Are We More Like 1932 - or 1923? 29 comments
Martin Hutchinson
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Endless reports in the media have pointed out that this global recession is “worse than anything since the Great Depression.”
To be fair, it’s not even certain yet that this nasty downturn has beaten the mid-1970s downturn, though it probably will. But even if that does happen, by focusing exclusively on the 25% unemployment of the 1930s and the “Grapes of Wrath” Joad family as our inevitable future, we’re ignoring another equally unpleasant potential scenario: The Weimar German hyperinflation of 1923.
The U.S. authorities and those of the G-20 are currently avoiding most of the mistakes that during the period from 1930 to 1932 turned an ordinary recession into the Great Depression. In those years, the U.S. Federal Reserve deflated the money supply by about 30% in real terms. Central bank officials didn’t realize they were doing this; banks kept failing, thus reducing the country’s bank deposits, while the Fed did nothing to offset the money supply shrinkage the bank failures produced.
U.S. President Herbert Hoover raised tariffs via the Smoot-Hawley Tariff Act of 1930, causing world trade to fall by 65%; his huge income tax increase (with the top rate going from 25% to 63%) in 1932 also contributed greatly to the global economic meltdown. All three mistakes have been avoided this time:
- The money supply has expanded rapidly, bringing negative real interest rates almost everywhere except Brazil.
- And fiscal policies have been expansionary and protectionism limited.
The history of the Weimar German inflation was quite different. During World War I, Germany ran moderate inflation, which accelerated in the last year of war and the first years of peace. By 1921, prices in Germany were already 15 times those of 1914.
But it was over the next two years - 1921 to 1923 - that true “Weimar inflation” occurred. By the time it ended in November 1923, the German mark was worth only one-trillionth of what it had been worth back in 1914. The middle classes lost all their savings, but one rich industrialist, Hugo Stinnes, was able through repeated borrowing in rapidly depleting marks to amass an industrial empire that controlled 20% of Germany’s industry.
The German hyperinflation was finally quelled by Chancellor Gustav Stresemann and Reichsbank director Hjalmar Schacht, who in October 1923 announced the replacement of the paper mark by a “Rentenmark” (security mark) worth 1 trillion paper marks and backed by a nominal mortgage over German land assets worth 3.2 billion Rentenmarks.
The mortgage was fictitious, but it created confidence in the Rentenmark and prevented the creation of extra Rentenmarks, so inflation rapidly ceased, while the budget was balanced through so-called “windfall-gains taxes” on debtors whose debts had been extinguished by the previous hyperinflation. Normal business was resumed by Germany, which was able to return to a new gold Reichsmark in July 1924.
You can debate which was worse, the U.S. Great Depression or the Weimar hyperinflation; there are arguments for both sides. The Great Depression lasted much longer, from 1929 until the United States entered World War II in 1941. On the other hand, the Weimar hyperinflation wiped out the entire savings of the German middle class.
The lack of confidence in the economy, and the overall misery that this produced, meant that the German reaction to the Great Depression that arrived six years later was much more extreme than in the United States - leading to the election in 1933 of Adolf Hitler.
The current policy mix reflects those of Germany during the period between 1919 and 1923. The Weimar government was unwilling to raise taxes to fund post-war reconstruction and war-reparations payments, and so it ran large budget deficits. It kept interest rates far below inflation, expanding money supply rapidly and raising 50% of government spending through seigniorage (printing money and living off the profits from issuing it).
Even John Maynard Keynes, no monetarist, recognized the problems with this, stating in his 1920 treatise the “Economic Consequences of the Peace” that “the inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”
The really chilling parallel is that the United States, Britain and Japan have now taken to funding their budget deficits through seigniorage. In the United States, the Fed is buying $300 billion worth of U.S. Treasury bonds (T-bonds) over a six-month period, a rate of $600 billion per annum, 15% of federal spending of $4 trillion. In Britain, the Bank of England (BOE) is buying 75 billion pounds of gilts over three months. That’s 300 billion pounds per annum, 65% of British government spending of 454 billion pounds. Thus, while the United States is approaching Weimar German policy (50% of spending) quite rapidly, Britain has already overtaken it!
