Saturday, January 26, 2008

This Weekend's Contemplation #1 - Comparison of the Current Economic Situation to 1929

The article below from Market Watch makes a comparison of the current situation to the one our relatives faced in the not so distant past of 1929. Text in bold is my emphasis.

A number of people I talk too have commented that Ben Bernanke, George Bush, and others appear to be very worried when they have been on the news recently discussing the economy. For good reason, there are too many similarities between the current situation and 1929. The similarities go far beyond the stock market, which I continue to argue is a minor part of this process. There was an economic slowdown starting in 1930, consumer spending slowed, unemployment began to increase as consumer spending slowed, all resulting in the bank insolvencies in 1930 – 1931, ultimately ending in the bank failures of that period. Once that happened the economy slid very quickly into a deflationary period that only WWII was able to end. Now we have bank insolvency (the credit crunch), a slowing economy (threat of a recession), consumer spending is beginning to slow (that is why the Administration wants to put money in everyone’s hands), and unemployment is moving up. So are bank failures next? They are already here, not just nation wide yet. When Citigroup and Merrill Lynch need equity injections and B of A buys Countrywide, these are not growth plays, these are survival moves.

Lately, whenever the market has a bad day, the reflex among financial-news editors is to compare our current situation with 1987 and wonder if a "Black Monday"-style crash is on the horizon.

But some observers draw a darker metaphor, noting that much of what we are seeing now also took place in 1929. As we know, that meltdown -- unlike the 1987 crash -- was not followed by a happy ending, but rather by a decade of poverty, shantytowns and sporadic famine.

Popular imagination has the Great Depression opening with a bang in October 1929. We forget that even by December of that year, the market had no idea what was really in store. After a period of wild, bipolar volatility, stocks had taken two big tumbles (a 12.8% drop on Oct. 28 and an 11.7% fall the next day) while the top bankers and "captains of industry" rushed to shore up the market. By November, the Dow had hit its low for the year at 198, down from the giddy September high of 381.

But, the financial pundits and government leaders of the day insisted, the economy's fundamentals were still strong. Mass unemployment was, some months after the crash, still just something that went on in Germany and Britain. America was strong and merely needed a push to keep the financial markets from harming the broader economy.

With that in mind, Herbert Hoover -- only nine months into his presidency -- assembled leaders from the public and private sectors to create an economic-stimulus package. Among the measures, Time magazine reported at the time, was a promise from Congress to offer bipartisan support for a tax-cut package. The proposal called for $160 million in tax relief -- only about $22 billion if adjusted against the gross domestic product at the time, and therefore much smaller than the plan under consideration here in 2008.
(The article contains a link to an article in Time Magazine dated December 1929, just to get some historical perspective.)

Also on the table was an assurance from the Federal Reserve that it would provide cheaper credit. Granted, the Fed had much less power over the money supply in those days, mainly because the amount of liquidity it could create was limited by the supply of gold it held to back the dollar.

Of course, there were a litany of public-works projects, plans for new corporate investments, and even a promise by Henry Ford to raise wages at his auto plants.

None of this worked. What was first seen as speed bump to the expansion of American finance became something much larger. The Dow continued falling, hitting 157 in 1930, 73 in 1931 and finally a mere 41 points in 1932. It did not reach its 1929 high again until 1954, a generation later.

Certainly, our economy now has far more differences than similarities with the economy of 1929, and few expect a new depression for the decade ahead. But it's also worth remembering that the best laid plans of presidents, chief executives and senators can sometimes come to nothing.

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