CNNMoney’s ‘Depression Comparisons Misguided’ Shows It’s Imminent 16 comments
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After reading CNNMoney.com Editor Paul La Monica’s piece on the comparisons to the Great Depression, we felt compelled to respond. Unfortunately for Mr. La Monica, the article regurgitates common beliefs about the Depression which conflict with historical fact and basic economics. We hope to set things straight. We begin with Mr. La Monica’s words:
The unemployment rate skyrocketed during the Depression, peaking at nearly 25% in 1933. The current unemployment rate is just 5%. And that's only up from 4.5% a year ago. Contrast that with the far more explosive spike at the beginning of the Great Depression - from about 3% in 1929 to nearly 8.7% in 1930, according to the U.S. Bureau of the Census.
These numbers are accurate. However Mr. La Monica’s use of a lagging indicator for his strongest point is telling. The economy won’t experience the highest unemployment numbers until it hits bottom. At that point, his commentary would be too late to be of any use.
Another hallmark of the Depression was deflation, which is obviously not happening today. Wages are rising - albeit by less than many would like.
Once again we agree. Deflation was the hallmark of the Depression. But deflation is evident by the fall in the general price level, not just wages. Today a larger, more widely held asset class is falling in value than coincided with the beginning of the Great Depression. Does that mean it could be worse? The rise in wages is not good news either. According to Murray Rothbard, real wages were increasing into 1931, “thereby greatly aggravating the unemployment problem as time went on.” Perhaps this could cause the ‘explosive spike’ in unemployment that Mr. La Monica first cites. He continues with a description of how different it is today:
The main fear is inflation in the cost of food and oil. And there's reason to believe that inflation pressures may eventually ease since there is a bit of a speculative bubble going on in commodities. Plus, if the Federal Reserve can stabilize the dollar, that could cool off the recent run-up in gas and food costs.
Inflation fears were the main concern during 1930-1933 as well. It was given by investors as the ‘excuse’ for the U.S. corporate bond sell-off. Simultaneously, the CPI was falling. A speculative commodity bust (see chart below) and a rising U.S. dollar would also fit with the onset of the Great Depression. Mr. La Monica’s analysis of today’s environment could have been given in 1930.
click to enlarge images
Finally, there's the issue of the stock market. I've taken a lot of flack for mentioning the bounceback in stocks since many readers seem to think that what happens on Wall Street does not affect Main Street.
This is where similarities are even more exact.
As you can see from the chart above, after the initial Crash of 1929, the DJIA bottomed out in November. Its ‘bounceback’ lasted until April of 1930, (a typical .618 retracement, check your S&P500 chart of the recent rally, yes same .618 rebound) at which time itwas generally accepted that the ‘worst was over.’
Even Hoover remarked in a speech on December 5th that the worst was behind them (according to Murray Rothbard, America’s Great Depression). What occurred next is related to us by Fredrick Lewis Allen in Only Yesterday:
During the first three months of 1930 a Little Bull Market gave a very plausible imitation of the Big Bull Market. Trading became as heavy as in the golden summer of 1929, and the prices of the leading stocks actually regained more than half the ground they had lost during the debacle. For a time it seemed as if perhaps the hopeful prophets at Washington were right and prosperity was coming once more and it would be well to get in on the ground floor and make up those dismal losses of 1929. But in April this brief illusion began to sicken and die. Business reaction had set in again. By the end of the sixty-day period set for recovery by the President and his Secretary of Commerce, commodity prices were going down, production indices were going down, the stock market was taking a series of painful tumbles, and hope deferred was making the American heartsick.
This ‘third leg of the bear market’ (1930 to 1933) was characterized by the failure of the banking system to provide credit and money for the proper functioning of the economy. With bank failures currently looming, ignore history at our own peril.
Mr. La Monica continues:
Keep in mind that the Depression was kicked into gear, if not necessarily caused, by the stock market crash of October 1929… The Depression was a product of a one-time shock that took years to recover from.
