GLOBAL ECONOMIC DEVELOPMENTS

Leticia Scheinkman

Final Assignment

1.The first age of globalization came to an abrupt and painful end with the economic and
financial crisis that engulfed the world starting in 1929. Is globalization again at risk as a
result of our current global economic and financial crisis? What similarities between the
two episodes suggest that globalization is again at risk? What differences suggest that it
is not? What is your evaluation of the risks, at the moment, on balance? In Addition,
READ the attached article: G20 Process- from the economist.

First of all it is important to understand the socio-economic, politic and geographic situation that
both 1929 and 2008 crises were based.

The great depression which originated in 1929 in US and spread world over by 1930’s was
characterized by barren business and huge unemployment. The main cause of this depression
which took all the nations towards financial crises was crashing of the stock markets in 1929.
Thousands of investors lost their money in stock markets, leading to a longest recession which
comprised huge layoffs, unemployment , wiping out of business activities and which left millions
of people depending on government or charity for food.

Both episodes were preceded by rapid credit expansion and financial innovation that led to high
leverage. However, while the 1920s credit boom was largely US-specific, the 2004-07 boom
was global. With much higher levels of real and financial integration than during the interwar
period, a US financial shock now has a larger and more immediate impact on financial systems
elsewhere. These greater financial vulnerabilities must be balanced against weaker global
economic conditions in 1929. Germany was already in recession then. Wholesale and, to a
lesser extent, consumer prices in major economies had already stagnated or begun falling
before the onset of the US recession. Slowing activity thus led to deflation almost immediately.
In contrast, inflation above target in mid-2008 has provided an initial cushion in the current
crisis.

As mentioned above one of the factors which triggered off this depression was failure of stock
markets on October 29, 1929, which led to loss of about 40 billion dollars to stakeholders.
Though stock markets after that started to regain on the path of recovery, by end of 1930, but
some other factors at work impelled America to do into deep recession.

During the period of 1930’s 9000 banks filed for bankruptcy. Bank deposits were not insured
and thus as banks failed people lost their savings. The banks which survived in this turmoil, due
to gloomy economic conditions and to survive in these conditions stopped creating new loans,
which in turn led to slowdown in business activities and less expenditure.

Bernanke, Ben S., 1983, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic
Review,
Eichengreen, Barry, and Kevin H. O’Rourke, 2009, “A Tale of Two Depressions,”
Romer, Christina, 2009, “Lessons from the Great Depression for Economic Recovery in 2009,”
IMF (2009). World Economic Outlook, April.
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Another important point on the 1929 crises was the trend of economic protectionism which
became a fiscal and monetary policy in many countries including the US. Countries decided to
charge high import tariffs on imports in order to protect its own factories and market, this led to
deterioration in global trade leading to economic retaliation. Alghough few countries follow this
process the same can’t be applied in general.

This process is not seen on the now a days crises and taking into account that the monetary
system migrated from being anchored to gold, a commodity worldwide accessible, to the dollar,
by an unbalanced treasures deficit and surplus system, it make sense to think that the
globalization process is irreversible.

The current global crisis is perceived as the most severe financial crisis since the Great
Depression, and the IMF now predicts that 2009 will have the deepest global downturn in the
post-World War II era. However the response to the crises was much more coordinated now a
day’s not just thankful to the globalization, economic integration and technology but also
because leaders, like Germany, Japan, Russia, before hostile to the very notion of market
capitalism, today are working together with the United States to cope with a common problem.

Liquidity and funding problems have also played a key role in the financial sector transmission
in both episodes. Concerns about the net worth and solvency of financial intermediaries were at
the root of both crises, although the specific mechanics differed given the financial system’s
evolution. In the Great Depression, the problems arose from the erosion of the deposit base of
US banks in the absence of deposit insurance. In four waves of bank runs, about one-third of all
US banks failed between 1930 and 1933. The failure of the Austrian bank Creditanstalt, in 1931,
set the scene for bank runs in other European countries.

