Monday, February 23, 2009

How a recession bottoms out

Paul Krugman in Who’ll Stop the Pain? New York Times 02/20/09 gives a good, concise definition of how a recession could be said to naturally bottom out:

Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.

Or consider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they’ve worn out or because they’ve become obsolete, so we’re building up a pent-up demand for cars.

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather’s recession. But recovery may be a long time coming.

The closest 19th-century parallel I can find to the current slump is the recession that followed the Panic of 1873. That recession did eventually end without any government intervention, but it lasted more than five years, and another prolonged recession followed just three years later. [my emphasis]
Why dogmatic conservatives are arguing when they talk about the ineffectiveness of government stimulus is essentially based on this. Even the worst recession eventually bottoms out.

In 1873, basically nobody in the US but the powerless scattered socialists had any real notion of major government intervention being an effective alternative to reverse an economic downturn. For that matter, I don't think that even socialists had ideas like what we now know as Keynesian economics, in which the government of a capitalist country could use deficit spending to stimulate the economy. Socialists thought that recessions were a chronic problem of capitalism and could be abolished only by replacing the system of private ownership with some sort of permanent public ownership of industry and banking.

The Panic of 1873 was set off by the collapse of the bank Jay Cooke & Co. on September 18, 1873. From the site just linked, we see an excerpt from President Ulysses Grant's annual address of December 1, 1873, in which he seems to be saying that the proper management of the relatively new national currency and gold supplies along with the promotion of exports were the main recourses for the government:

My own judgment is that, however much individuals may have suffered, one long step has been taken toward specie payments; that we can never have permanent prosperity until a specie basis is reached; and that a specie basis can not be reached and maintained until our exports, exclusive of gold, pay for our imports, interest due abroad, and other specie obligations, or so nearly so as to leave an appreciable accumulation of the precious metals in the country from the products of our mines. The development of the mines of precious metals during the past year and the prospective development of them for years to come are gratifying in their results. Could but one-half of the gold extracted from the mines be retained at home, our advance toward specie payments would be rapid.

To increase our exports sufficient currency is required to keep all the industries of the country employed. Without this national as well as individual bankruptcy must ensue. Undue inflation, on the other hand, while it might give temporary relief, would only lead to inflation of prices, the impossibility of competing in our own markets for the products of home skill and labor, and repeated renewals of present experiences. Elasticity to our circulating medium, therefore, and just enough of it to transact the legitimate business of the country and to keep all industries employed, is what is most to be desired. The exact medium is specie, the recognized medium of exchange the world over. That obtained, we shall have a currency of an exact degree of elasticity. If there be too much of it for the legitimate purposes of trade and commerce; it will flow out of the country. If too little, the reverse will result.

The experience of the present panic has proven that the currency of the country, based, as it is, upon the credit of the country, is the best that has ever been devised. Usually in times of such trials currency has become worthless, or so much depreciated in value as to inflate the values of all the necessaries of life as compared with the currency. Everyone holding it has been anxious to dispose of it on any terms. Now we witness the reverse. Holders of currency hoard it as they did gold in former experiences of a like nature. [my emphasis]
Harper's Weekly for 10/04/1873 said of the newly unfolding crisis:

In the opinion of sagacious business men the panic might have been ended on Saturday, or at all events checked, but for the failure of the Lake Shore Railroad to pay the Union Trust Company a call loan of $1,750,000. This, in addition to the delinquency of other large borrowers, compelled that institution to close its doors. The panic was renewed in a more alarming and disastrous form. All confidence vanished, and the day was one of the wildest ever witnessed in Wall Street. The Stock Exchange was open but two hours, when the governing committee held a meeting and closed the doors, thus practically putting an end to speculation until settlements can be made and confidence and reason resume their sway in Wall Street. The failures of Saturday were the Union Trust Company, the National Trust Company, the National Bank of the Commonwealth, Ketchum & Belknap, and Edward Haight.

In the general panic which prevailed on Saturday an urgent appeal was made to the
general government to take measures which might tend to allay the alarm, and save the business of the country from further and perhaps greater disasters. In response to this appeal, President Grant, Secretary Richardson, and General Hillhouse, Sub-Treasurer in this city, on Saturday evening had an interview at the Fifth Avenue Hotel with many prominent financiers. The proposition was made to the President to lend the Treasury reserve of $44,000,000 to the banks as a measure of relief. Mr. Reverdy Johnson, at the request of the capitalists, advised the President that while there was no legal authority, there was precedent for the loan, and urged him to respond favorably to the proposition, or to one of a similar character. The President declined, however, to authorize the loan, as without warrant of law. It was finally decided, as the most feasible measure of relief within the power of the general government, to direct the Sub-Treasurer to buy unlimited amounts of five-twenty bonds or bonds of '81 at par as fast as they were offered. This plan of relief was accepted by prominent bankers as probably the course best calculated to allay the panic and restore confidence. [my emphasis]
How "quaint", as Abu Gonzales might say. It was respectable prose to refer to the "sagacious business men" as "capitalists". The most severe recession so far in American history was beginning, and the "sagacious" businesspeople and commentators were fretting that the government might try to do too much to intervene and stabilize the economy. For those among our Republicans still living in the 19th century (and that seems to be quite a lot of them), this still sounds like prudent practice.

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