Today’s credit markets have not recovered from this ‘one-time shock’ either. The main crash has already occurred in the value of real estate loans held by financial institutions. Writedowns have already totaled $380B. However rating agencies and financial guarantors have allowed bankers to prevent realization of most of the losses and subsequent forced increases in reserves. As Warren Buffet recently stated, “You've got a lot of leeway in running a bank to not tell the truth for quite a while.” According to Homer Hoyt in One Hundred Years of Land Values in Chicago; “Real-estate loans, not failed stockbrokers’ accounts, were the largest single element in the failure of 4,800 banks in the years from 1930 to 1933.” As Mr. La Monica goes onto say:
The massive plunge in the value of an asset, in this case stocks, sent the economy spiraling into its most severe downturn in history.
Replace ‘stocks’ with ‘real estate’. Mr. La Monica then cites Chris Probyn, chief economist of Global State Street Advisors, for the reason ‘why today is different.’
'But the Fed has cut interest rates. Congress has responded aggressively with a fiscal stimulus package,’ Probyn added.’ One of the problems in the Great Depression was that there was no fiscal policy employed preemptively to stop it.’
This is easily dismissed, because it is factually incorrect. According to Murray Rothbard, before October 1929, the rediscount rate was at 6%. It was lowered to 4% in November 1929, 2% by December 1930, and finally 1.5% in mid-1931. At the same time, President Hoover “increased expenditures by $130 million of which $50 million was new construction.” State and local governments increased expenditures by $700M. The Hoover Dam began construction in 1931. Despite (relatively) greater fiscal stimulus as well as drastic rate cuts, the fractional reserve banking system collapsed in 4 years. Why? Bankers were unable or unwilling to lend, either because of continued losses on real estate loans or because of a run on deposits. The unavailability of credit and money caused the deflationary spiral of the Great Depression.
Nothing New Under The Sun
Currently, the Federal Reserve is providing banks access to half of its balance sheet as the lender of last resort. This is to keep the banking system lending. However further mortgage downgrades, financial guarantor failures or the complete use of the Federal Reserve balance sheet could force banks into crises similar to that of 1930-33.
We don’t like the similarities either. But we also can’t ignore them. Mr. La Monica’s article represents the current widespread belief that is so commonly wrong at major market turning points.
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This article has 16 comments:
One item to take into account is the value of the dollar from 1930 to 1933. In nominal terms, did the value increase or decrease vis a vis other currencies? This is important, whereas in 1930 foreign investors were not a stabilizing factor.
As stated, the net result was deflation during the great depression. Currently we are experiencing inflation that eventually will spill over to real estate thus stemming the housing deflation. The downside to real estate is limited to the point where housing once again becomes affordable for first time buyers. Historically this is about 3.5 times gross medium average wage.
Accordingly, there is about 10% downside left (depending on region). Once we get there, inventory and defaults should start decreasing. Then you can mark the bottom in housing.
As for equities, it is a whole different ball game. If stocks get too cheap, there are plenty of buyers with plenty of cash to come snatch up good American companies. This is why the bottom hasn't fallen out, excluding the banking sector. Even there, there is a bottom; problem being is that no one has clear visibility as to what triggers a bottom, unlike housing.
In summary: For housing, first time buyers coming back into the market solidifies a bottom. For equities (excluding banks), massive foreign inflows set the bottom. For banks and financials, we won't see massive foreign buying because they, like us, haven't a clue what the true long term value is.
It could take years for the banking sector to stabilize. If anything, bank equities will likely experience wild swings in both directions for the next few years. Housing will stabilize long before the banks get their act together.
Saul Sterman
My Grandfather built and rented housed during the late 20's using one to finance another, and another, building a portfolio of properties.
The bank squeezed the lumber company who called in it's accounts. No one had credit and house prices were falling, no buyers were available. Loss of jobs meant rent was almost impossible to collect.
In the end the bank foreclosed on everyone..... My Grandfather ended up penniless trying to start over like everyone else. The bank survived.... but the lumber company was gone as were the carpenters, bricklayers and landlords.
