Lessons of the 1920s

This isn’t a bad basic primer on the cause of the Great Depression and the connection between it and the beginning of the Great Depression 2.0.

The lessons of the 1920s are clear, and they bear directly on the build-up to the present crisis. Developed capitalism without social democracy and strong labor unions leads to productivity increases far outpacing wage growth, extreme inequality, insufficient working-class purchasing power, an unprecedented buildup of household debt and nowhere for profits to go but into capitalist consumption and financial speculation. With financial growth not reflecting comparable health in the productive economy, a bubble formed in stock market speculation and household debt grew faster than household income. By their nature, bubbles break. The popping of the speculative bubble brought about the stock market crash of 1929.

The crash and ensuing Depression afflicted what we have seen was a highly vulnerable economy. Because the economy had by the 1920s become industrially mature, growth no longer depended upon the breakneck expansion of the capital goods sector, but was now, and for the first time, fuelled by the production and consumption of consumer durable goods like refrigerators, radios, vacuum cleaners and, most importantly, automobiles. Consumption replaced investment as the driver of economic growth. (4) Robust growth would now require high wages.

With wages stagnant, working-class households’ ability to sustain the consumer durables boom became dependent, as it would again from the mid-1970s onward, on unsustainable household debt levels. Supplementing income-based purchasing power with credit had been a fact of life since the late nineteenth century, but the debt increments increased especially rapidly during the 1920s. The proportion of total retail sales financed by credit increased from 10 percent in 1910 to 15 percent in 1927 to 50 percent in 1929. When working-class purchasing power and household debt approached their limit by 1926-1927, the rate of growth of consumer purchases began to decline. Key growth markets like autos and construction became saturated and excess productive capacity became conspicuous. Production fell and profits were directed to financial speculation and bubble creation. The stock market and the economy responded accordingly. The Great Depression was at the door.

A comparable dynamic was in effect during the period preceding September 2008. From the mid-1970s to the year before the housing bubble began to leak, 2005, the gap between productivity growth and flat wages grew wider and wider. As in the 1920s, national income shifted steadily and increasingly to the top. Inequality approximating that of the 1920s grew. 1928 and 2007 were the highest inequality years since 1900. (Each year, not coincidentally, was followed by a major meltdown.) Workers once again resorted to debt to maintain living standards. The ratio of outstanding consumer debt to disposable income had more than doubled, from 62 percent in 1975 to 127.2 percent in 2005. Since 1995 the debt burden, measured by the percentage of household income pledged to debt service, had become increasingly concentrated in the lower three income quintiles. Financial speculation, which had accelerated since the mid-1970s, took off with a vengeance after 1999. Echoes of the 1920s were loud and clear.

That’s a great piece of data I hadn’t seen before, concerning the increase in the percentage of retail sales “financed by credit” from 1910 to 1929. It clearly shows the same debt parabola that we often observe before a period of credit contraction.