The most fitting word to describe the past few months is “panic.” Economists have been scaring the world with the financial crisis, citing convincing arguments that it can only be compared to the Great Depression, which had such a severe impact that the U.S. economy only saw an upturn at the end of the 1930s, while Europe – completely “derailed” – headed straight for a world war.
In my opinion there are two reasons behind this approach.

First, there have been no serious economic crises in developed countries for more than a quarter of a century, so many experts have nothing to compare the current upheavals with.
Second, the scope of financial meltdown, corporate losses and government bailouts seems so overwhelming that one can hardly believe in the ordinariness of what is happening.
In this article I will try to show that the current economic depression is not “great” at all, and that the global economy will soon recover.

SOME COMPARISONS

The events that began in the autumn of 2007 in the U.S. and Great Britain had become a full-blown financial crisis by 2009. Banks and other lending institutions around the globe have seen total losses of more than $7.4 trillion.

The general depreciation of wealth (i.e. the value of assets and securities) has neared $50 trillion. A majority of developed countries have experienced slower GDP growth rates and consensus projections for 2009 envision steep declines in the United States, Europe, Japan and Russia. This is all true. Yet is this situation really similar to what was taking place during the years of the Great Depression?

At that time a crisis broke out amid sweeping speculation on the stock market, sustained by an increasing number of loans bankers provided to brokerage firms. Bankers were lending brokers $9 per $1 of their own money (a ratio that is practically the same today). These loans swelled from $7.6 billion in 1924 to $26.6 billion in late 1928. It is not surprising that the U.S. stock market grew at an unnatural rate of 28% per year. At the same time, increasing industrial production was accompanied by deflation, as competition stepped up rapidly while staple goods became cheaper (for example, the price of a Ford T, the most popular car at the time, dropped from $950 to $290 between 1908 and 1925). Unlike today, governments practically did not interfere in the economy (the state procurements in the U.S. did not exceed 1.4% of GDP) and central banks did not print more money (all leading economies restored the gold standard in the mid-1920s, which sharply reduced the flexibility of bank regulation).

The financial system was not “generating” money from derivatives to dish it out among the public, as is the case today, but, rather, accumulated the funds of individuals and legal institutions for subsequent use in stock market speculation. Therefore, the crisis deprived companies and individuals of a considerable portion of their own money and savings, not access to new loans like what is happening today. All of this predetermined the scope of the disaster.
The crisis of 1929-1933 was much worse than the current one. Today there
are “horrific” accounts about a two-fold decrease in U.S. stock indices from October 2007 to March 7-11, 2009. But in 1929, these indices were halfed not in 18 months, but in two and a half months – from September 3 to November 13, 1929. In the fourth quarter of 2008, i.e. in the fifth quarter since the banking crisis began, GDP in leading countries decreased by 1%-1.2% (anticipating a 5%-7% annual contraction). But U.S. GDP had plunged 21.5% by the spring of 1931 from the early autumn of 1929.

U.S. unemployment grew from 4.7% in October 2007 to 8.5% in March 2009, while in the euro zone it increased from 7.2% to 8.5%. However, during 18 months in the Great Depression it jumped from 4.7% to 18.4% in the U.S., while in Germany it increased from 5.2% to 26.5% from 1930-1931. U.S. unemployment is currently at 1975 levels, which is more than 1% lower than the levels of 1982-1983. Unemployment in Europe is lower than it was in the mid-1990s, which nobody viewed as a time of economic depression. U.S. GDP actually grew 1.1% in 2008, while in the euro zone it increased 0.8%. A recession is practically inevitable in 2009, but fluctuating developments in a market economy are natural, so it would be odd to view this as something completely unexpected.

There is no question that banks and financial companies have become victims of the crisis: AIG alone lost $99.3 billion in 2008, Citigroup – $42.8 billion, and the Royal Bank of Scotland – 24.1 billion pounds. In the first 18 months of the on-going crisis, 46 U.S. banks have gone bankrupt, whereas 615 collapsed in the first eight months of the Great Depression (from October 1929 to June 1930). Reckless lending has stopped, but payments have not, as was the case 80 years ago. Depositors have not become beggars and the Federal Reserve System has injected three times more money into the banking system than the officially-declared losses of the banking sector. The situation is better in continental Europe: in the euro zone, the banking sector reported considerable profit in 2008. Things were quite different in the 1930s.

