I grew up despising Herbert Hoover. After all, he was responsible for the "Great Depression." That’s what my parents and teachers taught me. Actually, he was the fall guy and had little to do with the cause of those hard times. Yet, he was vilified and his political party dramatically weakened for two decades. It wasn’t until I began to read about economics years later, that I determined Mr. Hoover was a good man who was suffering from a bum rap.
The fact that one person can be set up to take the fall for a nation’s economic pain testifies to the kind of hatchet job the press can pull off. Newsweek Magazine recently criticized President Bush for his "Cowboy mouth and dumb diplomacy." This, at a time when he still retains popularity. Imagine how the wolves will howl if the economy sinks further. Unfortunately, the public is probably not that much different today than they were in the 1930s. They will accept the verdict that the President is chiefly responsible for an economic downturn.
The sad part about the last depression continues to be the lack of understanding about what caused it. Extensive inflating of money and credit brought on a boom and eventually, a bust. The similarities between then and now are striking. If we have another depression, the economists and the media will blind themselves to the real cause. They will be far more interested in casting blame. The whole thing will be so politicized and distorted, that the important lessons to be learned won’t register. We will fail to acknowledge that a government monopoly on unbacked paper money and bank credit not only debases the currency, it gives the government unlimited financing for social schemes, foreign aid, subsidies and war. It allows the government to intervene virtually anywhere. It further enables the state to persuade its central bank to inflate endlessly and foster speculative booms, which then turn into the kind of devastating bear markets that wipe people out.
Are we in store for a depression now? Fortune magazine quotes Warren Buffet on the insanity of stock values reached during the great bubble. "Unfortunately, the hangover may prove proportional to the binge," says Mr. Buffett. Commenting on these remarks, Richard Russell wrote, "We have just seen the greatest binge or bubble in U.S. stock market history. What if the bear market is ‘proportional’ to the bubble? In that case, we may experience one of the worst bear markets in U.S. history. At any rate, that’s the kind of bear market that I see ahead." Highly successful money manager, Michael O’Higgins says, "When you say it can’t be like 1929 through 1931 [when stocks lost 89 percent of their value], you’re right. It could be worse." He looks for a depression to begin imminently. "Perhaps the greatest deflation and depression of all time," he says, "following the greatest speculative boom of all time." He goes on to say that the depression will not end until high levels of corporate, government and consumer debt are liquidated.
The Fed feverishly pumps out additional money and credit to forestall a collapse. It’s an unhealthy system where only more debt can save us. Dan Denning described this perverse predicament. "The scope of the debt problem in America hasn’t been fully understood. The single distinguishing feature of the current version of American capitalism is credit creation. So much debt has been created in the last twenty years that it requires huge amounts of new credit simply to keep the system liquid. The necessity for ever-larger amounts of credit to keep the system liquid weighs on the ability of the Fed to reflate. It’s like pouring more and more water in the bathtub with a big hole in the bottom."
It’s interesting to read what Andrew Dickinson White wrote about the great French inflation in the 18th century that destroyed the currency and economy of France, and compare his comments to the monetary expansion of today. "Whenever a great quantity of paper money is suddenly issued, we invariable see a rapid increase of trade. The great quantity of the circulating medium sets in motion all the energies of commerce and manufacturers; capital for investment is more easily found than usual, and trade perpetually receives fresh nutriment."
He describes the consequences. "There arose the clamor for more paper money. At first, new issues were made with great difficulty; but, the dike once broken, the current of irredeemable currency poured through; and swollen beyond control. It was urged on by speculators for a rise in values; by demagogues who persuaded the mob that a nation, by its simple fiat, could stamp real value to any amount upon valueless objects. As a natural consequence, a great debtor class grew rapidly, and this class gave its influence to depreciate more and more the currency in which its debts were to be paid. The government now began, and continued by spasms to grind out still more paper; commerce was at first stimulated by the difference in exchange; but this cause soon ceased to operate, and commerce, having been stimulated unhealthfully, wasted away. Manufacturers at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce.
"A still worse outgrowth was the increase of speculation and gambling… For at the great metropolitan centers grew a luxurious, speculative stock-gambling body, which, like a malignant tumor, absorbed into itself the strength of the nation and sent out its cancerous fibers to the remotest hamlets. At these city centers abundant wealth seemed to be piled up. In the country at large there grew a dislike of steady labor and a contempt for moderate gains and simple living.
Mr. White continues, "… how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the working men and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries, or wages; how securely it creates, on the ruins of the prosperity of all men of meager means, a class of debauched speculators, the most injurious class that a nation can harbor – more injurious, indeed, than professional criminals whom the law recognizes and can throttle; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality."
Are we any smarter about economics and monetary affairs today? We have highly educated men in charge, considered to be brilliant. Mr. White wrote, "The men who had charge of French finance….. were universally recognized as among the most skillful and honest financiers in Europe."
That’s the inflationary side of the current predicament. Then there’s the many factors that lead to depression. Among them, a stalling economy unmoved by low interest rates and record money creation. This money floods the world, fostering a mind-boggling trade deficit while ruining the profits of domestic companies. The erosion of corporate profits puts the clamp on business spending and crucial capital investment. We live in a society without savings where most citizens live paycheck to paycheck. It is only savings and investment that can make the economy healthy. The consumer, by persisting in needless borrowing and spending, promotes the building of shopping centers and superstores rather than factories. These temples of overconsumption and entertainment add to consumer spending that now make up to 90% of GDP. An economy which depends on consumer borrowing and spending as the main source of its prosperity is a disaster waiting to happen. Now that the consumer has started to capitulate and consumption begun to wane, a depression will gather steam. When you eat the seed corn, there’s no way out but a bad ending.
Corporations and consumers are deep in debt. A weakening dollar, foreign animosity, geopolitical risk and higher energy costs add to the witches brew. While some of these circumstances may be resolved in the near term, it will not temper the onset of a depression. The only question is the severity of the coming steep downturn. At best we’ll muddle through with steep inflation and stagnation. At worst expect a panic, crashing asset prices, dollar devaluation, staggering unemployment, a tidal wave of bankruptcies, a credit collapse, the final stages of a bear market and general impoverishment.
P.S. I suspect the bear market in stocks will be over when the financial guests on CNBC don’t want to offer their opinions. Right now they are all chirping the same song. A recovery is imminent. No one ever says, "I don’t know what the future of stock prices will be. I’ve been wrong so often I hesitate to guess."
That’s what I’ve been saying to those who ask me about gold for quite a few years. I’ve learned that no one knows the future. If you make an educated guess, it needs to be heavily qualified by announcing the limitations of the speaker. I probably don’t say it enough in print. These are my educated guesses. But frankly, I think it better to listen to someone who’s been wrong a long time than someone who’s been right.
-- Posted Tuesday, 18 March 2003