U.S. authorities probably won’t pursue expansionary monetary policies with quite the dogged Germanic persistence that caused the mark to fall to one trillionth of its former value. However, the turnaround needed to stop a Weimar repetition will be very unpleasant, so there will undoubtedly be considerable denial and fudging of the figures as inflation begins to take off (especially if Ben S. “Drop Money From Helicopters” Bernanke is still serving as the head of the U.S. central bank).
As investors, we need to ensure that our money is safe from the inflationist onslaught. Our portfolio should thus currently contain no bonds - even Treasury Inflation Protected Securities (TIPS) are linked to the U.S. consumer price index (CPI), which has been fiddled before and will be again, so will not provide true inflation protection.
Only gold will play its traditional role as a protector of savings against inflationary onslaught. Once policymakers get serious, gold prices will drop, as inflation risks recede. But before that gold prices are likely to shoot much higher, perhaps beyond their 1980 peak of $2,300 in today’s dollars. You have to remember that gold is a thin market, with only $100 billion mined annually, so a surge of hedge funds into the gold market could move the price very quickly indeed.
Two avenues into gold should be attractive, the SPDR Gold Shares ETF (GLD) which invests in gold directly and the more financially solid gold mining companies, such as Barrick Gold Corp. (ABX) and Yamana Gold Inc. (AUY). Since gold has fallen back recently to below $900 an ounce, it may be a good time to buy.
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This article has 29 comments:
I'm so glad you brought up 1923, because this reminds me more of that period than anything else. I also think there are a few parallels to be drawn to the mid-70s recession, but 1923 is more spot-on. Of course, I don't think we'll experience Weimar-like hyperinflation. Instead, we'll get double-digit inflation and it's possible that the Feds do exactly what they did in the 1980s to stamp out high inflation. In which case, there is a lot more pain to come.
I understand the long case for gold, but I like other hard assets better right now. Gold has already had a good run-up and I think there's less of a margin for error if inflation does not hit as hard as we might like to think. Silver, palladium, and platinum look better to me because they should go up if inflation does hit, but they are also undervalued right now regardless, so even if it doesn't hit - I think they still go up. I know some people find this crazy, but I also like some of the stronger REITs out there. Prices have been battered enough so that most of the downside has been factored in for the survivors; the tricky part is figuring out who the survivors will be.
USD still too strong to allow inflation. Palladium might approach parity with platinum, $2,500 cars will not use Platinum.
Honeycutt: glad you have an open mind and are not fighting last year's battle. You are absolutely right.
What do you think of Cobalt plays?
The folks who doubt this are the same ones who thought real estate could not lose.
On Apr 09 10:37 PM Bill S. Friend wrote:
> Laugh Out Loud indeed. The paralells are certainly there including
> a huge expenditure on a war on two fronts. Unemployment is still
> rising and a social unrest is brooding as Wall Street raids the nations
> coffers. The government continues to fudge the numbers and Bernake
> cannot answer the questions while looking you in the eye. History
> is all we have to draw comparison, and we would be foolish not to
> learn from our mistakes.
- at this point in the Great Recession, world trade has fallen over 35% (japan is down 60%). if we remove oil from this number (as it was insignificant in 1930) - world trade is already off 65%. in a perfect world there should be no duties - but our world is imperfect with huge differences in labor costs and currency values.
- movements of investments needed to be timed. the dollar will not crash in the next week. going to an investment too early will cause painful losses in the interim. bonds are a good investment for now if you purchase them inside an etf (such as TIP). exactly because of what Martin is suggesting will happen, you do not want to own bonds directly where you cannot get out of them in a key stroke.
- echoing what RW Richmond says - it is better your gold is physical. it does you little good in a vault in london during a black swan event.
On Apr 09 05:50 PM Conan the Barbarian wrote:
> USD still too strong to allow inflation. Palladium might approach
> parity with platinum, $2,500 cars will not use Platinum.
Everything makes perfect sense until you make this comment.
Yes, Gold may well hold a role but inflation will be reflected in tumbling exchange rates.
