A Depression in Our Future?
Wood, Christopher
Christopher Wood A DEPRESSION IN OUR FUTURE? A free-marketeer predicts it. rr he game is up. We were living during a period of fast money. The press had already coined their epitaphs. Earlier...
...The challenge for conservatives will be to preserve some semblance of market capitalism during this traumatic period...
...Was it 2 a.m...
...Those who argue to the contrary claim that governments can now stop depression by printing lots of money and spending lots of it...
...Because the stock market crash in late 1987 was twice as bad in percentage terms as 1929, the subsequent depression promises to be twice as bad, too...
...Depression or slump, call it what you will, will have arrived...
...This is what began to happen in October when $1 trillion was wiped out of the stock market...
...to greedy excesses...
...THE AMERICAN SPECTATOR FEBRUARY 1988 19 depression since as a large continental economy (especially if Canada and Mexico are included in a trade zone) it could weather a protectionist climate far better than the Asian and Western European economies which are so dependent on exporting to America...
...The same is true today...
...Debt, however, as any housewife knows, is debt...
...dt still only midnight...
...The outcome one day will be a run on the Federal Reserve itself when foreigners finally lose all faith in the value of the greenback as a hard currency...
...It is a question of culture not politics...
...Tilden was less reticent...
...That is why in 1988, when the pressure of today's higher yen and weaker dollar finally become unbearable for Japan's export industry, Tokyo will follow Wall Street and stage an even more spectacular crash in its wildly inflated share and property markets, just as in 1929 Wall Street's followed eight months later and was more spectacular than London's...
...Hong Kong resorted to shutting its market...
...Indeed the U.S...
...What caused it...
...Nobody can be indebted forever...
...It will not be easy...
...Most important is the accumulation of debt and its subsequent liquidation when borrowers default and capital is written off and so wealth destroyed...
...Where are the economists writing about the consequences of debt...
...Keynesians talk about "demand," monetarists about the money supply, and supply-siders about cutting taxes...
...In trying to put pressure on the Germans by talking down the dollar, Treasury Secretary James Baker has made this clear...
...The crude supply-side view has never been accepted by the European right, be it British Prime Minister Margaret Thatcher or those advocates of sound money such as the Swiss and German banking establishments...
...That is why during the Continental Illinois episode the Fed bailed out not only depositors up to $100,000, as deposit insurance requires, but all depositors even if they lived in Switzerland...
...Because technology has not yet changed human nature, no thoughtful person should have expected this time around to be any different...
...This bailout mentality is neither financially responsible nor politically courageous...
...In a deflation this will not happen, which is why money supply will contract as debts are liquidated, just as it did in the 1930s despite the best efforts of the central bankers and their printing presses...
...This is of course only good-times insurance...
...The combination meant a once-in-a-lifetime boom for those working in the money business...
...Unfortunately many younger participants in the financial markets weren't reflective enough...
...This did not stop the Washington and Wall Street establishments from immediately proclaiming that unlike 1929 the crash would not lead to a depression because of "safeguards" in the system...
...Indeed these worries—not, as the press reported, the budget or trade deficit—were the main reason for the crash...
...Whereas during the 1970s savers who left their money in the bank saw the value of their capital eroded, in the 1980s they have earned a return comfortably above the falling inflation rate (even if it did not quite match the gains in the Dow Jones index...
...To investors this world of glut had one key message: that there were few attractive areas in which to invest spare cash in new productive capacity...
...Debts will be called in, borrowers will default, and liquidity will contract...
...Only then can there occur the inevitable sobering hangover...
...Instead the growth of money and credit led to financial asset inflation and a piling up of debt...
...That will mark the end of the dollar as the world's reserve currency, and with it the end of America's heady luxury of being able to borrow the money its government prints, and also the end of Pax Americana...
...Somecompanies in Japan even borrowed money to speculate in the Tokyo stock market to prop up sagging export earnings...
...This is nonsense...
...Unfortunately it is sheer bunk...