In the current crisis, reassurance from deposit insurance has largely prevented bank runs by
retail depositors. Instead, funding problems have arisen for financial intermediaries relying on
wholesale funding, particularly those issuing or holding (directly and indirectly) US mortgage-
related securities whose value was hit by increasing mortgage defaults. With large cross-border
linkages, the problems have immediately been international in reach. In contrast, the spillovers
were more gradual in the 1930s, with the US funding problems transmitted through rising capital
flows to the US and money supply contraction in the source countries.

Secondly it is the protection enjoyed by these private and investment banks. Booming economic
conditions made these banks take higher risks, among which most of the deals of these banks
were highly leveraged transactions. However these risks turn out to be evil for these high flying
banks as they didn’t get enough capital in support of their high risk investments.

Unlike in the Great Depression, when countercyclical policy responses were virtually absent
(with the exception of the sterling block going off gold in 1931), there has been a strong, swift
recourse to macroeconomic and financial sector policy support in the current crisis. Central
banks in the major currency areas have intervened massively to provide financial systems with

Bernanke, Ben S., 1983, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic
Review,
Eichengreen, Barry, and Kevin H. O’Rourke, 2009, “A Tale of Two Depressions,”
Romer, Christina, 2009, “Lessons from the Great Depression for Economic Recovery in 2009,”
IMF (2009). World Economic Outlook, April.
Page 2
liquidity and lowered policy interest rates. Exceptional discretionary fiscal stimulus will support
aggregate demand this year.

Despite the stunning contraction of industrial production and trade across the globe in the
second half of 2008, the global economy is still a far away from the calamities of the Great
Depression. The traumatic financial sector adjustment seen in the early 1930s has been
avoided. Declines in activity and inflation in the US – the core economy – have so far been less
virulent than they were during 1929–31. Perhaps most importantly, the destructive forces of
debt deflation have not set in. This suggests that benefits of the unprecedented policy support,
an international monetary system that provides for reflationary adjustment and more favourable
initial macroeconomic conditions have outweighed the effects of greater vulnerabilities and
cross-border linkages.

This is a sharp divergence from experience in the Great Depression, when the decline in
industrial production continued fully for three years. The question now is whether final demand
for this increased production will materialise or whether consumer spending, especially in the
US, will remain weak, causing the increase in production to go into inventories, leading firms to
cut back subsequently, and resulting in a double dip recession.

The deterioration in financial conditions from balance sheet contraction, asset fire sales, and
increased demand for liquid assets has been more rapid than during the Great Depression and
at least as strong, if not stronger. The facts mentioned above makes me believe that the main
drivers of the globalization, reduced costs of transportation and communication together with
reduced barriers policy for trade and investment will still keep the integration process in track.
Clearly, policy actions to restore confidence in the financial sector, stop asset price deflation,
avoid debt deflation, and support a global recovery will be kept up and should be coordinated by
a supranational organ, such as the Global 20 meeting suggests.

Bernanke, Ben S., 1983, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic
Review,
Eichengreen, Barry, and Kevin H. O’Rourke, 2009, “A Tale of Two Depressions,”
Romer, Christina, 2009, “Lessons from the Great Depression for Economic Recovery in 2009,”
IMF (2009). World Economic Outlook, April.
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2.T. Friedman's book, the world is flat seems to indicate that geography is no longer an
obstacle to economic activity. E. Leamer seems to think otherwise. Using the arguments
– for and against- would Israel's level of economic development be greater enhanced by
peace with its neighbors or by  a free trade agreement with China and India? READ
carefully E. Leamer's article and 1st chapter of T. Friedman's book.

Bernanke, Ben S., 1983, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic
Review,
Eichengreen, Barry, and Kevin H. O’Rourke, 2009, “A Tale of Two Depressions,”
Romer, Christina, 2009, “Lessons from the Great Depression for Economic Recovery in 2009,”
IMF (2009). World Economic Outlook, April.
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