Ten years after the Asian financial tail-spin and almost 20 since the Wall Street panic that reversed the 1985 Plaza Accord, central bankers are running up warning flags about the fragility of their global system. The International Bank of Settlements might be reserved about the likelihood of a crisis but it raised the stakes by using the D-word — a depression of 1930s dimension — not just a recession like that of the late 1970s.
Returning from two years in Toyko in April 1990, I waited for the bursting of its real estate and stock market bubbles to bring down the world economy. Instead, Japan’s technocrats sailed through a protracted deflationary cycle by ignoring the advice of free-market economists to deliver a short, sharp shock of the kind that devastated post-Soviet Russia.
Having got Japan wrong, and not keen to join those commentators renowned for predicting eight of the last three recessions, I stopped asking, “When will capitalism collapse?” Instead, I gave lectures titled “Can capitalism collapse?”
One theme in those talks was that another depression will not be a replay of the 1930s. The first point to grasp is that the Wall Street Crash of October 1929 was a symptom of the Depression, not its cause. The flood of funds into the stock market had followed the drying up of opportunities to gain average rates of return from investing in physical production. In brief, the effective demand for T-models had been met. Planned obsolescence and hire-purchase were still in their infancy.
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The stock market imploded because the ratio of share price to earnings passed the point where there were enough “greater fools” to buy over-priced stocks. As Warren Buffett learned at the time, the stock market is a voting machine, not a weighing machine.
A second difference from the 1930s is how much bigger the world economy is today. The force needed to stop its expansion will have to be much greater than around 1930-32. That mass might also allow the system to keep from stalling at a lower growth rate.
Connected to this increased size, the global order now has three principal centers, Europe, North America and East Asia, against only one and two halves 80 years ago. In the last 15 years, the global economy has got by on a single engine until at least one of the others restarted.
On top of these objective factors, there is a psycho-sociological reason why the start of another depression will not replicate October 1929. Too many people are watching that possibility. The danger spots become wherever no one with the power to act is looking.
Two points of similarity with the 1920s remain. First, any tripwire will again be in the financial sector, such as adjusting the yuan to the US dollar. Secondly, financial imbalances will be able to trigger a collapse because they represent another bout of excess manufacturing capacity.
Tomorrow: But what if it blows?