How did the Great Depression and the Crash of 2008 affect the buying power of the US dollar, and what can this knowledge tell us today, three years after the 2008 Crash?
Some have drawn comparisons between the present worldwide financial crisis and the 1930s Great Depression. In stating that the current global financial crisis is the "worst since the Great Depression." analysts have not been shy. Also recently, Nobel Prize-winning economist Paul Krugman said on his blog that he "got that 30s feeling, all the way."
We have to note, as tempting as it might be to draw comparisons between the Great Depression and the 2008 Crash, that today's world is drastically different from that of the 1930s. There are huge variations in everything, from what people wear, to what people eat, to how people get to work when comparing the US economy from the 1930s to today.
These gaps should not be looked through by economists. But we still use the US dollar, and to operate as a society and country, we still need economic activity. Considering that, in the aftermath of stock market crashes and depressions, maybe there are lessons we can understand about the worth of a currency.
While the food we consume today may vary from the flavors of the 1930s, there has been little improvement in certain aspects of our diet. Take a staple of human experience, for instance: a loaf of bread. A loaf of bread is seen by some people as an economic standard (similar to the Big Mac Index). You could purchase a loaf of bread in the US for nine cents in 1930. A loaf of bread today would cost you around $1.98 in the same currency.
That might sound like a significant distinction. But the average income per year in the U.S. was $40,712 in 2009 and $1,970.0 in 1970. While price comparisons may not always be absolute or universal in differences between 2011 and 1930, they reflect changes not only in the understanding of the value in society but also in the American way of life. When addressing disparities in purchasing power between the 1930s and today, it is crucial that we do not neglect social and microeconomic changes such as gender equality, civil rights, and key innovations such as the microwave or the washing machine in American culture.
The Consumer Price Index (CPI) stood at 17.3 in October 1929 during the Great Depression, reached a bottom of 12.6 in May 1933, remained about 13 or 14 for the rest of the 1930s, and did not exceed 17.3 again until April 1943. By contrast, in October 2008, the CPI was 216,573, fell a handful of points through 2009, and recovered its footing to 218,178 in May 2010. This seems to mean that when the US plunged into deflation, intensifying the depression in the 1930s, the 2008 crash saved us a deflationary spiral that would have extended the recession. In the 1930s, three years after the stock market crash, the CPI fell to 13.3. In contrast, the CPI stands at 226.545 as of August 2011. We aren't in such poor shape relative to the 1930s.
If we look at the US inflation rate after the stock market crash of the 1930s, we can see that the inflation rate drops into a deflationary trap that has been hanging around for around four years (bottoming near -10 percent). The US tended to fall into a somewhat deflationary gully (bottoming near -2%) for a single year relative to the 2008 crash. The example of the 1929 economy tripping up and dropping into a 10-foot-deep pit and the 2008 economy tripping up and falling down the side of the road into a ditch may be used.
Now, back in 1929, the US Dollar Index already did not exist. Moreover, the US dollar was sponsored by gold at the onset of the Great Depression. When the US government suspended the gold standard, prohibited the use of gold for purchases, and banned most private ownership of gold, this changed in 1933. And, also in the midst of the January 1934 Gold Reserve Act (over four years after the 1929 crash), the CPI remained largely unchanged for some time. A few potential explanations for this include slack demand and a 21.7 percent unemployment rate (a substantial climb from a 4.2 percent unemployment rate in 1928 and 8.7 percent in 1930). While the value and sense of the unemployment rate today may have changed significantly since 1930, the figures remain with psychological effects and business consequences.
While it may be easy to equate the Crash of 1929 with the Crash of 2008, one can not help but feel that contrasting the two crashes is a bit like comparing apples and oranges when taking into account different variables such as oil, the US dollar as a global reserve currency, globalization, social shifts, and growing technology. The Dow Jones Industrial Average (DJIA) dropped 12.82 percent on October 28, 1929; the DJIA dropped 11.73 percent the next day. In contrast, October 2008's next nearest one-day percentage loss was 7.87 percent. Where the US economy of 1929 seemed to crash and could not recover, the US economy now seems to have collapsed and is struggling to get back on its feet.
Investors were inspired by the 2008 Crash to take another look at precious metals. Gold is a practical benchmark for comparing the value of the US dollar after the Great Depression with the value of the US dollar after the 2008 crash. The price of gold was relatively steady in the 1930s.