Assets and currencies of others outside the dollar system will be largely immune to the effect of dollar inflation, particularly as its role as a reserve currency would evaporate overnight. Investments in economies such a Russia and China that will be largely immune to the dollar crash may well provide a better haven than Gold.
Also most of the demand for Gold will be in the US. It may well be that others are prepared to sell some by then. Of course the US Government and large US Corporations may have to resort to using Gold as currency, and that really would have an impact. I would think it will pretty soon be made illegal for anyone else to hold the stuff.
On Apr 10 03:47 AM Steven Hansen wrote:
> the dollar will not crash in the next week. >
My doubt is whether he still does?
Are you sure it is not just a cardboard cut-out?
On Apr 09 11:22 PM Conan the Barbarian wrote:
> High Inflation, probably. Volcker will be brought back into the limelight
> to soothe the savage inflationary heart. Probably by the end of the
> year.
With wage earners not having a raise in buying power since 1973, is it any wonder that most can't afford to own a home and pay their mortgage? The wealthy controlled about 20% of wealth in the early 70s and now control 35%
Corporate taxes as percent of GDP is 2% now, as opposed to 3% in the early 70s and 4%-5% in the 50s and 60s. The mean net worth of the top 20% is up 75% since the early 80s, while real wages are down 12% since 1978.
Workers have compensated by going into debt and having two earners per household to make do on what one earner could manage with in the 50 and 60s. The two earner household has higher cost of living, canceling out some of the benefits of having mom and dad work. Now you need two cars, childcare, etc., so both can work, and most are still in debt.
Comparisons of the 20s or 30s with today are probably not completely accurate.
Did you read Alan Greenspan's book, The Age of Turbulence? Two points: first, Mr. Greenspan has a pretty high opinion of himself. Second: What was the worst crisis he faced during his regime? Not the crash of 1987. Not the Asian Currency collapse. Not the collapse of Long Term Capital Management. No: the crisis that threw the Fed into a tizzy was when Congress voted to index Social Security to inflation. Greenspan and his crew knew this entitlement was unaffordable so they did the only thing they could do: the redefined the way inflation was measured so as to understate what it really is! They moved the goal posts and thus are cheating our seniors to penury! It's all there in the book! This writer owns some GLD and some AUY but is mostly in energy. This writer's investment income is primarily denominated in currencies other than the US dollar.
Funny, I've been holding a few percent of my portfolio in GLD for over 6 mos. now, and it's done essentially nothing. Has it protected the value of my money? Yeah, I guess...but it hasn't GROWN it. Oddly enough, those shares of BAC and WFC that I bought in early March have performed MUCH better.
I keep reading posts here suggesting that gold is worth >$2000 ("in today's dollars")...yet it's trading right now for about $860. Go figure.
Your insurance policy does nothing either..... Until fire strikes. The sad thing is, that if it does, your paper GLD policy may go up in smoke as well.
Policy makers have read and re-read the histories of earlier monetary crashes and inflations and have made a determined decision. That is, risks from higher inflation carry far less evil than a depression.
Depressions bring social unrest, violence and war. Inflation just impoverishes the elderly, the poor and the the improvident and can be brought under control, as Volcker showed, by monetary shock.
Why hold physical gold and silver? If history is any guide the political class will get it wrong, they always do. At the least, gold will appeciate, at the worst it may well make an unbearable situation bearable.
I'm afraid that stagflation might be the best thing we can hope for. If the Fed times everything just right we might get it. Otherwise I can completely see the Fed pressing down on the gas too long only to realize they are about to run the car off the road when its too late to stop. I see the Fed printing and printing until the velocity of money begins to normalize. The problem is with all the fear mongering the press loves to do (this bad economy story will never die.....Obama should have been careful what he wished for.....and he clearly wished it) people are going to increase their savings rate and the unemployed will greatly reduce their spending. The Fed will continue to print money far to long. When good times begin to emerge their will be far too many dollars in circulation. Foreign held dollars may also start to find their way back into this country. The Fed can try to buy back all those dollars but with what???? Will all those toxic securities be worth anything? And we know the federal government isn't going to be paying down the national debt anytime soon. So once things take off I think they will really take off. Then the medicare and social security crisis will happen and tax rates will go way up slamming the breaks on the economy. The point is that I think the Fed has lost its ability to control the money supply and the economy via money supply control because they really won't have the options. Medicare and social security will require more money be printed.
