Great Depression & Global Financial Crisis, Essay Example

Introduction

Till the financial crisis of 2008 happened, Great Depression of 1930s was the largest financial crisis faced by the world (Crotty 563). There are lot of similarities in the events preceding the crisis and some differences that created unique responses from the affected parties.Both the events were followed by a slowing economy, loss of jobs and uncertain future (Moshirian 502). These events also brought about social change and altered the set thinking patterns in the society (Stiglitz 2). These were the turning points to the changes in the business structures and policies regulating the businesses (Crotty 565).

Great Depression (GD) that started in America in the late 1920s was initiated by a crash of the stock market that created panic amongst the business community and bankrupted several individuals(Almuniaet al 220). Banks that were investing money in the stock market also lost the savings of their customers and were unable to pay them back. This created additional panic due to bank closures and an inability of individuals to recover their savings (Almunia et al 221). People who had invested in stock market, businesses and those who had savings were all affected by the crisis. This led to spending curbs in the society, especially for luxury goods and affected the manufacturing industries that were driving the economy and employment (Almunia et al 221). People lost their jobs and this created further insecurities amongst people. This went on till the 1940s and only ended when the second-world war created led to creation of jobs in the war related economy (Almunia et al 222).

Global Financial Crisis (GFC) on the other hand started in 2007 with the credit crunch in the US financial markets that led to a liquidity crisis (Crotty 567). This is believed to be the most severe economic crisis since the Great Depression. While it is difficult to point the beginning of this crisis, the bursting of housing bubble in the US with falling house prices and a loss of investor confidence in the related instruments are believed to be the driving force. The impact was felt greatly by the financial community but also affected businesses that rely on credit from these institutions. With failure of the financial institutions and banks unwilling to offer loans beyond an extent, several businesses were affected and the stock market plunged in the next few months (Inside Job). As the economy was now more globalized than in 1930s, the impact of GFC was felt across the globe and affected the growth of all economies(Crotty 568).

The world economy faced periods of low and high growth driven by increased and decreased demand patterns these two periods stand out as landmarks in terms of their degree and length of impact on the society. The economies across the globe are still affected by the slow growth initiated by the GFC and are struggling to revive the growth of their industries and demand (Carmassi et al982).

Similarities between the two events

The United States

United States was the common factor for both the crisis as that is where the crisis started and slowly spread to rest of the world. By 1930s, United States had emerged as a major force in the world economy and the aggressive business environment led to the regulatory system playing catch up with the developments in the industry (Eichengreen and Irwin871). This was evident during the GD where manufacturing wages created a disparity and prevented the rising of the middle class who would consume the products manufactured by the industry. This was also evident during the GFC, where the financial institutions dealt in products that were operating within the regulatory framework but made use of the gaps in the regulatory guidelines towards capital requirements (Shaikh 5).

Power Center

Before the GD, Henry Ford was voted as the greatest man in history and was in control of the most important business in the United States (The Great Depression). Employees were happy working for Ford as they were rewarded for their hard work by Ford and they could reap benefits from a booming industry. This did not last forever and with the economy slowing, the production lines could not be fully utilized which led to loss of jobs and social agitation.

In case of GFC, this power rested in the hands of the bosses at the Wall Street whose creative minds and business connectivity enabled them to broker deals and create products that would lead to higher profits for them (Colander et al 251). Organizations got merged or restructured for financial gains for the organizations, sometimes without a consideration for the employees (Beating the bottom line).

Bursting of a bubble

The period prior to both the events was an economic boom driven by the industry (manufacturing and technological) but with a fundamental flaw in the source of that growth. The manufacturing boom of 1920s that created millionsof jobs in the factories producing goods was creating an imbalance between the rich and poor in the society (Eichengreen and Irwin 871). The low wages offered to the labour ensured that the rich became richer and poor became poorer. This created a demand supply gap in the society and led to share prices of these and related firms crashing on the stock market with no hopes of an immediate recovery(Eichengreen and Irwin 871). While there were products being manufactured, the buying power rested with only few people.

The early 2000s also witnessed a period of strong growth driven by technology and financial industry. One bump in the financial bubble was faced during the late 1990s where the technology firms were overpriced and took several investors down when the reality of the business became known. This, however, did not impact other sectors that much as technology was still separated from other industries. The growth was also broader based this time with middle class participating in the growth. The housing boom led to rising real estate prices and a boom in the associated financial products that were packaged and sold by the financial institutions (Cukierman 3). The housing prices were unrealistic and the bubble burst with buyers realizing the high price they have paid for their houses and a subsequent lack of desire to repay the mortgages (Colander et al 254). The banks were left with no choice but to write off massive loans which affected all financial institutions that were holding the related securities (Inside Job).The world is still recovering from this crisis as it left much deeper impact on the investors and consumer confidence than the technology bubble of 1990s.

