Bad News: We're Back to 1931. Good News: It's Not 1933 Yet
Ambrose Evans-Pritchard
President Obama has inherited a contracting economy where jobs are disappearing fast and the Fed is printing money furiously, buying bonds to stave off deflation. The scenario is similar to that of early 1931, but it is not yet like 1933, the second leg down. And it is that second phase of depression that is most awful. During the thirties, America came close to open revolt; Eleanor Roosevelt feared the country was beyond saving, while FDR directed his anger against Wall Street. The Fed was an ideological deadweight. It began purchasing bonds in mid-1932 to boost the money supply, but then stopped; a third of the rescue funds in Hoover's Reconstruction Finance Corporation had been embezzled. Today there has been no such failure, even if the Treasury's policies have been hit-or-miss. There has been massive fiscal and monetary stimulus, and interest rates are at zero. The Fed is printing money on an industrial scale, buying $600 billion of mortgage bonds to force down the cost of home loans, and propping up the commercial paper market to avoid mass corporate default. The wash of money should ensure that the next 18 months will not mimic the cascade of disasters from late 1931 to early 1933. It buys time. But it does not solve the deeper problem, which is that a West addicted to Ponzi credit has put off the day of reckoning with ever more extreme monetary policy with each downturn, stealing prosperity from the future. It will be an extremely delicate task to right the ship again. Central banks will have to extricate themselves from their venture into the bond markets without setting off a bond debacle in 2010 or 2011. Governments will have to map out of a path of strict discipline for years to come. This will be Barack Obama's grim test of statesmanship.