The situation in the manufacturing sector is not as clear as it is often depicted. The slump that occurred in a majority of developed countries in October 2008-February 2009 was indeed considerable. Industrial production plunged 11.4% in Great Britain in February 2009 compared to the same month a year ago; output fell 11.8% in the U.S.; it was down 17.3% in the euro zone; 20.2%-27.1% in Malaysia, Singapore, South Korea and Taiwan and plummeted 38.4% in Japan. However, three factors need to be taken into account here.

First, the industrial sector accounts for 14%-23% of the GDP of developed countries today compared with 24%-50% during the Great Depression.

Second, retail sales in the U.S., the European Union and Japan only fell 5.2%-6.3% year-on-year, while Japan alone posted a drop in personal income. Personal income grew 3.6% in a year in the U.S. and 3.9% in the euro zone (which indicates a temporary decrease in demand as consumers are being very cautious in their spending).

And, third, we should not discount the economic rebound that began in February-March 2009, which I will discuss later.

For now, I will quote some preliminary results. Table 1 shows the scope of differences between the Great Depression and the current crisis. An analysis of the figures proves that comparing the two crises looks somewhat odd.

THE DEPTH OF THE CRISIS AND FIRST REACTIONS

It is well known that the crisis of 2007-2009 began in the American financial sector. Few were surprised because analysts had been talking about the unhealthy nature of expanding credit in the U.S. for a long time. The volume of government and municipal debts has grown more than 230% over the past quarter of a century, consumer loans have increased 490%, loans for the corporate sector have surged six-fold and mortgage loans have skyrocketed 8.1-fold.

U.S. banks could invest their clients’ money in high-risk derivative instruments or use the money to speculate on the stock market because a provision of the Glass-Steagall Act – an act passed in 1933 that divided the spheres of responsibility between commercial and investment banks – was dismantled and replaced with the Financial Services Modernization Act of November 12, 1999.
The current financial crisis broke out as banks began to pile up bad debts on mortgage loans, which was followed by defaults on other “securitized” bank products. Total losses at financial institutions caused by “mortgage products” alone had reached at least $1.3 trillion by March 2009, but the burden of “toxic assets” has not shrunk much, if at all.

Let us consider the U.S. mortgage system first, which, as of July 1, 2008, was worth $14.9 trillion. According to official statistics, every 466th house on which buyers defaulted was put up for sale in the U.S. in March, which corresponds to 0.21% of all extended loans. Another 1.76% of borrowers make late interest payments. A total of 550,000 homes were put up for sale across the U.S.; admittedly, the supply is excessive, but by no means is it an indication of the paralysis of the industry, nor does it confirm the estimates that put up to half of all mortgage loans in the subprime category.

It is more likely that the problems were caused by a dramatic devaluation of derivative instruments – the negotiable papers secured on portfolios of mortgage loans. The reason behind this is the unheard-of panic on this market. Housing prices in the 20 largest U.S. cities have dropped 29% since the fall of 2006, but the true problem is the endless resale of the same asset secured on housing, not its depreciation. In essence, the current losses are comparable with the losses of investors who put their money in hi-tech company stocks in the late 1990s, thus losing a large portion of their capital: but these are the losses of profiteers in the first place.

The fictitious nature of these losses can be seen in an analysis of the derivative market of financial instruments, which investors used to hedge from non-payments of loans or price fluctuations on commodity and stock markets. The aggregate nominal value of securities, according to the Basel-based Bank for International Settlements, amounted to $683.7 trillion by the summer of 2008, which exceeded world GDP by 12.4 times. Some experts, citing these figures, claim that the modern financial system is not viable. But a closer look reveals that the real value of this mass of securities amounts to $20.4 trillion, of which a large part is made up of contracts on interest rates, exchange rates or commodity prices, thus balanced between buyers and sellers, and whose execution will not cause the whole system to collapse. “Just” $4.32 trillion may go down the drain if stocks on leading exchanges depreciate to zero or if not a single loan provided by the world’s 50 largest banks is repaid. If governments succeed in stabilizing the banking systems, the losses will be “limited” to hundreds of billions of dollars.

