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David McWilliams: Here’s how we can avoid the predicted depression

The Corona shut down is not normal. Therefore, economic policy has to be abnormal

The colours of the traditional barber’s sign, a pole with red and white diagonal stripes, signify blood and the barber’s apron because the barber use to double-up as the local leacher. He was the man who bled the sick. For hundreds of years, since the Greeks, rudimentary medics believed that sickness was carried in the blood and the solution for this was to drain the patient of blood in order to expel the bad blood. The theory was that the less blood, the less the disease had to work with. Sometimes they used leeches to do this but oftentimes, they simply cut a vein – or perhaps an artery. The barber had blades, knives and scissors, sure what more did you need?

Obviously, bleeding killed patients who would have otherwise survived. It is remarkable that this brutal medical practice continued up to relatively modern times. For example, George Washington, the founder of the American Republic, was bled to death when in fact he was suffering from common tonsillitis. In a 24-hour period in December of 1799, Washington's doctors relieved him of 40 per cent of his blood. Not surprisingly, he expired.

Bad medicine kills people. Similarly, bad economics kills economies.

This week, the IMF indicated that the world will experience the greatest slump since the Great Depression. However, what the IMF omits to tell us is that the Great Depression was completely unnecessary. It was almost entirely due to profoundly inappropriate policy pursued for too long by too many countries. In short, bad economists bled the world. Had the policy mix been different, there would have been no Depression and maybe no Adolf Hitler, possibly no second World War, and no concentration camps, saving the world millions of deaths.


Let's look at a bit of history and then let's see what we can do now to avoid a global depression. In 1929, the Roaring Twenties' bubble burst and the world was hit by the collapse of the stock market. The advice of US treasury secretary Andrew Mellon – whose grandparents were from Tyrone – was simple: liquidate, liquidate, liquidate. In the face of a fall in stocks, Mellon advised people to keep selling. Such an attitude had a whiff of morality off it. Mellon saw selling as a sort of financial purge, expunging previous excess. However, there's no room for morality in a financial crisis. Mellon's advice obviously made things worse as losses spread across all assets but that was only the start of a litany of mistakes, blunders and miscalculations.

Because much of the stock market was financed with borrowed money, as selling mounted, good assets had to be sold to pay for losses on bad assets. This in turn led to a negative downward link from people’s wealth to their income, and jobs were lost. which punctured demand yet further.

As a result the world was caught in a sudden deflationary spiral where falling prices beget falling prices, prompting more selling and more unemployment, driving down wages, driving down spending power, begetting yet more falls in prices and demand. People with any money saved fearing the worst, pushing down demand further and creating more deflation.

The solution to deflation is inflation. The solution to a collapse in private spending is a rise in public spending and the solution to a rise in private saving is a fall in government saving. States should have spent and the central banks should have injected money into the economy.

Tragically, the advice they got at the time was to do the opposite.

The Great Depression only came to an end when the brilliant Franklin Roosevelt printed money, opened up the taps, borrowed and spent

On the fiscal side, government reacted to a fall in growth, (which obviously led to a fall in tax revenues), with austerity, which made growth fall yet more. On the monetary side, the central banks reacted to the crash by maintaining the gold standard, which insisted that all currencies were backed by gold. Once the crash happened, countries that had borrowed heavily in the later 1920s experienced an outflow of gold to pay for these debts and this outflow of gold demanded that they raise interest rates to “attract in” more gold to replace the gold that had left. Higher interest rates imposed higher repayments on businesses that already were experiencing falling sales and falling revenues. And so they retracted further, exacerbating the slump and deflation.

Policy was bleeding the economy dry, when the opposite should have happened. Economies needed a transfusion of cash not a credit crunch.

It is often argued that Hitler came to power because of Germany's hyper-inflation in 1923. This is not true. In 1928 the Nazi party's support was in the low single digits. He came to power in 1933, following the 1932 election, when Germany was experiencing chronic deflation not hyper-inflation. This deflation was the result of Germany maintaining the gold standard rather than printing money, and following austerity rather than increasing government spending. The upshot was Hitler's rise. Most of Europe endured similar if not quite so extreme experiences. The culprit was terrible economic advice.

Ultimately, the Great Depression only came to an end when the brilliant Franklin Roosevelt abandoned the gold standard in 1935, printed money, opened up the taps, borrowed and spent, faced down conservative opinion in order to boost demand and boost employment.

This is the story the IMF should be telling us. A coming depression can be avoided by massive government spending right now, paid for by central banks without causing debt ratios to rise or risking austerity in the future as governments seek to balance the books. One of the greatest and most dangerous myths is that there is a limit, when faced with an emergency, on government expenditure. This is simply not true. In 1946, for example, the UK’s debt to GDP ratio was nearly 300 per cent.

The greatest risk now is not spending and the reason is simple: when companies go out of business, they don’t open up again and when people lose their jobs, they lose their skills and their networks very quickly, becoming unemployable reasonably rapidly. This is why long-term unemployment is so hard to fix. The way you fix long-term unemployment is not let it happen.

The Corona shut down is not normal. Economically, there is nothing normal about it because the traditional commercial arbiter isn’t sales, profits, innovation, productivity, profits, costs or demand. The referee this time is a virus.

The following image might be a little indiscreet, but the virus has the economy by the balls and until we can prise the virus off, nothing is normal. Therefore, policy has to be abnormal, one-off and absolutely focused in its determination to save businesses. Capitalism is suspended. A form of war communism is upon us until this virus is beaten. Part of that armoury is "free money" or helicopter money, printed by the central bank and deposited in every account, which I have already recommended. Another tool in the arsenal is huge government spending, financed by the central bank, with the aim to avoid, in as much as we can, the depression that the IMF has warned about.

The imperative couldn’t be any clearer.