The other depression

PUBLISHED : Friday, 21 November, 2008, 12:00am
UPDATED : Friday, 21 November, 2008, 12:00am

In times of uncertainty, turning to the pages of history can be useful to find ways to weather a storm. Amid the present financial turmoil, it is natural to search for clues as to what we can expect or should do by looking to the last known global economic calamity, the Great Depression of the 1930s. Parents and grandparents have told of the hardships they endured; from this, it could be assumed we have a handy reference point from which to draw up appropriate battle plans. But, as neat as such thinking may be, we would do much better to follow the advice of American historian Scott Nelson and read up on a far more relevant meltdown: The Panic of 1873.

Professor Nelson specialises in 19th-century history and teaches at America's second-oldest university, the College of William and Mary in Williamsburg, Virginia. He told me this week how his 97-year-old grandmother knows the depression years well, but also recalls how her grandparents spoke of an even worse financial downturn six decades earlier. His research, being turned into a book, has unearthed startling similarities between that crisis and the one the world is now experiencing.

The last depression was grounded in Germany being unable to pay debts hanging over from the first world war, factory inventories being overly large and Wall Street crashing in 1929, which, when combined, resulted in excessive strain on British gold reserves. This does not sound like the excessive lending, risky investments, housing crash and bank collapses of our troubles.

Startlingly similar, though, are the events leading to The Panic of 1873. What Professor Nelson's grandmother calls 'the real great depression' started in Europe as a crisis brought on by banks with bad mortgages. Amid optimism in France, the newly formed Austro-Hungarian Empire, and the states unified by Prussia into the German Empire, lending institutions sprouted and flourished. The mortgages they issued for municipal and residential construction were liberally approved, and a building boom centred on Berlin, Paris and Vienna began in about 1870. There was perhaps even more buoyancy in the post-civil-war US, with a railway construction frenzy leading the economic charge. In the rush to lay tracks, rail companies borrowed heavily and crafted complex financial instruments guaranteeing generous returns to raise capital. On both continents, land values soared.

But the economic fundamentals were not as they seemed. Much as China has today become the world's manufacturing hub, the US was surging forward with agricultural and industrial innovation; by the early 1870s, its cheap produce and goods, loaded into giant steam ships, were flooding European markets. Flour, meat and rape oil seed prices collapsed. The crash began in central Europe, in May 1873, as it became clear that growth projections were too optimistic. Banks, unsure of who was holding bad debts, raised inter-bank lending rates, causing tightness in credit. Stock market crashes in Vienna, Berlin and the US followed. American railway firms quickly started going under and it became apparent the promises made to investors were false.

Professor Nelson said the depression lasted for more than four years in the US, six in Europe; the ramifications were decades-long. Hundreds of banks shut their doors, tens of thousands of companies closed, and more than a quarter of the workforce was unemployed - similar to during the Great Depression.

The ways companies went about doing business was radically changed. Governments imposed trade tariffs to protect their economies. Empire-building in Asia and Africa gathered pace.

Governments too often ignore history in making decisions. That is not the case with the present meltdown but, as Professor Nelson points out, many officials seem to have opened their history books at the wrong page. They fear inflation, the scourge of the 1930s, but a just-as-damaging phenomenon, deflation, endured during the 1870s. He worries that focusing on 1929 will lead to a flawed diagnosis and an inappropriate remedy. Given what the depression of 1873 led to, I hope his message is heard.

Peter Kammerer is the Post's foreign editor