Great Depression, Ominous Political Headwinds and the S&P 500

by: Rakesh Saxena

Contrary to what numerous Middle East analysts are concluding, the crisis in the Gulf economies is not all about oil and gas. “Hundred of trading companies domiciled in Dubai, Abu Dhabi and Muscat are in danger of closing down since the legal and semi-legal trade with Iran has come to a standstill,” the manager of a Gulf-based consumer-goods exporter told a conference of investors in the emirate of Sharjah last weekend. “Demand for food, utility and luxury items in Iran has plummeted by 80% in 2008, and many products have simply been banned by officials manning Iranian ports.”

The global recession is buffeting a range of political headwinds, which will translate into protectionism, and anti-free-market legislation and subsidies, in the months ahead. But, when planning stimulus and rescue packages, are regulators, central bankers and Washington lawmakers incorporating the lessons of the early-1930s into their calculations? Scholars, led by Fed Chairman Ben Bernanke, are drawing on the lessons of the Great Depression to make their case for aggressive monetary and economic intervention. But have they accounted for the fact that the collapse of asset valuations and debt-related agreements may have caused the Second World War in the first place?

Without the Great Depression, it is difficult to visualize the sharp rise in the popularity of the Nazi Party. In May 1928, the Nazis held a mere 12 seats (2.5%) in the Reichstag; by March 1933, shortly before Adolf Hitler tore up the elite Weimar Constitution, that number had risen to 288, or 44% of the German parliament. The German Left, which controlled 41% of the Reichstag in September 1930, was totally wiped up by 1934 as industrial workers and unemployed Germans were convinced by the economic policies of the Nazi Party in ever-increasing numbers.

Arguably, the global map today is different, and a third world war is not on the cards by any means. But it is important to grasp the fact that the shape of the global economy in the years following 1929 fundamentally altered the process of capital accumulation (into a version of state capitalism) in Germany, a process which culminated in the frontal assault on Jewish properties on the night of November 9, 1938 (Kristallnacht, or the Night of Broken Glass).

It is the potential changes in the treatment of domestic and foreign capital in the developing world which will exert a powerful impact on equity markets (DIA, QQQQ, SPY) through 2010. Legislation and other measures cementing such changes will inevitably result in periodic market sell-offs, since certain guiding premises driving the $8 trillion-plus government intervention will stand substantively damaged.

Besides Iran, there are other highlight examples which traders need to post on their radar screens. Worsening economic conditions in Latin America, which are resulting in the expansion of socialist concepts, are already a real threat to American assets in Venezuela, Bolivia, Nicaragua and Ecuador. Pakistan’s failure to improve the plight of its citizens (with respect to food prices, health care and civic services) threatens the entire region (particularly India) with more disruptive terrorism, even near-war conditions at some point this year. And, as domestic economies deteriorate, we will witness the further consolidation of state capitalism in Russia and China; what this consolidation means for western capital is still an open question.

This is not the forum to dwell on the political consequences of the dire economic outlook for 2009. What should concern us is the manner in which forthcoming political events in the emerging markets will affect (a) assets and earnings of those constituents of the S&P500 who are exposed internationally and (b) the viability of the Obama Stimulus Plan. Both factors must influence domestic equity prices.

Because, as far as monetary actions and financial rescues are concerned, there is one primary distinction between the Great Depression-era and today: the global economy is much more intertwined and much more complex now than it was in 1929. History is indeed repeating itself, but not in like manner. Students of the Great Depression need to be aware of that fact.

Disclosure: Author holds short positions in QQQQ and SPY