My advice is to save up about a year or two worth of money so you can survive unemployment with reasonable security. After that spend you money on assets of any kind that will hold their value. Over the next ten years buy real estate, precious metals, and anything else you think you will really need (lawn mower, new fridge, new stove....whatever) Spend it because prices must go up.
If you like gold, buy physical gold. Coins are imho better than bars.
Deep
On Apr 11 03:01 AM johngonole wrote:
> Allan,
>
> I'm afraid that stagflation might be the best thing we can hope for.
> If the Fed times everything just right we might get it. Otherwise
> I can completely see the Fed pressing down on the gas too long only
> to realize they are about to run the car off the road when its too
> late to stop. I see the Fed printing and printing until the velocity
> of money begins to normalize. The problem is with all the fear mongering
> the press loves to do (this bad economy story will never die.....Obama
> should have been careful what he wished for.....and he clearly wished
> it) people are going to increase their savings rate and the unemployed
> will greatly reduce their spending. The Fed will continue to print
> money far to long. When good times begin to emerge their will be
> far too many dollars in circulation. Foreign held dollars may also
> start to find their way back into this country. The Fed can try
> to buy back all those dollars but with what???? Will all those toxic
> securities be worth anything? And we know the federal government
> isn't going to be paying down the national debt anytime soon. So
> once things take off I think they will really take off. Then the
> medicare and social security crisis will happen and tax rates will
> go way up slamming the breaks on the economy. The point is that
> I think the Fed has lost its ability to control the money supply
> and the economy via money supply control because they really won't
> have the options. Medicare and social security will require more
> money be printed.
>
> My advice is to save up about a year or two worth of money so you
> can survive unemployment with reasonable security. After that spend
> you money on assets of any kind that will hold their value. Over
> the next ten years buy real estate, precious metals, and anything
> else you think you will really need (lawn mower, new fridge, new
> stove....whatever) Spend it because prices must go up.
Do it on an ongoing basis.
A month maybe, 2 years of devaluation, I think not.
On Apr 09 11:22 PM Conan the Barbarian wrote:
> High Inflation, probably. Volcker will be brought back into the limelight
> to soothe the savage inflationary heart. Probably by the end of the
> year.
Plus only owe 160,000 on my house. What can i say ,,,,i'm a miser :)
On Apr 11 03:01 AM johngonole wrote:
> Allan,
>
> I'm afraid that stagflation might be the best thing we can hope for.
> If the Fed times everything just right we might get it. Otherwise
> I can completely see the Fed pressing down on the gas too long only
> to realize they are about to run the car off the road when its too
> late to stop. I see the Fed printing and printing until the velocity
> of money begins to normalize. The problem is with all the fear mongering
> the press loves to do (this bad economy story will never die.....Obama
> should have been careful what he wished for.....and he clearly wished
> it) people are going to increase their savings rate and the unemployed
> will greatly reduce their spending. The Fed will continue to print
> money far to long. When good times begin to emerge their will be
> far too many dollars in circulation. Foreign held dollars may also
> start to find their way back into this country. The Fed can try
> to buy back all those dollars but with what???? Will all those toxic
> securities be worth anything? And we know the federal government
> isn't going to be paying down the national debt anytime soon. So
> once things take off I think they will really take off. Then the
> medicare and social security crisis will happen and tax rates will
> go way up slamming the breaks on the economy. The point is that
> I think the Fed has lost its ability to control the money supply
> and the economy via money supply control because they really won't
> have the options. Medicare and social security will require more
> money be printed.
>
> My advice is to save up about a year or two worth of money so you
> can survive unemployment with reasonable security. After that spend
> you money on assets of any kind that will hold their value. Over
> the next ten years buy real estate, precious metals, and anything
> else you think you will really need (lawn mower, new fridge, new
> stove....whatever) Spend it because prices must go up.