...Skeptics should notethat right now some 50 percent of the deposits in the American banking system are held by foreigners...
...Europeans simply do not share Americans' perennial optimism...
...Among Wall Street's investor cognoscenti, however, there was general tacit agreement that the party was drawing to a close...
...Thismentality stemmed from a laudable desire to cut income taxes, but it forgot the other side of the equation, namely cutting spending...
...The result was companies either buying back their own shares or the shares of other companies, hence takeover fever...
...That is the accumulation of debt...
...As the 1980s rattled on, the financial fever intensified until the only scorecard that counted was the number in the bank account...
...The only difference is that this time the transition occurred much faster and Britain's wealth was dissipated fighting Hitler, not consuming...
...second, the deregulation and globalization of the world's financial markets...
...It is betting the integrity of the dollar, which is still the world's reserve currency as witnessed by the willingness of foreign central bankers to hold it...
...It dwarfs the much written about 12.8 percent fall on Black iliesday of October 1929...
...Conservatives should be wary of such pat answers, which imply a touching faith in bureaucrats...
...Deflation means falling prices, a contraction of bank lending and so of the money supply, and a resulting slump in economic activity...
...The capitalist world last experienced deflation during the Great Depression...
...T n fact the main contrast between 1 1929 and now is not that conditions are better but rather that they are worse...
...When it sets in, the Fed can print all the money it likes but will find itself "pushing on a string...
...The easy answer is liquidity...
...We are not there yet...
...Credit is debt...
...Industrialists drew the same conclusions as investors...
...Financial assets promised a superior return to the business of producing goods and selling them...
...Because they either thought that history is irrelevant, or that somehow "this time it is different," they are destined to repeat the same mistakes as their forefathers...
...And that is clearly politically unacceptable...
...But because it is in the nature of markets to test extremes, financial mania could only be expected to lead Christopher Wood is the Economist's New York-based finance correspondent...
...When the establishment speaks about safeguards, it is really talking about panaceas such as government deposit insurance for the banking and thrift industries...
...As for those supply-siders who contend that trade deficits are meaningless, this would be true only if the world had one currency and one government...
...It is this kind of thinking which explains why the Bundesbank is so reluctant to do Washington's bidding...
...This was truly the stuff of history...
...For as the world's biggest debtor, America will suffer a corresponding loss of politicalpower when the dollar forfeits its role as the capitalist world's reserve currency...
...That should also mean a temporary rebound in the dollar...
...The stock market will doubtless rally, drawing suckers in before sliding remorselessly down as it did from 1930 on...
...For the money supply can only expand when borrowers want to borrow and lenders want to lend...
...In the past three years debt increased more than three times as fast as profits...
...The rationale was the same in all cases...
...B y crashing in October the stockmarket has flashed its warning...
...He wrote: "There is one cause, and only one cause, of all panics and depression in the economic world...
...Many bonds issued in the leverage-happy 1980s will default...
...In the 1970s booming commodity prices encouraged a tremendous flurry of production...
...This makes sense...
...When it reopened a week later, the result was a one-day 35 percent plunge...
...Too often for comfort it was true...
...Now, despite the warning of the October crash, many continue to believe in the ability of governments to head off depression when all the signs point to the disintegration of any significant economic cooperation between the major economic powers, America, West Germany, and Japan, and its gradual replacement by dog-eat-dog protectionist economic warfare...
...Such comforts are relative...
...The baubles may have differed—a manor house for the City slicker, a Long Island mansion for the striving Wall Street yuppie, and golf club memberships at $2 million for the Tokyo eager beaver...
...From its peak in August, the Dow had plunged a breathtaking 36 percent...
...Debt is growing much faster in America's economy than money is being made...
...This trend is unsustainable...
...Butthe real future disaster and future shock will be in the debt markets...
...In the 1980s much of this relatively new capacity became uneconomic, be it oil wells, steel mills, or aluminum smelters...
...ntil October 1987 the prophets of doom had been discredited...
