REMEMBERING 1930
by Bill Bonner
dailyreckoning.com
"More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly."
Woody Allen
Why has this recession been such a dud? The figures from the manufacturing sector are impressive - the biggest drop since the Great Depression. But manufacturing was already being "hollowed out" in the U.S. as more and more industries moved production to foreign countries.
And the high tech sector has gotten smashed. But the absurdities in technology - the New Era, the productivity miracle, eyeballs, eliminating ignorance from the planet, preposterous valuations - were piled so high they had to fall over.
Yes, people have been laid off - but the unemployment rate, at 5.6%, is still very low.
But consumers and investors still act as though it were 1998. "In the past 12 months," say the managers of Hoisington Management Company of Austin, Texas, quoted in Grant's, "new home sales were 2.8% higher than a year ago. In the late stages of earlier recessions, they were down by an average of 23%. In the past calendar year, vehicle sales fell 2%, but late in prior consumer-led recessions they had dropped 15%."
We've never even visited Vienna, but along with the Austrian economists, we think recessions have a function. Like rainy days, they remind us to fix the roof. But, what is wrong with this one? The drizzle has been so light - in most areas of the country - that homeowners have scarcely had to get out a pot to catch the drips.
Typically, consumers lose jobs, or worry about losing them. Even in the mild downturn of 1992, unemployment reached 7.6%. But, so far, the worst this recession has been able to do is 5.6% - barely worse than what economists regard as full employment.
Consumers must be losing income...but you wouldn't know it. Thanks to the avarice of the home mortgage industry, they've been able to trade additional parts of their homes - bedrooms, dining rooms - for ready cash.
Business profits are down sharply. Balance sheets and earnings reports are ugly...but investors, as though they were talking to a man who had been in a bad car wreck, have tried not to notice. Stocks still sell for absurd prices. At 40 times earnings, the S&P is twice as expensive as most European markets.
How can you explain it, dear reader?
Consumers and investors are "brain damaged," says Marc Faber. Fair enough, as explanations go. But we are curious here at the Daily Reckoning headquarters. From whence cometh the brain damage, we asked ourselves.
No sooner was the question asked, then answered: "One theme [in recent U.S. economic history] is preponderant," writes our favorite Austrian economist, Dr. Kurt Richebacher, "consumer confidence and consumer spending."
Whereas European or "old school" economists saw economic growth as a consequence of capital investment and profits, American economists thought they saw an easier way to get rich. "For policy makers and economists in America, consumer spending is the most important GDP component..." he writes.
It became most important in the 1920s when William T. Foster and Waddill Catchings put forth the idea, in a series of books, that "the one thing that is needed above all others to sustain a forward movement of business is enough money in the hands of consumers."
"Contrary to prevailing opinion," Dr. Richebacher elaborates, "the boom of the 1920s was far more a consumption boom than an investment boom, the first of this kind in history. It centered on the rise of the automobile. The tripling of automobile productions was the single biggest force for economic growth in the boom, and it propelled similar growth in related industries, such as steel, rubber and highway construction.
"But by no means was it only new technology and the bull run of the stock market that stoked the auto boom. It was made possible through another watershed innovation that enabled millions of lower-and middle-class people to buy the car without having the money. This innovation happened in the financial sphere and was the invention of consumer installment credit. For the first time in history, consumers could spend large sums in excess of their current income..."
We cannot recall 1930 "just like it was yesterday." We cannot recall it at all. Still, the credit boom of the 1920's and the aftermath in 1930 are so similar to recent - and perhaps upcoming - events that it wouldn't hurt us to remember them.
Auto production peaked in April of '29. By the 4th quarter of that year, passenger car output declined by 70%. But big drops had happened before. Few people worried about it. Then, the market crashed in October. But that, too, had happened before. Why shouldn't prices rebound as they always did? Surely, this was a buying opportunity, thought many investors.
"The great shock to the prevailing complacency," Richebacher continues, "occurred more than a year after the stock market crash, in late 1930, when production continued to fall and serious troubles in the banking and the credit markets surfaced."
The serious troubles were the result of an unsustainable burst in credit and consumption. Installment had given consumers new purchasing power. But, it gave them no new wealth. Bills still had to be paid. As consumers loaded up automobiles and other items, industry expanded to meet the need. Investors saw the expansion, thought it would never end, and bid up prices accordingly.
Inevitably, consumers eventually ran out of credit and the money to pay their bills. They had to cut back. Businesses - which had borrowed heavily to increase production - were suddenly bad credit risks. And the banks, which had lent the money, were also in trouble - because they didn't have the money to cover all the loans that were going bad.
As loans went sour, Richebacher explains, "lenders, both banks and investors, virtually stopped lending, apparently fearful of the rapidly deteriorating credit quality."
Finally, the entire economy seized up. A quarter of the workforce was soon unemployed. And both consumers and investors had learned their lessons. The generation that lived through the '30s despised credit ever after and regarded stocks with distrust and contempt.
That generation has largely disappeared from American economic life. Another waits to take its place, brain- damaged.
Your correspondent,
Bill Bonner |
