Analogies to The Great Depression are Misplaced

I think references today to The Great Depression are misplaced.  Two recent articles note the differences between today and the 1930s. 

First, from The Telegraph

[I]t is not yet like 1933. That second leg down was the result of "liquidation" policies by a Dickensian leadership blind to the dangers of debt deflation. By then the Gold Standard had degenerated into an instrument of torture. It forced the Fed to raise rates from 1.5pc to 3.5pc in October 1931 to stem gold loss, with predictable results for shattered banks.

It is worth glancing at the front page of New York Times on Monday March 6, 1933 to see what the world looked like three days after Franklin Roosevelt moved into the White House.

The newspaper splashed with the story that FDR had closed the US banking system – invoking the Trading with Enemies Act – and ordered the confiscation of private gold. From left to right, the headlines read: "Hitler Bloc Wins A Reich Majority, Rules Prussia"; "Japanese Push On In Fierce Fighting, China Closes Wall, Nanking Admits Defeat"; "City Scrip To Replace Currency"; "President Takes Steps Under Sweeping Law of War Time"; "Prison For Gold Hoarders". ...

Roosevelt took over a country where the economic machinery had completely broken down. The New York Stock Exchange and the Chicago Board of Trade had closed. Thirty-two states had shut their banks. Texas had restricted withdrawals to $10 a day.

Few states could borrow on the bond markets. Illinois and much of the South had stopped paying teachers. Schools closed for months. An army of 25,000 famished war veterans squatting in view of Congress had been charged by troopers of the 3rd US cavalry with naked sabres – led by a Major George Patton.

Armed farmers threatening revolution had laid siege to a string or Prairie cities. A mob had stormed the Nebraska Capitol. Minnesota's governor was recruiting Communists only for the state militia. Lawyers attempting to enforce foreclosures were shot. More than 100,000 New Yorkers applied to go to the Soviet Union when Moscow advertised for 6,000 skilled workers.

We forget how close America came to open revolt. Eleanor Roosevelt feared the country was beyond saving. Her husband kept the faith. He channelled the anger against Wall Street, diffusing it. "The practices of the unscrupulous money-changers stand indicted in the court of public opinion," he began his presidency.

The Fed was an ideological deadweight. Bowing to pressure from Congress it began to purchase bonds in mid-1932 to boost the money supply, but then recoiled, before retreating into pitiful self-justification. A third of the rescue funds in Hoover's Reconstruction Finance Corporation had been embezzled.

The environment is very different today.

Today there has been no such failure of US institutional imagination, even if, as George Soros argues, the Treasury's policies have been "haphazard and capricious".

The twin blasts of fiscal and monetary stimulus have been massive. In short order the Fed has slashed rates to zero. It is now conjuring money out of thin air on an industrial scale, buying $600bn of mortgage bonds to force down the cost of home loans, and propping up the commercial paper market to avoid mass corporate default. Ben Bernanke, a Depression junkie, is proceeding with a messianic sense of certainty. The wash of money should ensure that the next 18 months will not mimic the cascade of disasters from late 1931 to early 1933.

I do not agree entirely with the reading of history of The Great Depression at Popular Delusions,  However, the author does point out several salient facts about The Depression.

[T]he crash on Wall Street and the credit crunch it created caused an abrupt halt to those international capital flows and turned a US scarcity of liquidity global. Then, as now, liquidity masked a multitude of sins and its sudden flight revealed an underlying financial fragility few had hitherto guessed at. 

First up were the Austrians. The capitalisation of their banking system had been weakened by the inflation of the 1920s while a consolidation aimed at strengthening the system in fact weakened it and made it more concentrated. The focus of the crisis, the troubled Credit-Anstalt was larger than all of its competitors combined. By May 1930, what had started as a nervous withdrawal of funds by foreign investors unsure of Austria's banking health became a full-blown run and in June the authorities put in place capital controls to restrict the flood of gold leaving the country. 

Now the global panic was on. If the Austrians could withhold gold, so could her Eastern European neighbours and soon there were bank runs in Hungary (where Credit-Anstalt had branches), Poland, Czechoslovakia and most importantly given the political consequences of the slump there, Germany, which came off gold in July/Aug 1931 (Kindleberger suggests part of the panic's contagion was caused by some American investors not realising that Germany and Austria were different countries). 

Britain was the next country to come under fire, succumbing to the new financial reality (and blaming speculators) and leaving the gold standard in September 1931 and this was a cataclysmic event. Although financially weakened by WW1, the perception until then remained that Britain was the economic, financial and political leader of the world - if Britain could come off gold, anyone could, including the United States. 

