1929 Revisited

Many people asked for a transcript of Contrarian Debate: Janszen vs Mish the discussion between Eric Janszen and myself on housing, a possible recession, and the terminal state of the asset bubble cycle: inflation or deflation.

Others wondered why the "&*%@$!" format was streaming audio instead of MP3. I can not answer that question but I will pass that thought along to the person recording and we will attempt to have a different format next time if at all possible. Finally others questioned calling what took place a "debate". Well it was never intended to be a debate in the classic sense but rather a discussion of ideas and topics that each of us agreed to talk about in advance. Indeed there was far more agreement than disagreement.

In the discussion each of us presented a "What year is it?" scenario. Eric Janszen chose 1999 as outlined in Is it 1999 again? Yes and no. I chose 1929. I think it is fair to say we both agree that history rhymes but does not repeat, and those looking for "fireworks" as opposed to a discussion of ideas may have been disappointed.

There is no transcript available but following are my views on the parallels between now and 1929 and why this is not a repeat of the 70's. Let's discuss the 70's first.

70’s Rerun

Similarities

1. War in Vietnam war then vs. the war in Iraq now
2. Rising oil and commodity prices

Differences

1. Rising Oil prices [demand side shock vs. supply side shock]
2. Spiraling wages then vs. declining wages now
3. Wage and price controls then
   
4. Consumer Debt levels – Significant ability to take on more debt in the 70's
   
5. Housing down payments – 20% then 0% now
   
6. Two family incomes now vs. one family income then
   
7. The power of unions - then
   
8. Globalization & Global wage arbitrage - now
   
9. Outsourcing - now
   
10. Productivity improvements - The internet and other innovations - now
    
11. Declining credit standards - now
    
12. Downfall of communism
    
13. Long term interest rates under 5% - now
    
14. New creative financing ideas running rampant - now
    
15. Massive use of derivatives - now
16. China, India, and Emerging Markets
    

The differences noted above are staggering and Eric agreed.

20's Rerun

1. Throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the “call rate,” that is, the interest rate on bank loans to the stock market, artificially low. – Margin rates were just lowered here and the FF rate which was lowered to 1% supported a big housing boom.
2. In the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. We now have the biggest housing bubble in history.
   
3. In the 1920’s there was a massive infusion of money (gold) from war torn Europe stimulating our economy. We currently have a massive stimulus of cheap money from Japan and China via and various carry trades and cheap credit supporting our economy.
4. In the 20’s we intervened in foreign exchange markets to enhance or stabilize Europe’s power to buy our exports. We currently are involved in disputes with China over currency issues attempting to get China to buy more of our goods.
5. There were massive productivity improvements in the 20’s along with the industrial revolution and assembly line processing. The 90’s – 2000’s productivity miracle was the internet. Huge boom periods on account of disruptive innovation. By contrast there was no such innovative disruptions in the 70’s.
6. In late 20’s credit was expanding at a rapid pace but there was no need for additional productive capacity. Today GDP is rapidly falling but credit is still rising. There is no pent up demand for homes, restaurants, retail stores, strip malls, autos, truck, etc, just as there was no need for additional assembly line production in 1929. Speculation replaced productive capacity just as it is today.
7. In 1929 leverage was extreme via stock margin. In 2006 credit derivatives leverage is extreme to the tune of 340 trillion dollars worth with no one really understand exactly what the counterparty risk is.
8. A few days before leaving office in March 1929, Coolidge called American prosperity “absolutely sound” and assured everyone that stocks were “cheap at current prices.” Based on the “Treasury Model” and unsustainable earnings growth due to financing activities, we are once again told time and time again that “the economy is sound” and stocks are cheap at current prices.
9. "Keynesian Folly", along with other massive government interventions managed to convert what would likely have been a short, sharp recession into a chronic, permanent, stagnation with an unprecedented high unemployment that only ended with World War II. Massive government interventions between 2002 and 2005 prevented a badly needed recession and instead created the biggest asset bubble in history.
10. In 1933 gold coins were confiscated – now we have a threat of nickels being confiscated.
11. At the time, the stock market of 1929 was the biggest asset bubbles in history. We have now vastly exceeded all previous credit bubbles.
12. The Smoot-Hawley Tariff was signed into law on June 17, 1930. There are renewed threats of tariffs in the U.S. Congress right now.
    

Oddly enough I found one more similarity just today. In More Cream for the Fat Cats I see that "Corporate profits are at their highest level since 1929."

The above 12 points were the similarities I mentioned in the discussion and Eric chimed in with an additional one: Buying goods on credit. Buying on credit first became widely practiced in the 20's. It was done to "make things affordable". Now nearly everything is made affordable by stretching payments to lengths that certainly never would have been allowed in the 70's but are commonplace today.

That is where we parted ways. While agreeing on the similarities Eric also cautioned there were parallels to 1937 and presented his "Ka-Poom Theory" which you can also see in Is it 1999 again? Yes and no. On the other hand I am sticking to a simple "It’s not different this time" approach and that all asset bubbles collapse in a deflationary credit bust. Previous credit busting deflationary collapses include Japan, the Great Depression, the railroad bust of the 1880's, the South Sea Trading Bubble, the John Law Mississippi Bubble, and the Tulip Mania Bubble.

In an Interview with Paul Kasriel we had the following discussion on how inflation starts and ends.

Mish: How does inflation start and end?
Kasriel: Inflation starts with expansion of money and credit.
Inflation ends when the central bank is no longer able or willing to extend credit and/or when consumers and businesses are no longer willing to borrow because further expansion and /or speculation no longer makes any economic sense.

It is pure speculation now (corporate buybacks, leveraged buyouts, collapsing volatilities) along with foreign central bank asset buying that is driving stocks higher. None of it is getting into the average guy's pocket and none of it has anything to do with the real economy. Meanwhile real wages are falling, home prices are collapsing, and if I am correct job growth is about ready to fall off the cliff in a second wave down of reduced corporate spending. That combination will increase foreclosures, defaults, and bankruptcies (the latter of which obviously destroys credit).

There is little central banks can do about it either, just as they could not do much when all of the other massive bubbles throughout history collapsed. Nonetheless, “Keynesian Folly" will likely be attempted once again. The last execution by Greenspan produced the housing bubble and with it jobs. If the next attempt does not put money into consumers pockets and have them spend it on increased consumption (as opposed to paying off debts), the party is over regardless of what year this is.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/