The Long, Long Depression

The markets were......

Sketch of the crash of 1873

........on a roll. New companies were being listed every few days. Germany had a new currency, and its mighty exporters were doing business around the world. Greece had merged its currency with that of France and Italy in a bold experiment in monetary union. A massive new continental economy was flooding the world with cheap goods, disrupting old industries. And new technologies were creating global markets, where money and information zipped from bourse to bank virtually instantaneously. Until the crash came, it seemed as if everyone would keep on getting richer and richer forever.

You could be forgiven for thinking that was a description of New York in 2008. Or London in 2000. Or Shanghai right now. But actually it is Vienna in 1873.
In that year, the Austrian capital was the epicenter of one of the great bubbles of the Victorian era. Money was flooding out of the new, unified German economy, and much of it landed in the lightly regulated Vienna bourse. Over the course of three years, more than a thousand companies joined the market. Preparations for the 1873 World Exhibition in Vienna led to a massive building boom. The Austrian rail network doubled in just five years. Over six months, the Vienna market tripled in value. Then, in May 1873, it all crashed spectacularly. The market plummeted and had to be temporarily closed. The panic quickly spread to Germany, leading to what became known as the Gründerkrach, or “Founders’ Crash,” because it came so soon after the Gründerzeit, or “Founders’ Boom,” that had followed unification.

By November, it had spread to Wall Street, sparking a collapse that started when Jay Cooke & Company, a bank that had been one of the main financiers of the American Civil War and was among the most prominent finance houses on Wall Street, suspended payments on its bonds. “The brokers stood perfectly thunderstruck for a moment, and then there was a general run to notify the different houses of Wall Street of the failure,” reported the New York Times the next day. “The brokers surged out of the Exchange, stumbling pell-mell over one another in general confusion.”
The crash marked the start of what economic historians refer to as the long depression. During Edwardian times, it was actually known as the Great Depression, but rather like the Great War of 1914–18, it had to be renamed once a worse catastrophe came along. Either name would do, however; the slump was both long and great. It lasted from 1873 to 1896, and over that period output crashed, unemployment increased, prices fell, and migration soared. Most of today’s German population in the U.S. is descended from Germans who migrated here during the years after the crash, trying their luck in Cleveland and Milwaukee after they were laid off in the Ruhr.
The long depression was, for many years, of interest only to a small band of economic historians. Right now, however, it seems full of lessons for our own times. The parallels are almost spooky. In the 1870s, Germany had recently reunified, just as it has now. A currency union had been formed in Europe but was struggling to stay together. There was a new form of instant communication, the telegraph, that was more revolutionary than e-mail in the time saved over the technology it replaced. There was a new continental economy, and the U.S. was flooding the world with cheap grain just as China now floods the world with cheap computer chips. There was even a wave of financial innovation. In the years leading up to 1873 crash, new industrial banks such as Deutsche Bank had been formed, and the global bond market was fueling the railway boom. And, of course, there was an epic financial bubble that suddenly blew up. The question is whether we are going to witness another two-decade slump like the one that followed the 1873 crash.
Unfortunately, it is starting to look as if we might. The U.K. is already experiencing its longest depression since records began: The current downturn has lasted longer than the slump of the 1930s. Europe is heading for a deep depression next year as the austerity regime that will be needed for the euro to survive starts to bite. The U.S. will struggle to grow significantly. We are used to short, sharp recessions, because those were what we experienced for most of the 20th century. But it is now more than three years since the crash of 2008, and things are getting worse, not better.
When the markets blew up in 2008, policymakers rushed to make comparisons with the 1930s. True, that was a terrible depression, but one that was over quite quickly. The Great Depression was caused by a sudden collapse of demand and shrinking money supply. Now, as then, policymakers assumed that if the government expanded its deficits and central banks printed lots of money, that would fix the problem. It hasn’t, and it should be clear by now that it isn’t going to.
Why not? Because what we are really dealing with is a structural depression. In reality, the global economy is facing not one crisis, but three.
There is a debt crisis. The developed world has been building up debts on a spectacular scale for three decades. According to McKinsey data, global debt now stands at $158 trillion; that is up from $77 trillion in 2000. Put another way, global debt amounts to 266 percent of global GDP now, compared with 216 percent a decade ago. While economists used to think that debt was largely neutral — on the grounds that once person’s borrowing is another person’s loan — we are now discovering that borrowing on that scale is unsustainable.
Then there is a currency crisis. For most of the post-WWII period, the dollar was the anchor of the global economic system. That worked when the U.S. was the overwhelmingly dominant economy. It doesn’t work anymore. The dollar is now down to 60 percent of reserves, as central banks diversify away from a currency falling in value. At some point we will come up with a new core currency — perhaps the Chinese renminbi, perhaps gold. But until we do, there will be more chaos ahead.
And finally, there is the euro, perhaps the most dysfunctional monetary system ever created. Welding together the currencies of 17 very different economies, without any kind of fiscal union to compensate for the differences between them, was always a high-risk experiment. By now we can surely agree that it has failed. The euro was meant to promote faster growth and greater stability. It has become instead a cause of depression and volatility. Until it is dismembered, there is little chance of the global economy’s returning to stability.
This is a structural depression — just as the long depression of the 19th century was. And it won’t be over until we have fixed the way the economy works.
The trouble is, none of those tasks can be accomplished easily. The euro will take several years to restructure, and if it falls apart chaotically, it will plunge the world into a deep depression. Any replacement for the dollar will take a decade to establish itself. We don’t even have much idea what it might be yet: Historically, the reserve currency has always been either gold or the currency of the world’s dominant economy, but China is not ready to assume that role yet, and the shiny yellow metal has a long way to go to reclaim its place as the ultimate store of value, even if it is taking a far larger share of anxious investors’ portfolios. Only once those things are achieved will we be able to start reducing our debt to manageable levels.
The great 19th-century depression lasted for more than two decades. On the same reckoning, this slump will last until 2031. That may be too long a time scale: The old joke that economists make forecasts  only to give the weather guys someone to laugh at should stop anyone from making predictions for decades ahead. But the lesson of the long depression is that a downturn can last a very, very long time — and it’s already clear that this one isn’t going to be over soon.