Does the United States need another depression?

A financial crisis is not exactly a rare phenomenon. Since 1987 there have been four notable calamities, including the credit crunch today. The current situation is easily the largest since the Great Depression and such a comparison has prompted public concern. A considerable amount of outrage has been directed at the government over the rescue of the financial system. John McCain has been ridiculed for proclaiming that the fundamentals of the economy were sound. A little politically insensitive perhaps but depending on your point of view it may make sense. The basic free market understanding is that if something fails by its own accord it should be allowed to fail. Then the system can purge itself of the bad element and the good can rebuild the system anew. There is a minority in the United States that holds that view and, at times, their case is compelling. There is a passive consensus that the current crisis is born of willing regulatory ignorance. Left of center politicians see an opportunity to rewrite the rules of Wall Street on their own terms, ironically applying socialist iconoclast Naomi KleinâÄôs anti-market theories in reverse. The reregulation process will be heavily politicized and likely focus on preventing the current crisis from happening again. But no two crises are alike; no, each has its own uniqueness. In theory, if markets are allowed to ebb and flow, massive failures will admonish against making the same mistakes again. Those who believe in that can generally be called the liquidationist school of thought. As a matter of principle they believe that those who were responsible for the present morass, whoever they may be, must be punished even if it brings another depression. By and large, the liquidationists are made up of paleolibertarians, such as Ron Paul supporters, and steadfast fiscal conservatives. Their argument is that the monetary policy of the Federal Reserve was too loose, making money too cheap to borrow. The excess money helped to fuel the credit and housing bubble. Furthermore, the government has had a policy of interventions into the banking world for decades, creating an array of moral hazards. Indeed, since 1984, not a single large bank has been allowed to fail. Thus, large banks could operate with an implicit government guarantee. While bankers may not have maliciously exploited this fact, the safety net was still there. A fair point to bring up is that a recession is not explicitly catastrophic, nor completely negative. They let unproductive and socially detrimental industries fade and more beneficial ones to spring up. Politically, however, recessions are a hard sell âÄî they often invoke images of rampant unemployment and reduced living standards. Former Federal Reserve Chairman Alan Greenspan has been ostracized for his decision to keep interest rates well below the natural rate following Sept. 11. Foreign capital flows rushed in. The market thus was flush with cash, and borrowing became rampant. The present situation is a direct result, making one wonder whether a milder recession in 2001 would have been more acceptable than the present. There are some who believe that the present situation is actually being over-exaggerated, and panicky crowds are driving the fear and uncertainty that grip markets. The Minneapolis Federal Reserve recently released a report suggesting that the credit contraction had not been as severe as is widely thought. Others believe that all the talk of recession is becoming self-fulfilling. The statistics that are being offered up to support the theory that there is a crisis at all are mere scare tactics. Indeed, the evidence that panic has gripped the economy is undeniable. Economists from all over the political spectrum tire of the governmentâÄôs clamor. And they have a point. Most discussion over the fate of the economy still treats recession as a possibility, when in reality itâÄôs inevitable. Politicians deserve blame for talking more than doing. But politicians always exaggerate and use dire rhetoric. The Minneapolis FedâÄôs report was heavily scrutinized on release for its sloppiness. True, high-quality credit has not been much affected yet. The more common stuff is another story, as the difference in the borrowing rates of the two has soared apart. That matters because governments and business use short-term financing for funding day-to-day operations. The global scale of this crisis perhaps has not yet been realized. The Baltic Dry Index, a measure of international shipping, has nosedived 90 percent. Shipping accounts for huge proportions of international trade and the goods on those ships likely affect more modest classes, rather than bankers. The vicious cycle of financial deleveraging is having worldwide domino effects. Shipping is slowing because no bank will lend to shippers for the journey. Slowing trade is making developing economies ever more vulnerable. Destabilization there will be felt in the developed world. Too many lives are at hand for any of that to be allowed to happen in order to uphold principle. Still, it is easy to sympathize with liquidationists. History shows the haphazard government interventions into crises like this tend to lay the seeds for the next one. Excessive risk taking by anyone, be it homeowners, bankers, or investors, should be punished. But it simply cannot be sold to people in a democracy that a depression, even a deep recession, is good for them, even if it might be in the long run. Because, as Martin Wolf of the Financial Times observes, âÄústrangely enough, theyâÄôre going to elect a politician who doesnâÄôt think that.âÄù St. JamesâÄôs Street welcomes comments at [email protected]