If we contrast the 1930s with the 2008 Crash, where gold went through the roof, it is obvious that relative to the fiat free-floating US dollar currency we have today, the US dollar on the gold standard was a totally different species. Both currencies were the US dollar in 1929 and 2008, but it's like one was a Saber-toothed tiger in an identical way, and the other is a Bengal tiger; they're two entirely different species. Where we have seen inflation since the 2008 crash, when deflation set in, the situation was very different in the 1930s. The US economy, unlike the depression of the early 1930s, now appears to be in a "liquidity trap," or a condition in which monetary policy is unable to stimulate the return of the economy to health.
In terms of the stock market, on August 12, 1932, almost three years after the 1929 crash, the DJIA fell 8.4 percent. Although we have experienced great uncertainty in the last two months with massive intraday swings, we have not experienced any record-shattering daily percentage drops to the tune of the 1930s in 2011. In view of the DJIA, the CPI, and the national unemployment rate, where many of us may have the '30s feel, we're clearly not living in the 30s. Some people may feel like we are living in a depression, but for many others, the current global financial crisis just doesn't feel like a 1930s-like depression.
What's the worth of a dollar really? If we look at the 1930s CPI, we see that the CPI was 17.3 in October 1929 and the CPI was 13.3 in October 1932. This may seem to suggest, at first, that deflation had set in, that the value of the dollar had risen, and that prices had fallen. The rising unemployment of the 1930s must, however, also be taken into account. Let us imagine a country called Acadia with 5% unemployment, where a loaf of bread sells for 5 francs, to use an example. Now, imagine that unemployment is doubling to a 20 percent rate in Acadia, but a loaf of bread always sells for 5 francs. Although the price of a loaf of bread has not changed, the demand for a loaf of bread has changed, as the labor market value of the labor needed to secure a loaf of bread has increased as unemployment has increased. Given the weak labor market, though still having francs to buy food, the worker must essentially work harder and longer to retain his place in the labor market. Where a worker was once able to work in order to raise the necessary funds to buy food, he might now have to go without it.
The value of a franc with 20 percent unemployment is substantially higher from the point of view of a laborer competing in the labor market than the value of a franc with 5 percent unemployment. This form of interplay between consumer goods and the unemployment rate in a free market would seem to suggest that it can either become leaner as a population or a labor force becomes leaner the market for goods.
Fortunately, if we equate the CPI in October 2008 (216.573) to August 2011 (226.545), we seem to be out of the range of the 1930s financial troubles. The situation today in the world, however, is much different than it was back in the '30s. The world population in 1930 was about two billion people, to put the gap into perspective; today it's about seven billion people. Today we have, on a planetary scale, the Eurozone, globalization, and financial upheaval that the world has never seen.
Even so, the problem with the 2008 crash is that it impacts different communities and areas in the world more disproportionately than others. As such, we can still see the thriving shopping mall in Columbus, Ohio, in the midst of a financial crisis, but maybe we're missing the tent town in Reno, Nev. In this way, given daily economic activities, it may be easy for Americans to neglect the financial health of the country. It makes sense that a person, based largely on the world around him, will shape his outlook on the economy.
Thus, as you drive by restaurants like Carrabba's Italian Grill or Red Lobster and see that they are filled to the gills, it becomes impossible to believe that the country is in a depression. I assume that this outlook is the difference between a deflationary economic recession and through-the-roof unemployment and a continuing inflationary economic recession.
"After the stock market collapse in 2008, I can remember telling my friend, "Okay, so we're entering a crisis. At what point should we start selling apples on the street when there is no food in the grocery stores?" Our present plight does not seem to be the same as what happened in the 1930s, to say the least. But the disparity in experience goes back to cultural developments and the American way of life. The nation may be in a state of depression, but alas, cars are still on the roads, people are still going to lavish restaurants, iPhones are still selling, and life is going on. There could be places with large tent cities or recurring rolling blackouts in the US, of course, but from my limited viewpoint, I have never seen them or witnessed them and it would seem like not too many news outlets are reporting on such phenomena.
Fortunately, I have yet to see masses of people standing in a bread line or waiting for food in a soup kitchen three years after the Crash of 2008. I know, at least in the Midwestern U.S., where we do not see people selling apples on the street or grocery stores with empty shelves, we see a large number of empty shopping plazas, empty shopping centers, and empty homes.
On the street corners, we see people carrying signs begging for cash or jobs. They are now the faces of the present economic crisis. Not all Americans have been similarly impacted by the ongoing global financial crisis. While in the past three years, some may have suffered greatly, others have not suffered quite as much. Nonetheless, things could change rapidly and in the near future for the US economy. At the very least, the U.S. economy should ultimately recover as long as we continue to be able to safeguard our daily bread. This, too, will pass when all is said and done.