Derivatives do not reflect real wealth – otherwise how could their nominal value increase by $313.7 trillion from June 2006 to June 2008, or by world GDP six times over? The “deflation” of this market will certainly cause losses to players but it will not kill the world economy. Incidentally, who are those players? British financial institutions controlled 43% of the derivative market and U.S. institutions had another 24%. These banks have already been given more than $2.1 trillion in assistance, so there is no reason to worry about their future.

One might continue to dwell on financial markets and losses sustained by investors, but one thing should be made clear – the modern economy is quite resistant to upheavals on financial markets. It is enough to compare several figures.

In 1929-1933, the Dow Jones index plunged 91% and real GDP contracted 29.4%. During the next big crisis in 1973-1975, the stock market plunged 56%, while GDP shrank by a mere 3.9%. In October 1987, the Dow Jones fell 25% in a single trading session, but GDP posted a year-on-year increase. In 2000-2003, stock indices in the U.S. and the European Union fell 2.2-fold to 2.9-fold, but no slump in GDP followed. The current shock is more powerful than the upheavals in the beginning of the 1980s or 2001-2003, and it has manifested itself in the manufacturing sector, but not in the same manner as in 1929-1933.

The reaction of the financial authorities in leading Western countries looks more than adequate today. According to Bloomberg, the U.S. government declared and provided $3.8 trillion in assistance to the financial and manufacturing sectors from late 2007 to March 2009, which easily compensated banks and industrial companies for their losses. To support their economies, the governments of Great Britain, Japan, China and euro zone countries allocated $690 billion (plus an unspecified amount from the Bank of England), $610 billion, $586 billion and $380 billion, respectively. The participants in the most recent G-20 summit agreed to allocate $1.1 trillion in assistance to the most hard-hit developing economies through the IMF and World Bank. Unlike 1929-1931, when the average customs tariff, fixed by a majority of developed nations, increased by almost 2.7-fold, none of the governments has introduced tough or all-out trade restrictions (although everybody has used them to support some affected industries).

The rapid decrease in interest rates which stimulates commercial loans and saves a great deal of money for borrowers – who can divert these funds for current investments or consumption – appears even more significant. This process has assumed an unprecedented scale in the past few months. If October 2007 is regarded as the starting point of the financial crisis, the People’s Bank of China has lowered its key interest rate by almost one-third since then. In the period, the Swiss National Bank lowered its interest rate by five times, the Bank of England by 11.5 times, and the Federal Reserve System by 19 (!) times. (Only Iceland, Serbia and Russia increased their benchmark rates). The Federal Reserve lowered its interest rate to slightly more than zero for the first time ever. These measures have helped save more money in the economy than any budget injections could do, in what is the largest bid ever in history to lower interest rates.

Price drops on commodity markets, which is natural in a crisis, have helped to further decrease tensions in industrialized countries. This has made many exchange goods more affordable to industrialists, and oil and gasoline to the end consumer. Consumers in the U.S. have saved at least $40 billion in the past 12 months due to falling gasoline prices in 2007-2009.

As a result – if one talks about leading countries, such as the U.S., Great Britain, euro zone countries and Japan – we must admit that they have been given a powerful boost: these governments injected 3%-8% of GDP in their respective economies. Some 3.5%-4.5% of GDP will be saved on debt payments, due to the decrease in interest rates; and another 1%-1.6% of GDP will be saved by falling commodity prices. The total makes up 6.5%-11% of GDP in any given country, and this amount outweighs the production slump caused by the crisis. A majority of U.S. and European economists are ready to acknowledge that the recession will be over in the fourth quarter of 2009. I will risk being even more optimistic: the economic upturn in the U.S. will become a clear trend as early as the third quarter of 2009. The recession of 2008-2009 will not turn into a depression and will be nothing like the Great Depression.

GLOBAL MANIFESTATIONS OF THE CRISIS

Another reason for optimism is the different reactions to the financial crisis in various regions. The Soviet Union, which was curtained off from the world economy, was the only major economy not affected by the Great Depression (if one may put it this way, given the famine and deprivations that occurred in the country at the same time). There are no such isolated countries today, but differences in the scope and intensity of the crisis are much more pronounced than in the U.S. and Europe in the early 1930s.

