I say “potentially” because Ben Bernanke and his colleagues at the Federal Reserve have been striving manfully to avert such a monetary meltdown. Indeed, you could have predicted nearly every move the Fed has made over the past year, simply by assuming that it would do the opposite of what the Fed did during the Great Depression. It has done everything to prevent large-scale banking failure from taking the economy down. It has pumped liquidity into the financial system by cutting rates and targeting funds. It has risked its own credibility in doing so. It has arguably overstepped its statutory powers. It has been a wonderful exercise in the application of historical knowledge – just what one would have expected from a Fed chairman who did the lion's share of his academic work on the Great Depression.

Yet it is not immediately clear that the Fed – or for that matter the European Central Bank, which has been equally open-handed – has the capability entirely to offset this contraction. Friedman and Schwartz assumed that if the Fed had only been more enlightened between 1929 and 1933, the Depression could somehow have been avoided, or at least mitigated. We are now testing their theory that a central bank, if it is sufficiently expansionary, can avert a full-scale banking crisis. The test is not yet over. If, as seems inevitable, there is a recession in the United States, there will be corporate defaults. And when these corporate defaults increase, we will find out just what credit default swaps really are. Are they a wonderful, flexible insurance policy? Have they allowed risk to be allocated optimally as never before? Perhaps. But that is what they used to say about collateralised debt obligations, the key financial instruments used to turn “toxic waste” mortgages into “investment-grade” securities.

During the Depression – notably in 1931 – the Fed tightened monetary policy to avoid a drain on its reserves following the devaluation of sterling. This time around, we can be confident that Bernanke will tighten only if there is a clear domestic inflationary threat. He has been – and seems certain to remain – more or less indifferent to the exchange rate of the dollar per se. That is one reason why one of the consequences of Fed policy has been a significant depreciation of the dollar in terms of other currencies around the world.

This has its benefits for the United States. Increased net exports are the principal reason why the most recent GDP growth statistics are still in positive territory. However, what makes the weakening of the dollar doubly significant is that it has coincided with a time of real tightness in nearly all commodity markets.