Why Today’s China Is Similar To The Run-up Of Great Depression19 May, 2011, 3:54. Posted by Zarathustra
Tags: Economy, Great Depression, United States
Note: This article was first posted on 25 April.
It is probably easy to point out the differences between China in the last decade and the United States in the 1920s. Surprisingly, there are some similarities that very few people would care to admit.
Ben Bernanke’s account of the Great Depression focused largely on the aftermath of the crash: contraction of money supply as the banking crisis failed. He quoted Milton Friedman and Anna Schwartz on the Fed’s policy mistakes that:
The Fed’s first grave mistake, in their view, was the tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929…
The second monetary policy action identified by Friedman and Schwartz occurred in September and October of 1931… the United States and the great majority of other nations were on the gold standard, a system in which the value of each currency is expressed in terms of ounces of gold. Under the gold standard, central banks stood ready to maintain the fixed values of their currencies by offering to trade gold for money at the legally determined rate of exchange…
Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s; in this view, slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment. Other officials, noting among other indicators the very low level of nominal interest rates, concluded that monetary policy was in fact already quite easy and that no more should be done…
The fourth and final policy mistake emphasized by Friedman and Schwartz was the Fed’s ongoing neglect of problems in the U.S. banking sector…
Reading through these line, we would certainly understand he has expanded the monetary base so dramatically to save the day (and failed, somewhat). He certainly did not, as the Austrian Economists would have suggested, put the emphasis on what was happening in the period leading the the crisis.
Flipping through the Austrian’s account of the Great Depression, Murray Rothbard’s American Great Depression, it said:
To supply foreign countries with the dollars needed to purchase American exports, the United States government decided… to promote cheap money at home, thus stimulating foreign borrowing and checking the gold inflow from abroad. Consequently, the resumption of American inflation on a grand scale in 1924 set off a foreign lending boom, which reached a peak in mid-1928… Thus, in an indirect but nonetheless clear manner, American protectionist policy must shoulder some of the responsibility for our inflationist policy of the 1920s. – p. 139
And in helping Great Britain to return to the pre-war gold standard:
Whereas throughout 1922 and 1923 the interest rate on bills in New York had been above the rate in London, the Federal Reserve managed to push these rates below those of London by mid-1924. As a result, the gold inflow into the United States, of which about 40 percent had been coming from Great Britain, was checked for a time. As we have seen, U.S. lending abroad was also greatly stimulated, thus providing Europe with longer-term funds. – pp. 146-147
We can see how gold standard is essentially a currency peg. What the United States did was essentially to depreciate the US dollar against the Sterling in order to help the United Kingdom to go back to the pre-war gold standard, which significantly over-valued the Pound Sterling. The period leading up the the Great Depression also saw increases in exports, gold inflow, and foreign lending.
That’s exactly what China has been doing for the best part of the previous decade. By keeping the Chinese Yuan a.k.a. renminbi at an artificially low value, China’s exports were helped, thus the country consistently ran a huge current account surplus. And because of that, China accumulates huge foreign exchange reserve, somewhat similar to the gold inflow in the 1920s United States. Last but not least, China became the creditor of the rest of the world, pretty much like the 1920s United States which became the creditor of Europe.
So unfortunately, China is looking somewhat similar to US before the Great Depression.