An even greater depression

From 1876 to 1897, the US economy experienced one of the biggest contractions on record. Either we fix the banks and exchange rates, or we can look forward to a similar experience.

In February, oil prices rose but the quantity of oil imports fell, and slack consumer spending is breaking non-oil imports. Imports from China usually take a seasonal dip in February but overall these have remained strong, even as purchases from other regions have slacked off.

China has beefed up currency intervention, suppressing the value of the yuan to boost exports, and increased other export subsidies. This strategy keeps China growing by exporting some of the worst effects of the recession to the United States and other industrial countries.

Essentially, China is exporting unemployment – the ruinous strategy most countries tried, but failed to accomplish, during the Great Depression. The principal difference this time is that China has been given a pass. No one dared challenge China at the G20, least of all President Obama.

The wages of this appeasement are simple. Unemployment is moved from the coastal provinces of China to the US industrial heartland spanning from western Pennsylvania and New York to Eastern Minnesota and south to Missouri, as well as to industrial areas in the US Southeast. It is notable that President Obama's economic team has little relevant experience working or even consulting in these areas.

China's principal threat is that it will stop buying US Treasury securities if the United States takes steps to offset its currency and other subsidies. The Obama administration is foolish to buy it.
To undervalue the yuan, the People's Bank of China prints yuan and trades those for dollars, removing dollars from circulation; then, not having enough places to spend or invest those dollars, the People's bank purchases Treasury securities returning the dollars into circulation.

If the People’s Bank instead held the dollars, it would remove those from circulation, and the Federal Reserve could simply print additional dollars to buy the Treasury securities. The net effect is that the Federal Reserve would collect the interest instead of its Chinese counterpart, and US borrowing costs would be lower. That would benefit, not hurt, the United States.

The trade deficit remains 3.6 percent of GDP, down from more than 5 percent at the peak of the economic expansion in 2007. However, as the US, Chinese and other countries stimulus packages rev up the global economy, the price of oil will rise and US imports of Chinese products will again exceed 5 percent, thanks in large measure to China's currency and other export subsidies.

The trade deficit, even at current depressed levels, pulls the economy down more than Obama stimulus package lifts it. Once the effects of the stimulus package wear off, the trade deficit will thrust US economy back into recession.

Thanks to dysfunctional banks and the trade deficit, the US economy has entered a depression that compares with the 19th century "Long Depression." From October 1876 through June 1897, the US economy contracted 161 of 285 months. Unemployment peaked at more than 14 percent in 1876 and 18.4 percent in 1894.

Then, as now, bank failures and the dollar were central concerns. Either we fix the banks and exchange rates, or we can look forward to a similar experience.

Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the US International Trade Commission.

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