The crisis, as should have been expected, looks more severe in the U.S., because the volume of loans provided in that country (350%-360% of GDP), stock market capitalization (150% of GDP) and the trade deficit ($800 billion-$820 billion a year) were much larger than in the euro zone. U.S. unemployment grew to 8.5% from 4.7%, or an increase of 80%, in almost 18 months, while it increased by only 18% in the euro zone. Whereas 46 banks have gone bankrupt in the U.S. since September 2007, all banks have managed to keep afloat in the euro zone (despite the fact that benchmark interests rates in continental Europe are five times higher than in the U.S.). While profits at S&P 500 companies plunged by half last year, Europe’s largest companies showed a mere 39% decrease in profits. Furthermore, the losses of all banks and insurance companies in the euro zone, according to the results of 2008, have not even neared 70% of the losses suffered by AIG alone, and only exceed the losses of the Royal Bank of Scotland by 50%.

This shows some obvious advantages of the continental European economic model over the Anglo-Saxon one. This conclusion was confirmed during the G-20 summit in London in April 2009, at which all the parties agreed with a number of European proposals, such as control over ratings agencies, greater transparency of financial institutions, restricting the activity of systemically-important hedge funds and implementing uniform standards of fiscal accountability.

Stock markets reacted differently to the crisis, but arguably, they again tested the levels at which they were in the late 1990s (whereas in a majority of developed countries in 1933 they plunged to the levels of the beginning of the century or even earlier). At the lowest point of the slump, the Dow Jones Industrial Average stood at 6,473 points in early March, which matched the level of November 1996; Britain’s FTSE-100 was at 3,467 points, or 11% lower than November 1996. France’s CAC-40 (2,470 points) was up 19% from its level in late 1996, while Germany’s DAX (3,593 points) was up 37% from where it was in late 1996. None of the European indices has tested the lowest points hit in 2002-2003. Financial markets in emerging countries have found it much harder to withstand the crisis, shedding 65%-80% of capitalization, despite the fact that the scope of their production slump was smaller (as in China) than in industrialized countries.

Prices for real estate and fixed assets have also shown various downward trends. Where average prices fell 26% in the U.S. from October 2007 to March 2009 and 27% in Britain, they only dropped 11% in France and 6.5% in Germany. The number of new construction sites plunged 4.6-fold in the U.S. and dropped 3.9-fold in Britain, while it only fell 23% in Germany. Car manufacturers have been hit hard and this has had different repercussions around the world: car production in the U.S. fell 17.4% in 2008, whereas in Europe it only dropped 6.6% (and by a mere 2.8% in Germany). Consider that U.S. car makers received $39 billion in assistance, while European automakers only got 7 billion euros.

Examples of this kind abound and one can sum it up with a table comparing the economic situation in the U.S. and Europe. I wish to reiterate that various rates and scopes of the crisis warrant the assumption that it will not take the “standard shape” that was characteristic of the Great Depression of the early 1930s.

WHAT DOES THE CRISIS HAVE IN STORE FOR US?

This is probably the key question today. Admittedly, the governments of both the leading countries and other states (such as Russia) tried for a while to shut their eyes to problems emerging in their economies. Indeed, few could anticipate the crisis in the shape it assumed, beginning in the autumn of 2007, largely because our mentality expects existing trends to continue.

U.S. economists George Ackerlof and Robert Shiller noted in their new book that 49% of Americans in a 1980 poll said that a ball launched out of a pipe bent into a semi-circle will continue to fly in an arc. Experts, too, find it difficult to assume that trends may change.

Let us recall a recent story: in the beginning of 2001, when the S&P 500 and Nasdaq stood at 1,348 and 2,617 points, respectively, 50 leading experts polled by Business Week magazine said that by the end of 2001 the indices would hit 1,558 and 3 583 points - i.e. they extrapolated their growth by 15% and 40%. The indices fell to 1,137 and 1,922 points respectively in one year. Nevertheless, the next year analysts again agreed that the indices would grow to 1,292 and 2,236 by year-end, or by 14% and 12% respectively. And they were wrong again, as the real indicators fell, respectively, to 880 and 1,335 points.

