So, the world has survived the mortgage debacle and the stock market free fall. At least according to Obama’s State of the Union address: “Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again.”
What a relief. But wait: “While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover.” That was Herbert Hoover’s comment before the Great Depression really began to hot up. In fact, there are many similarities between the early 1930s and today. And they indicate we are far from through the worst. The third cause of the Great Depression has yet to strike us this time around.
First, let’s recap the other two. This from the excellent book your editor is currently reading on the financial crisis:
At first the securities firms sold only participations in mortgages; that is, on a single piece of property to one investor that they guaranteed. But soon Wall Street firms devised securities based upon pools of mortgages… Of the $10 billion or so in mortgage backed securities issued during the period, some 8 billion of the original face amount were in default by the early 1930s when Congress launched various inquiries into the practices of Wall Street.
Yes, you read that date correctly. And all the thoughts racing through your mind right now are most likely on track.
The mortgage mess of the last decade has been perpetrated before. By the same antagonists, using the same methods, the same terminology, the same victims, and ending with the same results. “The price declines in the mortgage-backed securities market in the late 1920s preceded the crash of the equity markets and the start of the Great Depression,” reports Frank Byrt from the National Bureau of Economic Research.
This may not seem like a revelation to some of you, but the extent of the similarities is remarkable. Repackaging loans, structured assets, special purpose entities – it’s all there.
And it get’s spookier. Aside from mortgage securitisation, and a stock market crash, guess what other asset caused trouble? Sovereign bonds!
Although it was mainly Latin American bonds that got the limelight back then, the conditions were similar to today. But the sovereign issues are yet to truly strike this time around. And the nations in question are much larger. So when you go back and review history to discover what happened next, remember to keep that in mind. Things are yet to really get bad in the financial markets. And with the Australian dollar at highs, along with the resources we export, who do you think stands to lose a lot?
Of course, you shouldn’t actually worry because this time is different. We have a money printer at the Federal Reserve who is willing to print us all out of trouble. And we have wise regulators overseeing our affairs. But why on Earth did nobody spot the similarities between the 1920s and 2000s before things got so bad? Surely people learn from catastrophes like the Great Depression?
Intriguingly, the Glass-Steagall law in the United States was introduced after Wall Street practices during the 1920s were exposed. Banking and securities dealing were to be kept separate to avoid the kinds of conflicts of interest that could lead to systemic trouble. It looks like repealing the law was a mistake. And the same lessons learned the hard way then were learned again.
So perhaps Glass-Steagall will make a comeback, as Senator John McCain has proposed, and the investment banks will have to choose between investment and bank.
But why trust politicians to do the regulating? If they were treated like CEO’s running a company, their own balance sheets would be called into question. Government income statements, such as they are, are expected to post record losses this year. The donations lists to prominent politicians are blotted with banks. It was their laws that encouraged sub-prime lending. It was their backing and oversight of mortgage giants that allowed securitisation to grow like it did. And don’t forget the Federal Reserve… it financed the whole venture with low interest rates.
You can’t expect that bunch to solve the problems with harsh regulation (which is actually enforced). Banks, central banks and politicians are too busy bailing each other out. If the public sector decides to continue supporting the collapsing parts of the private sector, it will merely make the crash more mighty. The question is who will drag the other down first?
Each failed stimulus made Keynesian true believers look either stupid or excessively optimistic. “With so much work done by do-gooders to little avail, things must have been really bad to begin with,” they think, as an excuse for miserable stimulus results. “Better do some more stimulating, until things get better.” It’s a self-reinforcing delusional state of mind that leads straight to bankruptcy.
But as a free-marketeer, can we really criticise fiscal irrationality in the face of pathetic management of private companies leading up to 2008? Shouldn’t the private sector have known better?
Maybe it’s those animal spirits again.
Or the private sector did know better. It knew that Fannie, Freddie, GM, AIG, etc. would get bailed out. It knew that government would foot the bill. It knew that the losses were limited, so it was time to go wild. And that’s what it did. With some help from the central bank each time the party slowed. This is what’s called, “moral hazard”, when central bank policies actually encourage dangerous financial activity.
Like drug dealers, first Greenspan and then Bernanke spiked the punch bowl they were supposed to be taking away from the Wall Street bonanza. Eventually, everyone at the party became hooked and needed more and stronger drugs just to stay sane. First lower interest rates. Then more money. Then security purchases. Then outright quantitative easing with brand new money whisked into existence.
Now that Washington has crashed the borrowing party, it too is on the same stuff – debt. And it’s looking to the same place as Wall Street did for a bailout – the Fed.
As we wrote last week, the demand for US dollars is waning. And could disappear overnight if the rules of the game are changed. Then the great reflation will begin. The dollars will come home to roost and Americans will learn once again what printing money gives you.
One already noticeable side effect is that Chinatown is New York’s new financial district. Apparently Americans are flooding into are place to save in Yuan. And it doesn’t surprise the average street goer one bit.