So, the banks create money from thin-air, lend it out, and then end up with the collateral after the bust comes from the boom they created.
This racket has been going on since at least 1694 when the Bank of England was established.
Any wonder we end up with more socialism?
Another difference today: we don't have bank runs any longer. It remains to be seen how the FDIC deals with the total collapse of several large deposit-taking institutions, but I do not expect to see people lined up to get their money. One would expect this to have a moderating effect on credit availability, especially with the printing presses going.
A final problem with your comparison is that the government calculated statistics very differently in 1930 than it does today. It's not so easy to compare them. This is especially true of price indices and everything dependent on them, but applies to unemployment as well.
The real reason to be afraid isn't that credit will be needed by corporations but not available to them. There will be plenty of foreign lenders ready to lend (though not in dollars) to sound non-banking corporations with strong balance sheets and sane strategies - another thing we didn't really have in 1930. No, I'm fearful that credit will remain available to individuals with no savings and companies with no equity, exacerbating the problem and perhaps drawing the rest of the world into our disaster.
I do not say that you are wrong to conclude that we are in dire straits right now. But neither am I convinced that there are no differences, that the data can be compared as you have, or that the Fed will bother to keep rates above zero if it perceives continued lack of credit availability. Whether ZIRP will do any good is another matter.
Inflation drives up the cost of credit.
Get out your handy HP12C (anyone who is active in the financial markets should have one) and tell me how much purchasing power you lose if a 30 year mortgage loan goes from 6% to 8%. Use a "maximum affordable P&I" of $2,000/month.
Oh hell, I'll do it for you.
At 6% you can take out a loan for $335,251.
At 8% you can take out a loan for $274,384.
This is a real devaluation of purchasing power of about 22%, and that was with only a rise to 8% on the 30 year fixed.
If it goes to 10%.....
You can't inflate out of this when purchasing power is defined by the cost of long money.
Deflation is occuring in wages, housing, and in the stock market, with the exception of commodities. I agree that there is inflation in fungible financial assets (foodstuffs, energy, most precious metals, etc.), as well as items of inelastic demand (ie health care and transportation) but the only reason is from deficit spending causing a false inflation of the money supply. At some point, the Fed lending window will dry up in the face of massive losses in liquidity and that will lead to a period of general deflation as lending starts to completely dry up.
One thing that will also drive deflation will be that asset classes that are highly fungible with money have an elastic demand. Cutbacks in energy use, food costs, and luxuries will contribute to a recession and increased unemployment. Divestment of dollar-valued assets and investments by foreign entities will also result in a contraction of the money supply.
These are longer term scenarios. So to summarize, we will see inflation for a period of at most 1 to 2 years as various markets correct, then a prolonged "Japanese-style" deflation as jobs and tax revenues become scare, decreasing the pressure on wage inflation necessary to feed long term inflation.
Short Ag; short oil, long Wal Mart and Costco? and what does that expected return look like in such a period - 3-5%? Or just sit in cash?
The intersection we recently passed was between allowing a necessary deflation to happen or threaten an ugly bout of elevated, perhaps hyper inflation. In a rare moment of lucidity, the Feds seem willing to let the dollar's value stay above the price of the paper it's printed on. But their spine is oh so pliable.
Look around to see how many things you can't combust or digest are going up. The oil game is just a sideshow to whip up a few bucks while there are enough weak hands still in the game.
Massive foreign inflows are the bell that rings at stock market tops, not bottoms. To illustrate, foreign Net Private Equity purchases reached a peak at $28B in February 2000. That peak was surpassed in May 2007 when foreign Net Private Equity purchases clocked in at $43B.
If you want to look for a bottom in the stock market, look for persistent foreign selling. Foreigners are no more immune to greed and fear than domestic investors.
See below link for TICC data.
www.treas.gov/tic/ticp...
It is a amazing the damage that central banking and government interference can do to an economy. Its like tag team wrestling; the government backed banking cartel damages the economy and then the government comes along to "fix" it.