The lessons of recent economic history

NEW YORK -- Last week started with economic flashbacks to the 1930s, with the federal seizure of California-based IndyMac bank swelling the lines of depositors desperate to get their money out.

But midweek brought visions of another decade, as wholesale inflation made its biggest jump in 27 years, stoking new fears that 1970s-style "stagflation" could return like some bell-bottomed bad dream.

What decade is it, anyway? And how much substance, if any, is there to these fears of unhappy times being here again?

"Fear" is just the right word with which to open a discussion of the run on IndyMac, the savings bank and mortgage lender hit hard by the credit and foreclosure crises. When depositors began lining up at the beginning of this month, the Los Angeles Times ran a story headlined "IndyMac Denies That It's Close to Collapse." Well, so much for official denials -- but the reactions of two IndyMac depositors interviewed for the Times' story were telling.

One, a woman who had $200,000 in the bank, said, "The only reason I'm panicking is if anything happens, my money is tied up." Another, a man who had $1,000 on deposit, said, "I don't know what happens when a bank fails; I don't trust the economy right now."

Fear feeds on views like that of the second depositor. The reason that we aren't likely to see anything close to a 1930s-style bank meltdown is the fact that bank deposits in this country are now insured up to $100,000. Whether he trusts the economy or not, a person with $1,000 in his account has nothing to fear but fear itself.

The first depositor, however, had reason to be concerned, as her $200,000 exceeded the Federal Deposit Insurance Corp.'s insurance limit. If all her money was in a single account, she could have ended up with just 50 cents on the dollar for any amount over $100,000, had she waited until the bank was seized by the FDIC.

In uncertain times, it pays to be sure about the rules, especially when nest eggs built up over a life of work are involved. But IndyMac to the contrary, the regulations that followed in the wake of the 1930s should well insulate us from any replay of that era.

The comparison of the current economy with the 1970s is another matter. There are indeed signs that the stagflation that marked that time -- a combination of stalled growth and rampant inflation -- may be making a most unwelcome return. The spikes this week in wholesale and retail prices pile on to an economic situation that already includes slow growth, rising unemployment and tight credit.

It's important to know and note that inflation, no matter what measure used, has yet to reach the nearly 14 percent peak from the worst days of stagflation. But the Federal Reserve does now find itself hooked on the horns of a dilemma: Cutting interest rates might help stave off or shorten an impending recession; it would also run the risk of sending inflation yet higher.

The economy is being buffeted by gales from all sides right now -- a banking crisis, weak growth, job losses, sky-high commodities prices (even with this week's drop in oil prices) and widespread inflation. It's not a pretty picture, and it's bound to play a major and perhaps decisive role in the coming election.

Short-term fixes will be offered from all sides, but it's worth considering that real solutions -- such as the Fed's dramatic raising of interest rates in 1980, which vanquished inflation but led to recession -- are often neither popular nor painless. In the meantime, we might all do well to remember what the economic history of the past century has taught us -- that fear and panic can become self-fulfilling prophecies.