...The debate was less about whether the revels would end than when...
...Do notbelieve them...
...This is a game which cannot go on forever...
...It has been called financial asset inflation, a perverse deviant of the 1970s phenomenon...
...Money was encouraged to stay idle because of the high real interest rates on offer...
...Obviously, those who say a depression is coming neither expect nor want to be believed...
...And as we saw in October, global greed begets global panic...
...With their industries suffering from excess manufacturing capacity, businessmen increasingly realized it made more sense to invest their spare or borrowed cash buying financial assets...
...The Chicago bank was effectively nationalized...
...Any fool can print money...
...It would be too late to sell...
...That amazingly swift turnaround looks increasingly analogous to the rise of America as the world's dominant power and the eclipse of Britain, a development which was complete by 1945...
...It is just the sort of financial excesses seen during the 1980s which historically, as in the 1920s, have been a harbinger of deflation...
...Following Wall Street down, Tokyo fell 15 percent in one day and London 22 percent in two days...
...It is called competitive devaluation and is simply another version of Smoot-Hawley...
...Interviewed a few months before the crash during a visit to New York, the chairman of Switzerland's largest bank, the Union Bank of Switzerland, said: "The rest of the world sells its products to America and lends America the money to pay for them...
...But many other commodities and industries were similarly affected—from sugar to tin, to steel to ships, to semiconductors to farmland...
...The sheer scale and speed of the crash clearly made nonsense of yesterday's conventional wisdom that 1929 "could never happen again...
...These are the largest of matters...
...Many modern economists would like to dismiss this way of thinking as "nineteenth century"--a harkback to John Stuart Mill and kindred souls...
...of shortage turning into excess...
...For if most market participants thought another depression was at hand, then the price of bonds, shares, and property would already have collapsed way below current levels...
...This is why the quickest and most efficient way of solving America's trade deficit, if not its budget deficit, would be a recession now...
...In Wall Street, the City of London, or Tokyo's Marunouchi financial district, the spiritual was out and toys were in...
...This fevered atmosphere developed for two reasons: first, the extraordinary bull market in financial assets in the 1980s, the biggest since the roaring twenties...
...Goods do not go up in price if there are too many of them around, however much money is being printed...
...S o the 1980s bull market in stocks and bonds was a speculative bubble which disguised the underlying deflationary forces ravaging the world...
...Dawn broke on October 19 when the Dow Jones industrial average collapsed 508 points to 1,738.74: a 22.6 percent decline in a single day...
...As soon as stocks 18 THE AMERICAN SPECTATOR FEBRUARY 1988 crashed bonds soared and interest rates plunged as the market discounted recession ahead and investors fled to quality...
...Earlier in 1987 the New York Times ran a headline, "Feeling Poor on $600;000 a Year" over a story about young investment bankers...
...When people finally lose faith in the banking system and the debt pyramid, as they lost faith in the stock market in October, there will be a worldwide scramble for cash...
...should be spared the worst of the subsequent Keynesians talk about "demand," monetarists about the money supply, and supply-siders about cutting taxes...
...This boom-bust cycle is as old as man himself...
...As the stock market has indicated, the odds massively favor deflation and liquidation...
...The 1980s boom in trading bits of paper, optimistically known as "securities," could not last...
...Either debt slows through liquidation of existing debts because borrowers cannot pay or profits must increase massively to pay off the debt...
...The result was supply gluts everywhere...
...The world had too much of everything, which is deflationary...
...By that they mean a mentality which assumes that debt must be paid off whereas in the glorious twentieth century, as one of their number put it to this writer, "rolling debt gathers no loss...
...The process will take time...
...The tough response is to say no to special interest groups...
...Rather the reverse is likely...
...Their warnings of an impending debacle had gone unfulfilled and everyone had continued to make merry and make money...
...The name of his game is obvious to foreigners...
...No one...
...Otherwise, the result is a continuous debauching of the currency...
...No person, no country, no government...