Of course, there are better safe havens than the Yuan. It is, after all, just paper. And, as former Federal Reserve Chairman Alan Greenspan pointed out on Fox News, fiat currency has a habit of losing value:
“We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that all of history suggest that inflation will take hold with very deleterious effects on economic activity…”
The solution? Greenspan continues: “There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard. ”
Yes, even a central banker knows a gold standard favours nations that are economically sound, like the US once was. As banking baron JP Morgan once said “Gold is Money. Everything else is credit.”
So which is it for your portfolio? Gold or credit? Emerging market consumers (and even central banks) are increasingly choosing gold. But how did gold do in the 1930s? Well, in the US it got confiscated. And we often receive emails asking whether that could happen again.
The reason President Franklin Delano Roosevelt decided to confiscate gold was because of its role as the world’s reserve currency. To the man on the street, gold was a barometer of trust in the government. Any increase in demand for gold indicated mistrust of economic policies. And FDR’s activities certainly didn’t inspire trust.
So, to avoid gold ringing alarm bells for US citizens, it was taken out of the economy. It’s similar to Cortes burning his ships upon landfall in the New World to avoid mutiny by his troops. With gold in the hands of the government, the stage was set for a massive dollar devaluation relative to those countries that remained on the gold standard. And you couldn’t convert your chips into real money to sit the experiment out.
These days, politicians don’t have to go through much hassle to achieve what FDR did. They just print money (to devalue their currency) and rely on banks to maintain speculative short positions in precious metals (to prevent a price spike that causes a loss of faith in the currency).
So hopefully you don’t have to worry about gold being confiscated. Instead, worry about the effects of inflation. U.S. analyst and fund manager Peter Schiff has been harping on about this for quite some time on various TV finance shows, not to mention at his brokerage firm. (He also predicted the mortgage meltdown.)
In this video he pretty much echoes last weekend’s Markets and Money. But it was a comment he made on the side that is fascinating. The media and policy makers point to inflation as a sign of economic activity. We previously reported on how they had given up generating economic activity via stimulus and skipped straight to generating inflation in some absurd horse-before-the-cart solution. Incidentally, this is what FDR was trying to achieve with his economic policies too.
But the mainstream has it wildly wrong within their own disastrous logic as well as common sense. Deflation is a sign of economic activity, not inflation. Competition, innovation, productivity gains, capital expenditure, savings … all the things associated with economic progress and wealth are deflationary. Lower prices are a sign of a competitive economy that’s delivering more of what people want.
Inflation is a sign of trouble. It’s when the purchasing power of your money declines… you get less and less while paying more and more. That’s why countries like Russia are implementing price controls to keep prices lower. If inflation were good, they’d be decreeing higher prices.
Anarchy in the DR Inbox
Joel Bowman’s article in the Markets and Money certainly stirred the hornet’s nest. Anarchy is something that makes people think of burnt cars and dead bodies, readers told us. Chaos would ensue and commercial relationships would not be possible without law enforcement. The country would be invaded and the infrastructure would crumble. So why are we advocating it?
This criticism is our favourite: “Who will pay for the roads?” the sceptical readers wailed.
Well, who pays for them now?
Just because government pays for things, doesn’t mean you don’t end up footing the bill. Channel 10’s 7 PM Project doesn’t seem to realise this, as it was advocating that the government foot the flood bill instead of taxing us…
And as for corporate law, what do you think is the source of those rules? Private individuals created, abided by and enforced them – all across many borders – long before government got involved. In the end, governments had to accept them into codified law. (From that point things deteriorated as commercial law became a policy tool for use by government.)
And defence was privately contracted in many places throughout the world. The Renaissance took place under the protection of mercenaries. (We won’t mention the US’s involvement in Iraq.)
Language, money and food were all creations absent of government. Although it hath been ruining them ever since.
The big difference between an anarchist system and a government one is that of monopoly. The government will set up one system of laws, one defence organisation and one set of infrastructure. A majority vote can change these, but none will go away and your peers subject you to them by threat of violence (jail).
If you refuse to pay for them, you also go to jail. Under anarchy, you choose what you get and what you pay for. There is nothing stopping you from competing with existing systems if you can do better and nothing stopping you from opting out. In other words, there is choice instead of compulsion.
Government is not the source of civilisation or a necessity of it. It is the means to implement conformity or compulsion. The opposite of being civilised.
Global Warming believers are just being sarcastic
We got an overwhelming response on the nature of Imre Salusinszky’s article on Global Warming. Thanks for the feedback and comments. Most people informed us the article was in fact satirical, or at least trying to be. Still, the whole thing seems a bit weak for satire. Writers who do this leave themselves open for critique.
But let’s not go there, in fear of filling up the DR inbox with things we won’t read. Instead, ponder this thought.
Imre mocks that 2010 was the coldest year since 2001 for Australia and that global warming has thus been beaten. But 2010 was also the equal hottest for the globe, a fact that readers of The Australian would have known. Imre’s sarcasm is meant to display pretend small mindedness – to only focus on Australia while the world is growing hotter is dumb. But apply the same reasoning to Imre’s point. Who measured temperatures far above the Earth’s surface, somewhere between us and the source of the Earth’s warmth?
Think of it this way: When the temperature inside your house falls, do you blame it on the insulation disappearing, or the sunset?