Economic Deja Vu

“We learn from history that we learn nothing from history.” — George Bernard Shaw

The New York Times published an op-ed piece by Paul Krugman today in which he argues that we are repeating the economic mistakes which led to the Great Depression. Some excerpts:

We chose to forget what happened in the 1930s — and having refused to learn from history, we’re repeating it. Contrary to popular belief, the stock market crash of 1929 wasn’t the defining moment of the Great Depression. What turned an ordinary recession into a civilization-threatening slump was the wave of bank runs that swept across America in 1930 and 1931. This banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure. As the decades passed, however, that lesson was forgotten — and now we’re relearning it, the hard way. . . .

Wall Street chafed at regulations that limited risk, but also limited potential profits. And little by little it wriggled free — partly by persuading politicians to relax the rules, but mainly by creating a “shadow banking system” that relied on complex financial arrangements to bypass regulations designed to ensure that banking was safe. . . .

As the years went by, the shadow banking system took over more and more of the banking business, because the unregulated players in this system seemed to offer better deals than conventional banks. Meanwhile, those who worried about the fact that this brave new world of finance lacked a safety net were dismissed as hopelessly old-fashioned.

The financial crisis currently under way is basically an updated version of the wave of bank runs that swept the nation three generations ago. People aren’t pulling cash out of banks to put it in their mattresses — but they’re doing the modern equivalent, pulling their money out of the shadow banking system and putting it into Treasury bills. And the result, now as then, is a vicious circle of financial contraction.