A Not-So-Great Depression
№2 2009 April/June
Vladislav Inozemtsev

Vladislav Inozemtsev holds a PhD in Economics; he is Head of the Department of World Economy at the Faculty of Public Administration, Lomonosov Moscow State University, and Director of the Center for Post-Industrial Studies.

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.


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
The crisis of 1929-1933 was much worse than the current one. Today
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

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

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

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.


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,
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

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.


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

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.

















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.

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.