Reserve team in the wake of the economic crisis is raising prices of commodities as a countermeasure of inflation. However, this has brought about many economic and social repercussions. For one, the enhanced commodity prices stifled the already fragile global economic state. One notable example lies in the cotton business. Soaring prices for cotton and oil have had considerable negative repercussions on the economy. The best effect of the soaring prices is that lead to some bit of cost push inflation, but more serious consequences are going to follow. One of this is that various business organizations are going to be shut down because prices of raw materials are extremely high. If many businesses collapse in this manner, this is going to affect the economy remarkably. The social impact of rising energy and food costs is that the poorest in society are hardest hit because these two items constitute much of their expenditure. Statistics reveal that of the poorest Americans, 50% of their expenditure goes towards food and energy bills while the richest only spend 10% of their expenditure on these commodities. Therefore, it is evident that the poorest Americans are the ones being hit hardest by the soaring prices of food and energy. This group also does not have any form of meaningful investments in the stock market as compared by their richest counterparts who benefit the most from rising stock prices as they have considerable investments in the stock market. Another Federal Reserve policy that was put in place after the 2008/2009 economic recession was devaluation of the US dollar. The aim of currency devaluation is that exports are made cheaper towards foreign consumers, and imports are made more expensive to all domestic consumers. The overall effect of this is that net exports will be increased. This has had its positive impacts on global economies, but it has also had its fair share of negative effects. The Federal Reserve System believed that, by devaluing the US dollar, there will be an enhancement in net profits since US goods will become cheaper in terms of foreign currency, which would increase the GDP and decrease unemployment levels17. However, the decline in the US currency has brought about an increase in commodity prices on a global scale. Therefore, this has not done much in alleviating the effects of the economic recession of 2008/2009. Devaluation employed by the Federal team is not logical since there are far too many players trying to do the same. Countries like Japan, Peru, Brazil, Korea and Taiwan have all come up with measures of ensuring that their currencies are weakened against the USD. China has ensured that its Yuan currency does not strengthen against the USD. Despite global calls for the Chinese Yuan to appreciate, China has stack to its plans. This is because; China is only interested in growth of the Chinese economy and its internal affairs. Brazil has increased tax on foreign inflows and investment funds in a bid to suppress demand for the Real, the Brazilian currency. It is, therefore, evident that devaluing the US dollar to boost exports and economic growth is not a valid argument as there are very many global players trying to do the same and achieve economic success. Besides, currency devaluation wars will cause competition in that countries will attempt to beat each other’s devaluation efforts and ensure that they have the weakest currency. As a result of this, it is evident that currency devaluation wars will damage global trade. The US needs to learn this since it happened after the Great Depression. After the Great Depression of 1928/1928, the Federal Reserve Team came up with trade tariffs of the 1930’s. At this time, the global market was damaged by these tariffs; hence, various nations cannot afford to take part in these devaluation wars as global markets would be destroyed18. All in all, the full mandate of the Federal Reserve team is to ensure that monetary policies are put in place so that there is creation of full employment, stability in prices and moderating of interest rates. After the Global Economic Meltdown of 2008, various Federal Reserve actions were put in place as a countermeasure to the harsh economic realities in the globe at this time. However, these have only brought about some slight impact in the economy, and the future does not seem well. The Fed team needs to analyze its economic policies so that a repeat of the economic recession is not realized in future. After the Great Depression of the late 1920’s, the Fed team came up with economic policies, but some of these policies in essence spoiled global business and compromised efficient operation of the global economy. An example of a policy that was put in place was the 1930 tariffs. These tariffs ruined global business operations. After the recession in 2008, the Fed team again came up with a policy that has started to ruin global business. This policy, devaluation of the US dollar has ruined global market since various players in the globe are competing to have the weakest currency so that they enhance net exports. It is, therefore, necessary for the Federal Reserve team to review some of these policies that it put in place after the 2008 economic recession, or else another economic crisis is looming. Bibliography Jeremy Atack, Peter Passell, Susan Lee. A new economic view of American history: from colonial times to 1940. New York: Norton, 1994. Jonathan Hughes, Louis P. Cain. American Economic History. Massachusetts: Pearson Addison-Wesley, 2010. Paolo Savona, John J. Kirton, Chiara Oldani. Global Financial Crisis: Global Impact and Solutions. New York: Ashgate Publishing, Ltd, 2011. Read More