It's a sign of the times that a 10th-grade history teacher recently assigned the following essay topic: What caused the Great Depression, and how do economic conditions then (the 1920s) and now compare? I know because a desperate friend called seeking references for her daughter. My first reaction was: good luck. For decades, the causes of the Great Depression baffled economists. My second reaction was: Lots of people may be asking similar questions. So now that her paper is done, I'll attempt some answers.
The parallels between the 1920s and today are intriguing and unnerving, because the Depression was -- after the Civil War -- America's greatest social calamity. In 1933 joblessness hit a record 25 percent of the labor force. Indeed, unemployment remained high until it was cured by World War II defense spending. The Great Depression was terrifying because it was so resilient.
Hardly anyone thinks it could happen again. Governments now respond quickly to economic weakness. Last week the Federal Reserve lowered its key interest rate to 5.5 percent, making a full percentage point cut in the past month. Most economists think the Fed will cut more. Similarly, the odds that Congress will pass a major tax cut increase daily.
Still, the slowdown -- or recession -- could prove unexpectedly nasty. Cuts in interest rates and taxes are crude weapons. People may trim spending if they fear losing their jobs. Businesses curb investment if profits fall and idle capacity rises. Booms often end badly because people and firms -- foolish or too optimistic -- become overextended. They have spent or borrowed too much.
Here, parallels with the 1920s become troubling:
The celebration of technology. In the 1920s, autos, the radio and refrigerators changed people's lives more than computers and the Internet have today. From 1919 to 1929 the number of cars more than tripled, to 23 million. As for radio, "There was no such thing as radio broadcasting to the public until the autumn of 1920, but . . . by the spring of 1922, radio had become a craze," writes Frederick Lewis Allen in his 1931 classic "Only Yesterday."
Stock market fascination. Investors in the late 1920s had "boundless hope and optimism," said one contemporary observer. Stock ownership, though much lower, grew proportionately more. As late as 1928, only 3 percent of Americans had shares; by 1930 -- even after the 1929 crash -- it was 10 percent. In our era, stocks have become truly democratized. From 1989 to 1998, the share of households with shares or mutual funds rose from 32 to 52 percent.
Heavy consumer borrowing. "The 1920s were definitely the beginning of modern consumer finance," says economist Martha Olney of the University of California, Berkeley. By 1929 about 15 percent of households bought a car on credit, up from 5 percent in 1919. The recent rise in borrowing is more widespread. From 1995 to 1999, consumer debt rose 34 percent to about $6.2 trillion (including $4.8 trillion in mortgages), says SMR Research.
Fortunately, some major differences also separate then from now. For one, bigger government makes more room for tax cuts or spending increases. Moreover, the world is no longer on the gold standard. Back then, paper currencies were backed by gold reserves. This gold standard was unstable. The United States and France accumulated much of the world's gold (55 percent by 1929), because exchange rates were unrealistic and trade flows were lopsided. Without ample gold, other countries couldn't easily expand their economies.
Once the Depression started, fears that countries would "go off gold" made matters worse. Countries tried to protect their gold stocks. They kept interest rates too high so that speculators wouldn't convert investments into gold. The Depression went global. Only when countries left gold did the Depression abate.
Highly simplified, this is the scholarly explanation of the Depression. Gone is the mechanism (the gold standard) that spread the Depression around the globe. If there's not a modern counterpart, then the U.S. slump shouldn't trigger a destructive chain reaction of weaker trade, investment and confidence. Unfortunately, that's still a big "if."
Washington Post Writers Group