...Exaggerated inflationary concerns bid up interest rates in the bond market until Treasury bonds were yielding nearly 10.5 percent...
...That too much debt is dangerous for an individual, a company, or a country should be obvious...
...Economics is not science but a best-guess art of studying how human beings squabble over available resources...
...Where are the economists writing about the consequences of debt...
...Fresh out of business schools with the obligatory MBAs and clone-like demeanor, many of these fresh-faced eager-looking types have suffered a shock...
...They will be as wrong about that as they were about the impossibility of a repeat of the 1929 crash...
...It was this rise in interest rates which broke the back of the bull market in stocks...
...In the meantime the financial markets will have to work their merry course...
...The debt is global, oppressive, and unpayable—which is why we face the gloomy prospect of a deep and protracted depression...
...The prophecy would have become self-fulfilling...
...In a slump the rest of the world will be effectively deprived of its main export market, the U.S...
...But the goal was the same...
...Today it makes more compelling reading than a pile of commentaries from professional economists...
...These money men have been flourishing in a climate of false prosperity...
...For how long...
...With good reason...
...Oil was perhaps the most dramatic example of supply and demand at work...
...Compounding the pain for producers, technology made the use of raw materials many times more efficient...
...There the damage will be worse than in stocks...
...In fact the main concern of most investors right up till the October crash was a return to higher inflation...
...As gold bug Ted Slanker put it in his newsletter: "When the whole economic system fails, how can the government, made up of the people and systems that are in trouble, save the system and the people...
...Nowhere was the fever more exaggerated than in the money business itself—the world of high, or perhaps low, finance...
...Yet during the Reagan years some conservatives (many of them former socialists, hungry for ideological fixes) have distorted their creed by seeking to argue that America's debt addiction did not matter because the economy could somehow grow its way out of it...
...The lesson: never try to cheat the market...
...The growth in outstanding obligations, whether personal, corporate, or governmental, has been called the "debt time bomb...
...So right up to the end of the bull market, bond investors continued to fret about yesterday's problem—double digit inflation—when the world during the 1980s has been sliding in the exactly opposite direction, namely deflation...
...Indeed Tilden wrote the book because he could find nothing in the writings of contemporary economists about debt...
...Bumper bonuses were paid in the past few years as countless securities firms leveraged up, hurling themselves kamikaze-like into the looming global battle to become the world's top financial middlemen, a fight from which only a few can emerge winners...
...All world stock markets, save Tokyo's, crashed convincingly with Wall Street...
...As a result liquidity piled up on the sidelines...
...With gluts everywhere central banks had to keep printing money to keep the economy growing...
...or 4 a.m...
...This swamp of liquidity led to today's financial scourge, nowhere more so than in America...
...There will be more traumas to follow...
...Contrary to orthodox monetarist theories, this was not inflationary because of the prevailing overcapacity...
...This time America has huge budget and trade deficits, its major banks are saddled with unpayable Third World debts, and the world's financial markets are electronically integrated, creating perfect conditions for a chain reaction...
...It also followed days of falling shareprices...
...But the longer the debt is allowed to accumulate through political fixing the worse the eventual liquidation and so the longer the subsequent depression...
...That cause is debt...
...The only action it can take in extremis is to bail out the problem by printing dollars, which is just what keeps happening, be it the multi-billion dollar bail out of Chicago's Continental Illinois in 1984, or the (very temporary) bail out of the insolvent Federal Savings and Loans Deposit Insurance Corporation in 1987...
...Economists calculate that at its current rate of borrowing America is likely to have an external debt of $1 trillion by the early 1990s, compared with an external investment surplus of $200 billion in 1982, which will have to be financed by willing foreigners...
...I n 1936, near the trough of the Great 1 Depression, Freeman Tilden, an obscure American novelist, wrote a remarkable book called A World in Debt...
...The only result was Keynesian-style deficit financing...
...The outcome might have short-term benefits for America's exporters, but in the longer term it is a dangerous gamble...
Vol. 21 • February 1988 • No. 2