The mood had changed by 2003: a consensus forecast warned about a 6%-9% decline, yet the indices posted gains by year-end. In 2006, a profit growth forecast for U.S. companies in 2007 was 14%, but the real growth was 2.9%. It was assumed in 2007 that growth would be 16% the next year, but instead there was a 50% drop. Of course, specialists finally acknowledged in late 2008 that profits would shrink by another 11% in 2009.

Was it surprising then to find out in early March 2009 that Citigroup and Bank of America had posted profits in January and February 2009, although they had been in the red for the past five quarters, while the forecast for the rest of the year looks very favorable? Or that U.S. stock indices grew 22%-25% from March 9 to April 3? Or that the number of orders for the construction of new homes grew 22% in the U.S. in February 2009 from the previous month? Or that the number of bankruptcies in the U.S. has been decreasing for three consecutive months? One cannot fail to notice that oil prices have stopped falling at $50 dollars per barrel, up 25%-28% from record lows in February 2009; that the metals market has posted a moderate growth; that the Baltic Dry index, which reflects container shipment tariffs by sea, has increased by almost 200% from November 2008 lows.

People in the most developed countries saw 2009 as the year of the true financial crisis, believing that the events preceding it were a prelude. They did not feel – nor are they feeling now – the scope of the assistance provided to their economies, while the mass media today only selects bad news or emphasizes the negative aspects in their reporting. For example, statistics on car sales in Europe showed they fell by 18% to 968,000 vehicles in February 2009, but the reference period is February 2008. However, compared with the previous month, this indicator grew by 9,400 vehicles, or almost 1%, followed by another 8.4% hike in March. It should not be forgotten that 2007 and 2008 were unbelievably profitable years for a number of sectors worst-hit by the crisis, such as housing construction and car manufacturing. It is enough to say that in 2007, on a wave of decreasing interest rates and easy access to loans, U.S. consumer spending on cars posted a 48% increase from 1997, while in 2008 purchases returned to the level of 2000-2001, not to the 1970s.

The situation on the commodities and currency markets is not a cause for serious concern, either. Despite speculations by certain “experts” about the impending end of the dominance of the U.S. dollar, the beginning of the acute phase of the crisis showed that the U.S. greenback remains the world’s reserve currency simply because of the tremendous amount of U.S. dollar-denominated debt, so in conditions of higher risks demand for dollars is increasing. The South African rand has shed 26.9% against the U.S. dollar in the past six months, the Australian dollar has lost 32.2% and the Brazilian real and the Russian ruble have plunged by more than 33%. Even the euro has fallen more than 20% against the U.S. dollar.

The depreciation of the U.S. dollar, even if it happens, is unlikely to benefit the world, as other countries are also ready to devalue their currencies, so nobody will gain a competitive edge. Therefore the crisis will not replace the world centers of economic power, nor will it create a new world currency, and Russia, whose ruble accounts for 0.14% of global currency trading and whose combined bank assets can only match those of Spain’s Banco Bilbao Vizcaya Argentaria SA, number 30 on the list of the world’s biggest banks, will meet the new buoyant wave in the same condition it entered the crisis – an oil-and-gas economy, critically dependent on the situation on the world energy market.

* * *

A majority of economic institutions in the world today are in a sort of stupor after the powerful blow the crisis delivered in the third and fourth quarters of 2008. But this does not imply that the post-crisis rebound will not be as surprising as the crisis. The funds injected into the economies of developed countries are so large, and the mechanisms of further injections are so elaborate, that there are no doubts that the efforts by the authorities will help restore economic growth in the U.S. and Western Europe within the next few months. One can agree with a recent statement by Edward Leamer, director of the UCLA Anderson School of Business Forecasting Unit: “We’ve frightened consumers to the point where they imagine there’s a good prospect of a Great Depression. That certainly is not in the prospect. No reputable forecaster is producing anything like a Great Depression.” Alas, this statement can hardly be applied to Russia, where experts are increasingly making the grimmest forecasts.