Scope of crisis

Both the events had long lasting impacts and affected a large number of people and businesses. The GD went on for more than 10 years and the world is yet to recover from the subdued growth initiated by GFC. While GD still affected US economy more than others, the impact of GFC was largely seen in the US and Europe and a trickle down impact on the other global economies as well (Colander et al 252).

Role of Financial sector

Financial sector with the unrealistic share prices formed the basis of GD (Eichengreen and Irwin 871) and the complicated financial instruments used by the financial institution led to GFC. Both the crisis while they started in the financial sector spread to the other sectors due to their dependence on the financial industry for their credit and liquidity needs. In both the situations the banking credit dried up leading to a slow recovery of the industry. The damage in both cases happened to an extent that the Government had to get involved in resolving the crisis by bailing out these institutions.

Political changes

Both the crisis events were followed by a change in the Government indicating the impact of the financial crisis on the individuals (Claessens et al 271). In the “road to rock bottom” (The Great Depression)depicting the events of GD, the impact of unemployment combined with the drought faced by rural America culminated in Hoover losing the election to Franklin Roosevelt by a huge margin (Almuniaet al 225). The year 2008 also saw Obama gaining victory over Bush administration and forming the Government (Almunia et al 231). People were disappointed with the lack of regulatory system to prevent the depressive state of economy and wanted a fresh perspective to pull the economy out of depression.

Differences between the two events

Policy responses

Back in 1930s the fiscal policies were lenient and financial institutions and industries were not as regulated as they are today. In GFC, policy measures were taken swiftly and more vigorously to counter the damages done by the crisis (Stiglitz 1510). Government also played a much larger role in controlling the situation than it did in GD as there was no reference to compare the crisis with. With GFC, people knew they did not want a situation similar to GD and acted smartly to prevent the economy from going into a depression(Cukierman 4).

Policymakers in current times are aware of the potential benefits of expansionary fiscal and monetary policies on consumer confidence and growth of the industry(Claessens et al 275). As a result these measures have been actively used by the Government to improve the confidence levels of business and industry (Cukierman 5). The decisions due to a vast knowledge on economic forces have also been more focused on improving the state of economy than they were in case of GD.

Federal budget at the time of GD was more balanced (Eichengreen and Irwin 871) than at the time of GFC when there was a huge deficit to be tackled by the Government. The deficit has steadily grown in the years since the GFC due to the money pumped by the Government in the economy. These measures were taken by the Government to subvert the impact of the crisis on the economy and citizens. GD was handled by increased regulation on the industry and financial institutions to prevent such situation from arising again (Almunia et al 240). GFC on the other hand focused on active monitoring and control of the situation before addressing regulatory changes (Cukierman 4).

With stronger banking system and regulations during the GFC, banks were protected to an extent by these regulations and mandatory insurance(Cukierman4). Banks back in 1930s were more vulnerable to the economic forces and losses than in 2000s. Banking capital requirements also provided a cushion to the bank from the losses incurred by them and prevented bankruptcy (Colander et al 259). Thus, the support for survival of banking institutions was much higher in GFC than in case of GD and this supported their recovery.

Banking System

Disappearance of banks from the economy further impacted the recovery as the information on the creditworthiness of the borrowers also went down with the banks. This further dried up the credit supply to the industry and prevented banks from offering attractive interest rates to creditworthy borrowers (Cukierman 3). Thus the real economy could not be supported by the credit supply from the banks and this slowed the recovery process. The redevelopment process of credit ratings took a long time and cause protracted decline in the credit supply to the industry. This became the major reason for an extended depression in the economy. In contrast to this, the adverse impacts of the liquidity crunch in the market were proactively handled by the Government (Cukierman 4). It even took over some insolvent financial institutions or supported takeovers and mergers between financial institutions to prevent real industry from getting impacted negatively.

Money Supply

The money supply was tightened during the GD to prevent the banks from incurring further losses (Eichengreen and Irwin 871). The liquidity shortages were initiated to prevent further monetary losses by the institutions. This slowed the recovery process. Several banks and other financial institutions closed due to defaults and declined further due to a declining money and credit supply. This also prevented the industries from faster recovery. GFC on the other hand was completely supported by the fed with huge amount of liquidity to prevent any further damage to the industry (Colander et al 262). Policymakers in GFC had a reference from GD and did not follow the same path of tightening the money supply.

At the time of GD, the Government was also limited by the existence of gold standard for the monetary supply and this need for maintaining a fixed parity with the gold prevented the Government from improving the monetary supply in the market to reduce unemployment. In case of GFC, no such constraint existed and the federal Government pumped dollars in the market to help recover the economy (Colander et al 264). In a free market, this led to depreciation of their currency but provided the needed monetary support for business and financial institutions.

