Why the U.S. economy is at risk of another Great Depression

Joseph Stiglitz explains what caused the Great Depression: The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression.

For the past several years, Bruce Greenwald and I have been engaged in research on an alternative theory of the Depression—and an alternative analysis of what is ailing the economy today. This explanation sees the financial crisis of the 1930s as a consequence not so much of a financial implosion but of the economy’s underlying weakness. The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932. Shantytown “Hoovervilles” were springing up everywhere. The underlying cause was a structural change in the real economy: the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity.

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

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2 thoughts on “Why the U.S. economy is at risk of another Great Depression

  1. Steve Zerger

    When will these economists ever get it? The economy functions fine as long as you flood it with cheap energy. The cheap energy is gone. Growth is over and it’s not coming back. It’s time to get over it, and to admit that natural resources are not just a subset of the economy. Things have fundamentally changed, and most economists haven’t a clue. There are a few exceptions – Herman Daly, Jeff Rubin.

  2. scottindallas

    Steve, you and Stiglitz are wrong. I agree with the premises both of you assert, cheap money is needed in a recession, and yours that cheap energy are essential for expansion. You are both wrong on the facts, the banks never loaned the money out, so, we haven’t have the monetary expansion he calls for. That expansion did and has gone into commodities speculation and has driven up the cost of food and oil, not for reasons of supply and demand, but commodities manipulation. But, actual demand is down, due to the higher prices, and some increased efficiencies. But, this is not true of all fuels. Natural Gas is incredibly cheap, though again, due to deregulation of electric companies, we’re not enjoying the corresponding decrease in rates.

    The best energy reporter I know is Robert Bryce out of Austin TX. There is a lot of puffery in the energy markets. We’ve had decreasing demand since 2007, yet all we’ve heard about is the extraordinary demand. Things haven’t fundamentally changed, they may well do so in 50 years (see Exxon’s recent report of 100 years of oil supply)

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