The recession and the parallels with the great depression.

The great depression started in 1929, Starting point being the “Black Tuesday” (19th October). The Dow Jones industrial average(DJIA) fell continuously for three years from 386 in 1929 to 40 which was the lowest point in the millennium. It reached the level the DJIA was in 1896, the year it was established. It took 25 years to get back to the 1929 levels.If we look at the great depression and the current recession we can see a lot of parallels.

The causes
Over leveraged financial position

1. 1929 the margin requirement was 10%.
2. When the stock market crash set in it led to cascading defaults at all levels leading to bank failures. 744 banks failed in the first 10 months of 1930.
3. Banks reduced lending and built up cash reserves fuelling the downward spiral.
4. Unsustainable credit driven boom.

Protectionism, Retaliation and the downward spiral.

1. Smoot-Hawley Tariff Act which raised the tariffs of 20000 imported goods and the trading partners retaliated by imposing their own higher tariffs. US exports dropped from 5.2 Billion in 1929 to 1.7 Billion in 1933

Contraction in money supply.

1. Bank failures led to drastic drop in credit availability
2. Consumers stayed away from credit
3. Excessive saving as part of the downward spiral

The current crisis too has developed in the same lines. It started with the credit driven boom and the over leveraged financial position. The financial system crashed first and the survivors are going to be over careful on what they with their loan and investment portfolio. We can see the glimpses of protectionism, Obama’s stimulus package is talking about protecting American jobs which could result in retaliatory measures from other countries. It has already resulted in significant decline in international trade.

The Solution:Demand side economics.

How can we boost demand.

By ensuring that there is money in the hands of people who are likely to spend. These are the people in the lower income groups who cannot afford to save as they have to spend money on their day to day affairs.

How can this be done: examples below

1. Instead of bailing out banks bail out the borrowers. Give money to the borrowers to close the mortgage.
2. Instead of bailing out GM give money to the people to buy cars. Give it free, subsidize etc.
   

The money in the hands of people who has a propensity to consume even in recessionary economy can boost demand therefore production therefore economic recovery.

....To be continued