Friday, 12 September 2008

The Next Great Depression?

A great deal can be learnt through history. In a practical sense its completely useless, as it merely just documents past events, but past events can help explain current and possible future events. If you can never get to grips with a subject matter it is best to look at history to try and to identify possible similarities. I have taken some quotes from a historical book and I think a lot of the quotes below could be said of the current situation we find ourselves in.

"If the Federal Reserve had an inflationist attitude during the boom, it was just as ready to try to cure the depression by inflating further. It stepped in immediately to expand credit and bolster shaky financial positions. In an act unprecedented in its history, the Federal Reserve moved in during the week of the crash—the final week of October—and in that brief period added almost $300 million to the reserves of the nation’s banks. During that week, the Federal Reserve doubled its holdings of government securities, adding over $150 million to reserves, and it discounted about $200 million more for member banks. Instead of going through a healthy and rapid liquidation of unsound positions, the economy was fated to be continually bolstered by governmental measures that could only prolong its diseased state."

"The Federal Reserve also promptly and sharply lowered its rediscount rate, from 6 percent at the beginning of the crash to 4.5 percent by mid-November. Acceptance rates were also reduced considerably. This enormous expansion was generated to prevent liquidation on the stock market and to permit the New York City banks to take over the brokers’ loans that the “other,” non-bank, lenders were liquidating."

"Dr. Anderson records that, at the end of December, 1929, the leading Federal Reserve officials wanted to pursue a laissez-faire policy: “the disposition was to let the money market ‘sweat it out’ and reach monetary ease by the wholesome process of liquidation.” The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. Rediscount rates of the New York Fed fell from 4.5 percent in February to 2 percent by the end of the year."

"During 1930, the Federal Reserve had steadily lowered its rediscount rates: from 4.2 percent at the beginning of the year, to 2 percent at the end, and finally down to 1.2 percent in mid-1931."

"President Hoover was proud of his experiment in cheap money, and in his speech to the business conference on December 5, he hailed the nation’s good fortune in possessing the splendid Federal Reserve System, which had succeeded in saving shaky banks, had restored confidence, and had made capital more abundant by reducing interest rates. Hoover had done his part to spur the expansion by personally urging the banks to rediscount more extensively at the Federal Reserve Banks. Secretary Mellon issued one of his by now traditionally optimistic pronouncements that there was “plenty of credit available.” And William Green issued a series of optimistic statements, commending the Federal Reserve’s success in ending the depression. On November 22, Green said: All the factors which make for a quick and speedy industrial and economic recovery are present and evident. The Federal Reserve System is operating, serving as a barrier against financial demoralization. Within a few months industrial conditions will become normal, confidence and stabilization in industry and finance will be

"By early 1930, people were generally convinced that there was little to worry about. Hoover’s decisive actions on so many fronts—wages, construction, public works, farm supports, etc., indicated to the public that this time swift national planning would turn the tide quickly. Farm prices then seemed to be recovering, and unemployment had not yet reached catastrophic proportions, averaging less than 9 percent of the labor force in 1930."

"During the second half of 1930, production, prices, foreign trade, and employment continued to decline. On July 29, Hoover called for an investigation of bankruptcy laws in order to weaken them and prevent many bankruptcies—thus turning to the ancient device of attempting to revive confidence by injuring creditors and propping up unsound positions."

"As a consequence, while the immigration law had already reduced net immigration into the United States to about 200,000 per year, Hoover’s decree reduced net immigration to 35,000 in 1931, and in 1932 there was a net emigration of 77,000. In addition, Hoover’s Emergency Committee on Employment organized concerted propaganda to urge young people to return to school in the fall, and thus leave the labor market."

"He hailed the Federal Reserve System as the great instrument of promoting stability, and called for an “ample supply of credit at low rates of interest,” as well as public works, as the best methods of ending the depression."

"As 1931 drew to a close and another Congressional session drew near, the country and indeed the world were in the midst of an authentic crisis atmosphere—a crisis of policy and of ideology. The depression, so long in effect, was now rapidly growing worse, in America and throughout the world. The stage was set for the “Hoover New Deal” of 1932."