Trade Restrictions

The focus during the GD was to regulate the industries and trade that led to the crisis (Eichengreen and Irwin 871). This also involved trade restrictions on imports and increased tariffs on over 20,000 imported items to prevent consumers from demanding these products and preferring products from the domestic market. This restricted the overall global trade and impacted other economies as well. The retaliation from the other economies and introduction of tariffs impacted US exports and further depressed the industry (Almunia et al 232). Such an action has been avoided by the Governments post the GD and major trading partners have avoided this during the current recession as well. On the contrary, the central banks have collaborated to prevent further damage to their economies by taking global trade partners into confidence and coordinating monetary policies through swaps agreements. The relations between the major trading countries during the GFC have also been more harmonious than the polarity during the GD (Almunia et al 234). Countries have focused on their growth rather than preventing the growth of trading partners through restrictions.

Unemployment levels

Unemployment during GD was largely industrial due to closure of several industries and has been reported at its peak as being above 20 percent (Eichengreen and Irwin 871). The recession during GFC has been broader based and has affected people from industrial, financial and service industry. The nature of business during GFC is different from the industrial domination of GD. The catastrophic consequences (The Great Depression) were more outreaching than the activities experiences during the GFC (Inside Job). Moreover the highest unemployment figures reported have been around 10 percent, which is still lower than the ones reported during the GD. This can be explained with the extensive support provided by the Government to stabilizing the businesses after the crisis (Almunia et al 239).

Conclusion

The economy during the GD was dependent on industries and a polarity exited between the rich and poor. There was a demand supply gap which affected the financial markets and led to closure industries and affected the employment levels across the country. The business was controlled by large industries and thus their failure also prevented faster recovery. In comparison, the GFC was largely an outcome of the creative financial products and while it impacted other industries and businesses, the issues were largely related to monetary and credit supply in the market. The role played by an experienced Government in handling the crisis can be seen in faster recovery or reduced tenure of a depressed economy.

The economy and industry are also better regulated during the current times and thus are not responsible for the current crisis. The financial institutions on the other hands have developed products over the years which are complicated and prevent the banks from actually following the capital requirement guidelines provided by the Government. This being the source of crisis has led to the Government tightening regulations on the financial institutions by including new financial instruments in the guidelines.

It can be said that both the crisis happened due to power in the hands of the owners of the industries or financial institutions. In case of GD, manufacturers offered extremely low wages to workers and created a disparity which resulted in demand for their products falling and ultimately their businesses failing. On the other hand, in case of GFC, financial institutions in their quest to generate higher margins on their financial products repackaged and sold their products to buyers who were not aware of the actual risks. As suggested in “mind over money” (2010) this lack of information led to financial institutions holding power in this information and ultimately leading to heavy losses for their financial partners. The greed of few individuals and their tendency to move around the regulatory system, or an absence of regulation, for higher profits was the central cause of both the crisis.

References

Almunia, M., Benetrix, A., Eichengreen, B., O’Rourke, K., & Rua, G. “From great depression to great credit crisis: similarities, differences and lessons.”Economic policy 25.62 (2010): 219-265. Print

Beating the Bottom Line. Directed by Hedrick Smith. Films for the Humanities and Sciences(1998) [documentary]

Carmassi, J., Gros, D., & Micossi, S. “The Global Financial Crisis: Causes and Cures.” JCMS:Journal of Common Market Studies, 47.5 (2009): 977-996. Print

Claessens, S., Dell’Ariccia, G., Igan, D., & Laeven, L. “Cross?country experiences and policy implications from the global financial crisis.”Economic Policy, 25.62 (2010): 267-293. Print

Colander, D., Goldberg, M., Haas, A., Juselius, K., Kirman, A., Lux, T., & Sloth, B. “The financial crisis and the systemic failure of the economics profession.”CriticalReview, 21.2-3 (2009): 249-267. Print

Crotty, J. “Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’.”Cambridge Journal of Economics, 33.4 (2009): 563-580. Print

Cukierman, A. “Monetary policy and institutions before, during, and after the global financial crisis.”Journal of Financial Stability.(2013): 3-5. Print

Eichengreen, B., & Irwin, D. A. “The slide to protectionism in the Great Depression: Who succumbed and why?”Journal of Economic History, 70.4 (2010):871. Print

Inside Job. Directed by Charles Ferguson. Sony Pictures Classics(2010) [documentary]

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Moshirian, F. “The global financial crisis and the evolution of markets, institutions and regulation.”Journal of Banking & Finance, 35.3 (2011):502-511. Print

Shaikh, A. “The first great depression of the 21st century.”Socialist Register,47.47 (2011): 5. Print

Stiglitz, J. “The global crisis, social protection and jobs.”International Labour Review, 148.1?2 (2009): 1-13. Print

Stiglitz, J. E. “Reforming the global economic architecture: lessons from recent crises.” The Journal of Finance, 54.4 (1999): 1508-1522. Print

The Great Depression Directed by Jon Else, Lyn Goldfarb & Stephen Stept. PBS(1993) [documentary]