And so the financial storm again struck the American shores from which they'd originated as the 1929 Wall Street crash returned, boomerang like, to threaten the heart of the US financial system anew. The Fed raised its discount rate from 1.5% to 3.5% to counter the panic by attracting gold flows and, for better or worse (probably worse since the action triggered a further liquidity squeeze and another round of banking failures), managed to stay on the now considerably smaller gold/exchange standard (at least for another few years). 

One of the reasons I think it important to understand these events more clearly is because globally (and in strictly economic terms) the events of 1931 marked the high watermark of the crisis. The countries which came off the gold saw their economies recover soon afterwards. ...

FDR's election helped trigger a third round of banking collapses when he came to office. After winning the 1932 election he hinted without ever confirming that he would take the US off gold. But he wasn't to be inaugurated until March 1933. For four months there was no one in charge and the uncertainty and fear that yet another government would devalue it's currency against gold as most of the Europeans had just done caused another panic as investors rushed for the exits. While the US remained on the gold standard, gold still formed the basis for the banking system's reserves which formed the basis for the economy's outstanding stock of credit, so the sudden gold outflow caused another sharp contraction in the money supply, another wave of banking collapses and another nosedive into recession ...

There is currently a credit crunch, though it has eased somewhat over the past month.  However, the government and the Fed are working madly to unfreeze it, unlike during The Depression when the Fed and the government were late in addressing the credit contraction, even raising interest rates during the Depression to stem the outflow of gold.

Thus, I think the analogies of The Depression to today are incorrect.

Comments

[dacian]

T., I commented on your blog we might not experience the same harsh times as in the '30s, but to me you seem very optimistic about the FED and bureaucrats getting us out of the mess. These credit bubbles (I mean with such a magnitude) are quite rare; the FED was quite late seeing it (either they ignored the size of the problem or for political reasons they refused to address it) but now is trying all sorts of "unorthodox" methods to handle it. As these things have not been tried elsewhere (a bit in Japan with modes results), we don't know what the effect will be; how if things get out of control? I mean the FED saying these are "unorthodox methods" means to a certain degree that they don't know what they're doing and where we go actually. And seeing the way they addressed the bubble before exploding, we might say they are not that competent (actually I'm not sure if there is such an individual who might give a miracle solution). What if we conclude that the last thing left is nationalize banks? What kind of market is that where prices are instituted by law? The prices for stocks, businesses and whatever their products are won't be fixed in a "free environment" but controlled by government as they will control not only money but banks as well; the prices won't send signals anymore?! So maybe the analogy with the Great Depression is incorrect, but we can reasonably state that we don't know what's going to happen next.

[unfettered]

Toro: If you'll entertain some amateur psychoanalysis, I can't help but notice that the posts have tilted from an emphasis on clouds to an emphasis on silver linings since you announced you were mostly long the market. We're all human and subject to confirmation bias, but ideally one's perception of the investing landscape should drive one's long/short allocation, not vice versa. Just something to consider, no offense intended.

[Toro]

Unfettered

No doubt about it. I'm a student of behavioral economics. We all talk our book.

The question is whether I have positioned myself because of what I think or I think because of how I positioned myself. It's probably both.

My greatest sin is that I am early. We value guys usually are. However, I contend that since I've started this blog, I've mainly been correct, whether that is on the housing market, coal, potash, the euro, REITs, etc. Of course, I've been wrong on some things, and will get some things wrong in the future. Perhaps I am wrong now. However, the negativity is overwhelming, valuations are attractive, cash levels are high, and there is reason to believe the market is in a bottoming process. We'll see.

T.

[IL]

The problem with comparing our current predicament with the Great Depression is that such a comparison can, paradoxically, breed complacency as in: "We're not doing as bad as we were in 193?, therefore we're going to be OK". It's like the drunk saying: "I'm not a heroin addict therefore I'm OK".
Unfettered, you are one perspicacious fellow. No offense Toro, I'm a big fan.

[Toro]

None taken, of course, IL.

Plus, now I know what "perspicacious" means! lol

T.

[unfettered]

>> Toro writes: "...since I've started this blog, I've mainly been correct..."

No argument here -- I've found the bear case made by you and others over the last year to be more convincing than the bull case. I continue to find the bear case more convincing, but then as you'll probably be early, I'll probably be late.

[Running Amok In Fantasyland]

I agree. This Depression will not be Great. But it will be memorable.