Wednesday, August 10, 2011

Europe Charges toward Second Great Depression

According to Hegel, “the only thing we learn from history is that we learn nothing from history.” The current crisis in the eurozone suggests an even more pessimistic reading. Having learned, after World War II to avoid the mistakes made in the aftermath of World War I, policy makers in Europe are now in the process of repeating those very mistakes.

At the end of what was then called the Great War, the victorious allies were faced with the need to reconstruct the global economic system. The decisions they took were disastrous, paving the way for the Great Depression and the renewed outbreak of war in 1939.

The punitive and ultimately unenforceable Treaty of Versailles, which called forth John Maynard Keynes’s polemic The Economic Consequences of the Peace was one such decision. Even more catastrophic, if less well remembered, was the decision to return to the gold standard at the parities prevailing in 1914, effectively reversing the inflation associated with the war.

Keynes returned to the fray with his book The Economic Consequences of Mr. Churchill, which correctly predicted the disastrous repercussions—in terms of unemployment and reduced economic activity—of the British Bulldog’s attempt, when he was UK Chancellor of the Exchequer, to depress prices and wages to prewar levels.

Keynes was ignored, and by the late 1920s the champions of fiscal orthodoxy were congratulating themselves on the successful restoration of prewar normality. But their apparent success had set the scene for the Great Depression that began in the US in 1929. (more)