CNNMoney.com’s
‘Depression Comparisons Misguided’ Shows It’s Imminent
By Paul Lamont
May 30, 2008
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.
“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 it was 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.
At
Lamont Trading Advisors, we provide wealth preservation strategies for our
clients. For more information, visit our
website or contact us.
Our monthly Investment
Analysis Report requires a subscription fee of $40 a month. Current
subscribers are allowed to freely distribute this report with proper
attribution.
***No
graph, chart, formula or other device offered can in and of itself be used to
make trading decisions. This newsletter should not be construed as
personal investment advice. For informational purposes only.
Copyright ©2008 Lamont Trading Advisors, Inc. Paul J. Lamont
is President of Lamont Trading Advisors, Inc., a registered investment advisor
in the State of Alabama. Persons in states outside of Alabama should be aware
that we are relying on de minimis contact rules within their respective home
state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure
form ADV, please email us at advrequest@ltadvisors.net, or call (256) 850-4161.