Are We Heading For An Economic Depression?

This is a complex matter, so I will approach the topic with this analogy:

In early days, folk would frequently use gold or silver as hard currency. The downside being that gold or silver is awfully heavy to lug around.

For convenience, a person would ask a goldsmith to look after that person's hard currency. The goldsmith would then issue the 'investor' with a paper receipt. The goldsmith would then wait for someone else, who was in need of some gold or silver, to turn up on his doorstep. The goldsmith would then lend the gold or silver he'd obtained from the investor to the borrower and charge them interest.

Furthermore, the goldsmith would then think, "Hang on a minute, I could make even more gold or silver out of this scheme." Subsequently, another person wanting 'a loan' would turn up and the goldsmith would issue this 'borrower' with a paper receipt in lieu of hard currency, and also charge them interest. Furthermore, he would similarly issue yet another paper receipt to a third borrower in much the same manner.

Now the first borrower who obtained the hard gold and silver would use it to purchase a horse and cart. This would enable the borrower to travel from village to village in order to sell his corn. Unfortunately, The horse slips on a wet embankment, breaks a leg and destroys the cart.

This borrower, now unable to sell his corn, has no idea how he can pay the interest due to the goldsmith (never mind the actual loan).

The other two borrowers have their wheat crops destroyed by a storm and an accompanying flood.

The investor, who lost his roof in the storm, now wants some of his gold from the goldsmith to pay for roof repairs.

So what have we got now?

We have one greedy goldsmith, who was charging interest on currency he never owned.

We have one investor and three borrowers, who are now virtually broke.

The investor is chasing the goldsmith for return of his investment(along with interest) and the goldsmith is chasing the borrowers for payment plus interest. However, there is no gold or silver to be found amongst any of these folk.

In the United States, there are banks that have actually lent up to 40,000 times their capital value to borrowers! During times of prosperity, banks and financial institutions are so enthusiastic about lending us money they don't actually have. These lenders need to be start being more proactive in avoiding over saturated lending. This would allow for a softer impact on people and business during economic dips.

In 1928- 1929, during the run up to the Great Depression, the issues facing the United States weren't too far removed from what they are facing now (massive government/business/ personal debt, deflating property prices, banks foreclosing on mortgage and business loans, workers being laid off, car prices plummeting, consumer spending and confidence diving and the value of the U.S. dollar pushing the currency markets off balance). All we need now, are people, nervous about losing their homes or businesses, pulling their money out of Wall Street, which will in turn cause more financial ruin for businesses and banks.

Unfortunately, whenever the U.S. (being the world's largest economy) coughs and splutters, many other nations end up catching a cold.

With the global economy being more integrated than ever, whatever happens to large economies overseas, will have a greater bearing on what happens here in New Zealand, especially since we are so reliant on our exports in agriculture and tourism. Our agricultural products are fetching good prices overseas, due to high food prices. Unfortunately, because of international pricing, it is becoming harder for the average Kiwi family to budget for food prices that have inflated 28 percent in the last year! Ironic, given that we produce more than we could eat nationally. Thus, consumers are cutting back, and the owner of the average family restaurant is struggling ('Eating out' is one of the first sacrifices consumers make, in times of economic decline).

The current food pricing situation appears to be driven by increasing demand in China and India, but also by the diversion of food crops (particularly U.S. cornfields) for the production of bio-fuels. This is ironic, given that the oil prices are also contributing to food price rises through the increased cost of transportation.

In the 1930's, the Great Depression, brought on what could retrospectively be called international trade wars. An example of this was when the United States, desperate for cash, slapped tariffs on imports. Canada, who was a big exporter to the United States, retaliated by slapping on tariffs on all imported U.S. goods. What saved Canada from absolute ruin was the fact that Britain offered Canada, a preferential trade deal (India, Australia, New Zealand and the rest of the British Commonwealth were part of this deal as well). Canada' s production levels still fell to almost 50 per cent ... and Canada's unemployment rate shot to 30 percent by 1932.

It wasn't until armament and mobilisation ramped up leading into World War II, that many nations were able to shake off the effects of high unemployment and low productivity, albeit that prosperity did not eventuate for many until well after the war and the associated rationing had ended.

As a side note, the Soviet Union was virtually immune to the effects of the 1930's economic shambles, due to the fact that it's economy operated in isolation. After the 1919-1920 revolution and civil war, the U.S.S.R. enjoyed continued industrial expansion that continued for decades. The U.S.S.R eventually struck it's nadir in 1990.

With housing, food and oil prices being so high, it is only a matter of time before international deflationary pressure is brought to bear on these products, squeezing the margins of many producers. Meanwhile, people and businesses will continue to struggle with the increased costs.

Developing nations are already feeling severe effects from rising food prices, with an even greater threat of starvation looming over many countries on the African continent. Fuel prices obviously exacerbate food prices even more, through the increased cost of transportation.

Another potentially nasty side affect of rising food prices, is the increased likelihood of riots across the world and even the overthrow of governments. The Prime Minister of Haiti has already lost his job, due to high food prices.

The Great Depression of the 1930's lead to the election of extreme governments in many nations. Some were Socialist left wing and others were far right. Governments with extreme policies had a tendency to send some nations down rocky paths during the 1930's 1940's. However I think I could blab on for hours on this one, so I'll stop here.

In short we need to remember what happened during the 1930's, and initiate strategies to avoid a repeat of what is essentially a nightmare scenario. We need to consciously moderate borrowing and thus avoid a run on banks and financial institutions, during times of crisis. We need to save money. We need to stop living of our credit cards and create financial plans to pay off our debts. We need to view housing as a steady investment and not a quickfire cash crop. We should look at reducing/removing tax on essential items such as food. We should have an alternative plan thought out, in case the global market collapses (e.g. sell and produce more for the domestic economy).

Please note, I am not an economist, I am an economic layman!

Thanks for reading.