"During 1929, the Federal government had a huge surplus of $1.2 billion"

"From a modest surplus in 1930, the Federal government thus ran up a huge $2.2 billion deficit in 1931."

"One thing Hoover was not reticent about: launching a huge inflationist program. First, the administration cleared the path for the program by passing the Glass–Steagall Act in February, which (a) greatly broadened the assets eligible for rediscounts with the Fed, and (b) permitted the Federal Reserve to use government bonds as collateral for its notes, in addition to commercial paper"

"Thus, the Hoover administration pursued a giant inflationary policy from March through July 1932, raising controlled reserves by $1 billion through Fed purchase of government securities. If all other factors had remained constant, and banks fully loaned up, the money supply would have risen abruptly and wildly by over $10 billion during that period. Instead, and fortunately, the inflationary policy was reversed and turned into a rout. What defeated it? Foreigners who lost confidence in the dollar, partly as a result of the program, and drew out gold; American citizens who lost confidence in the banks and changed their deposits into Federal Reserve notes; and finally, bankers who refused to endanger themselves any further, and either used the increased resources to repay debt to the Federal Reserve or allowed them to pile up in the vaults. And so, fortunately, inflation by the government was turned into deflation by the policies of the public and the banks, and the money supply dropped by $3.5 billion."

Notice some parallels between the present and the period being described above? The things I find most striking are the fact the FED drastically cut rates from 6% to 1.2%, compared with today in which they cut from 5.25% to 2% at present. Also the fact that at the beginning of the bust the government were running huge budget surpluses, and within a couple of years were running huge deficits, compared with now where the US has persistently for years now been running up huge deficits which will get worse.

Of course the period being described was the Great Depression and the Quotes were taken from Murray Rothbards book, Americas Great Depression. Contrary to what people believe the great depression was not suddenly brought about after the infamous stock market crash in October 1929, it was brought about over a 3-4 year period of excessive monetary inflation in the previous years during the 1920's boom and increasing inflationary policies during the bust along with increased government interference, which made the Depression so great. In fact the stock market also rallied during this time and didn't bottom out till around 1933. Hoover was the creator of the New Deal, Roosevelt just merely carried on with it with even more enthusiasm contary to the myth that Hoover had a no hands approach to the economy. In the end this is where we now stand,

"But here, in the crisis of 1933, the banks could no longer continue as they were. Something had to be done. Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money."

We all know what happened in subsequent years. Nixon removed the US from the gold standard, and in effect all western currencies from gold as bretton woods was dissmantled. Now the dollar and world currencies are backed with nothing as we enter another dissasturous chapter in history of fiat currency.

If we wish to draw the parallels to today, roughly in 1928 real estate prices began to fall compared with 2006 in the US. 1929 and stock prices began to fall, compared with 2007 when the Dow was at its all time high. So what does that mean in the next few years if we are only at 1930. Well we have a lot further to go and the governments and Central Banks are doing exactly what history has taught us not to do.

However there are differences, which I believe position the US in a worse position. Back then the US had huge budget surpluses in previous years, exported goods throughout the world and had huge oil reserves (cheep energy reserves which can never be overstated). They also theoretically had the dollar backed by Gold which meant even though the FED tried to inflate they were constrained, where as now it is a complete fiat currency meaning there will be no limits to inflate this time. Ben Bernanke the current head of the FED is supposedly a student of the Great Depression but from what I've seen, he's repeating what was done 75 years ago, and he's doing a pretty good job of fooling everyone. Nationalising Fannie and Freddie Mac, that were created at the end of the Great Depression, is an absolute disaster as I have said before, and is exactly what President Hoover and the FED would have done during the last depression.

I will end on the following note from Murray Rothbard. Maybe we are facing another depression and crisis of the same magnitude? Or worse?

"What was the trouble? Economic theory demonstrates that only governmental inflation can generate a boom-and-bust cycle, and that the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown in this book how government intervention generated the unsound boom of the 1920s, and how Hoover’s new departure aggravated the Great Depression by massive measures of interference. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of “enlightened” economists. And in any other depression, past or future, the story will be the same."

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