Time in reverse

History doesn’t repeat itself, but it often shows a certain poetry. The juxtaposition of the 1930s and the 2010s might just demonstrate the poetic device known as chiasmus — A,B,C followed by C,B,A. In this case, A stands for steep economic decline, B for mild recovery, and C for a relatively modest fall.

The first time around, the misguided official response to the collapse of a financial bubble led to a disastrous collapse of output. A few years of monetary and fiscal ease then supported a tepid recovery. A mild monetary tightening in 1937 produced a modest relapse.

Policymakers learned their lesson, or thought they did. When the financial bubble popped in 2008, they responded with tremendous monetary and fiscal stimulus. The economic damage was limited to higher unemployment and single digit percentage declines in GDP. These policies have, however, led only to a “B” period of second-class recovery. Right now growth is weak in the United States, and almost absent in the euro zone and UK.

More worryingly, the stimulus has set the scene for a first-class collapse. The problem is debts, which continue to expand. Governments are borrowing as if there were no tomorrow, while the private sector has not really deleveraged. In the United States, total credit outstanding has increased at 3.7 per cent annually since the 2008 credit crisis, faster than the three per cent rate of nominal GDP growth. In many emerging markets, including China, Brazil, Russia and Turkey, the pace of credit growth has been double or more the rate of nominal GDP growth.

If too much credit causes crises, and it basically does, then the world is in for one. This time around, though, stimulus — effectively throwing more money into the economy — might not work. The private sector could decide that governments are untrustworthy and the new funds could lead to unacceptably high inflation. It would be hard to avoid an A-level depression.

What would come next? In the 1930s, it was impoverishment, and eventually World War Two. Everyone should hope that history finds a new refrain.