Up until recently, the chaos caused by the Great Depression seems nearly inconceivable. At least, it was to influential Financial Times columnist Martin Wolf.
But in an editorial published yesterday, he writes that the euro crisis has led him to understand how fear and a lack of credible safety nets in the financial system can result in a disaster like the Great Depression:
Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events.
The unwillingness of European politicians to make strong changes that will bolster the structure of the union has generated the fear that it may be too late for institutions to control a downward spiral of bank runs, illiquidity, and subsequently defaults.
And fear alone creates a vicious cycle that could make this worry a reality. He writes:
How realistic is this fear? Quite realistic. One reason for this is that so many fear it. In a panic, fear has its own power. To assuage it one needs a lender of last resort willing and able to act on an unlimited scale. It is unclear whether the eurozone has such a lender. The agreed funds that might support countries in difficulty are limited in a number of ways. The European Central Bank, though able to act on an unlimited scale in theory, might be unable to do so in practice, if the runs it had to deal with were large enough. What, people must wonder, is the limit on the credit that the Bundesbank would be willing (or allowed) to offer other central banks in a massive run? In a severe crisis, could even the ECB, let alone the governments, act effectively?
We get scared just thinking about it.
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