Comparisons between 1930 and 2008

It is very clear we are in an historic economic period. As I have said (maybe too many times?) before, "History Repeats (or at least it rhymes)". But which period are we comparable to? The 1930s or the 1970s? This is the big question because the proper investment (and survival) strategy are almost opposite.

The 1930s was a period of terrible deflation leading to economic Depression. There are a lot of parallels between then and now. Are we headed back to the 1930s, or worse? Some would have us think so, in which case sell everything and go 100% to cash and hide it under the mattress.

On the other hand, this period could be more like the 1970s. Again, there are many reasons to think so. And the strategy in this case would be to buy everything possible that is a real asset. Paper money (cash) just becomes more worthless every day with inflation and a stagnant economy. Real assets will grow in value at least as fast as inflation reduces the value of a dollar.

I won't try to answer the question because there is not enough information to know for sure (and if I really knew this answer, I could name my price). But I did find some interesting academic notes on the subject from an Eric Rauchway, an economics professor at UC Davis and author of a noted book on the Great Depression. You can read his notes or hear his podcast at this web link:

http://www.econtalk.org/archives/2008/12/rauchway_on_the.html

If you don't want to take the time to listen or read in entirety, here are a few bullets that compare the 1930s to now, paraphrasing the author / interviewee, Rauchway:

• Fed raised interest rates, first in 1928 to attract foreign investment; Followed by drop in consumer spending. Immediate transfer via the uncertainty mechanism to the real economy.
• Parallel, recent drop in automobile purchases after Fed raised rates in 2006 to cool economy;

• 1930: people afraid they will lose their jobs;
• 2008: Bankers afraid they will lose their jobs and be unable to pay their bank borrowings back. Strange that Treasury Secretary Henry Paulson is angry about that, given the history. Nice parallel with the 1930s.

• Hoover administration created the Reconstruction Finance Corporation in 1932,
• Similar to the Troubled Assets Relief Program (TARP) in 2008.

• RFC originally going to lend money to banks to prop them up. Realized that this is not going to work and they have to recapitalize the banks. Hoover doesn't like the idea of buying bank stocks (nationalizing) in return for the capital (big mistake, as it helps bring public support on board and eliminates moral hazard).
• We recently went through in a few weeks what we went through from January 1932 to March 1933 back then. We sped it up, and we accepted bank equity or warrants in exchange for capital. However, the speed discomfits consumers. Banks now are rather cautious in lending, as a result of speed and uncertainty. Consumers are not yet spending.

• In the 1930s, Fed administrators were frustrated that the banks weren't lending after being recapitalized; RFC said it would lend in their stead, only to find that there weren't enough qualified borrowers.
• Maybe we'll recover much quicker too (because the bank recap was sped up). Uncertainty about what may happen next is offsetting, (though and is holding back lending). Lending encouragement is working as shown by declining spreads between various lending classes like mortgage rates and Treasuries. We must avoid being too conservative in our qualification of borrowers and must make borrowing very attractive with excellent rates and terms;

But here are ways the two periods are quite different, to the benefit of the current period:

• Hoover signed the Smoot-Hawley Tariff Act, with some zeal. Contrary to the myth that he was a laissez faire ideologue. Not a stand-idly-by guy.
• So far we have avoided any protectionist legislation, like rescinding NAFTA. Protectionism shuts off a need source of capital flow.

• Hoover became increasingly desperate through 1932. At some point you have to say Hoover should have been doing more. Hoover tried to coordinate businessmen to prevent a drop in wages. Ineffective, can't get enough businessmen to agree.
• We now know that direct government control of the economy does not work. Nixon proved again in 1972 with wage-price freeze. Get around it by letting companies laying people off--pay higher wages but hire fewer people. This keeps consumers buying, if fewer consumers;

• In early 1930s, unemployment was about 25%, annual figures: just shy of that in 1932, about that in 1933.
• From that experience we know now that unemployment is necessary, so wages will fall to a point to entice firms to hire workers; but if people don't have jobs, economy won't recover, people don't have any money to buy things, so firms have no money to pay for more employees. Circular flow of macroeconomics understood and hard to navigate politically.

• Difference then vs. now: no unemployment insurance, no deposit insurance, no old age pensions--state level and some private stuff, but tapped out by 1931 or 1932. Agricultural difficulties of the 1920s also used up some of these social welfare resources (in farm states).
• Now there is an extensive social welfare safety net at the state and national level; Feds can create money if needed, to keep people fed and sheltered; can also provide funding to states if needed and can provide medical care and food stamps, programs not in place in early 30s.

• In 1930s as people lost jobs, they drew money out of their savings, putting pressure on the banks. Banks already suffering because foreign debt was going into default (post WW1); stock related debts (margin accounts) going into default; municipalities and states going into default. No brake, no way of softening the blow.
• Today we have FDIC deposit insurance, hence eliminates runs on banks. Banking system won't collapse.

• In 1930s, there is a stark contrast between Hoover in 1930 and Roosevelt in 1933 (with hindsight). Hoover doesn't do anything to stop the bank runs. People's savings just vanish, no recourse. Lack of confidence in the system with no deposit insurance, people wondering if their bank will be next.
• We have many protections in place today to avoid bank runs as witnessed recently, especially Indymac

An even earlier depression in 1894, was the worst depression before the Great Depression. It was 40 years before the 1930s Depression (notice the 40 year cycle?) and somewhat fresh in people's minds, pretty horrible, but we don't have good measures. What happened to banks in 1894? There were pressures on banks.

There is controversy over how bad the unemployment was and how contraction of the money supply contributed to the 1894 Depression. But in 1930s, the money supply contraction can't be laid at Hoover's feet--the Federal Reserve was at fault for that. They created money on one hand to recapitalize failing banks, but took it away with the other, believing if they didn't it would create uncontrolled inflation (which we now know is better than uncontrolled deflation and is the stated goal of Bernanke and probably L Summers to come).

Hoover did increase spending, limited by institutions of the day (or lack thereof) and circumstances. But the Federal government wasn't big enough in the early 1930s to have a big effect on the total economy. Hoover tried to create big increases of public works by working with the state governments. But too little, too late, not enough stimulus."

These are the conclusions, in short, of Eric Rauchway. They are even better understood by Ben Bernanke and also by new, incoming Chair of the Council of Economic Advisers, Christina Romer. She is said to be more an authority on the Great Depression than Bernanke.

Logically, the best way out of excess debt is inflation. Inflation allows the debt to be paid in ever cheaper dollars, at the expense of the lendor, of course. But that is a story for a later day. So, if Bernanke and Romer have learned from the 1930s and do everything that it is said Hoover, and then FDR did not do, namely not doing enough to stimulate the economy, I think it is a solid bet they will ere on the side of over-stimulation which will lead to inflation and a run in hard asset prices.