Skip to comments.The Greatest Depression Is Coming
Posted on 03/11/2003 5:05:30 PM PST by sourcery
The Greatest Depression is Coming.
Thats no exaggeration. It will be worse in many respects than the Great Depression of 1929-1939. But those who are prepared will prosper.
The First Signs Are Already Here
The most noticeable sign is in unemployment. Sure, the official unemployment rate is low as of the time of this writing (5.7%), but the standard used to measure unemployment is seriously flawed. For example, that standard does not include discouraged workers; that is, those who have given up looking for work. It also doesnt include the underemployed, who are highly trained but cant find jobs in their own fields, leaving them to work in jobs for which they are overqualified and underpaid. Additionally, the Labor Department publishes new claims for unemployment benefits on a weekly basis. Economists consider anything less than 400,000 new claims a sign of a recovering economy. Yet 400,000 seems to be an average. With that many new claims each week and the help-wanted index hovering near 30-year lows, we can see that the official unemployment rate, regardless of the number, grossly understates the true percentage of unemployed.
How many people do you know who have been laid off? I know plenty. There are about 10 million of them in the United States. And very few of them are finding work easily.
Next, look at the stock market. The years 2000, 2001 and 2002 were all down years for all three major indices. The Nasdaq Composite has been impacted more severely than the other indices: it is down 74% from its high in 2000. The Dow Jones Industrial Average (DJIA) is down 33%, while the S&P 500 is down 47%. The stock market last saw three consecutive down years at the end of the Great Depression, 1939-1941. The last time we saw four consecutive down years was the period 1929-1932, at the beginning of the Great Depression. During that period, the Dow Jones Industrial Average fell from a high of 381.17 in September 1929 to a low of 41.22 in 1932, a decline of 89%. You can see that the Dow can now decline a lot more and still not break any records.
Look at stock valuations. Go to Bigcharts.com and plug in DJIA. As of the end of February 2003, the Price-Earnings ratio of the DJIA was 20.30, while that of the S&P 500 (represented by the ticker SPX) was 27.59. Those figures are still very high as measured by historical standards. The reason they havent fallen that much is because both prices and earnings have fallen since the carefree days of early 2000. Historically, the P/E of the S&P 500 is between 13 and 14, depending on which source you follow. Assuming earnings dont change in the meantime, that would imply that the S&P 500 should lose another 50% of its value before it is fairly valued. But thats not the worst news: at the bottom of bear markets, the P/E typically drops to around 5. That would imply a further decline of more than 80% from the current value. Can you picture an S&P 500 value of around 170?
People choose to bury their heads in the sand and ignore stock market history. Even if the stock market is boring to you, you must understand one cold, hard fact: the stock market leads the economy. The economy was roaring along when the stock market topped out in both September 1929 and March 2000. When the market started declining, the economy soon followed. In the spring of 1930, people thought that the worst was over: the DJIA recovered to nearly 300 as the economy showed signs of improvement. But then the DJIA took a hard turn south, dragging the economy down shortly thereafter. The DJIA had five major bear market rallies before it bottomed in 1932. So far in this bear market, we have had four rallies, each leading to newer lows.
The stock market has likewise led the economy into other weak periods. Cases in point were bear markets in 1962, 1973-1974 and 1980-1982.
Individual players in the stock market will lie through their teeth, because they have a position to support. But the stock market itself never lies.
Were seeing deflation for the first time since the 1930s. Thats right: downright deflation. Look at the list compiled by Comstock partners: PCs and peripherals; butter; TVs; toys; long-distance charges; used cars and trucks; audio equipment; womens underwear, nightwear, sportswear and accessories; milk; mens pants and shorts; pork chops; airline fares; new cars; electricity; ship fares; and kitchen, living room and dining room furniture. In most areas of the country, housing prices have started to drop. Rents are dropping. For Rent or For Sale signs appear at nearly every office building we look at, whether its here in Colorado, San Francisco, or anywhere. There are very few prospective tenants who are shopping for space. In fact, the only area where any inflation still exists is in health insurance and energy costs.
We have experienced several periods of disinflation since the Great Depression, but never downright deflation: that is, until now. In a period of disinflation, theres no inflation or deflation. Prices remain stable.
The Federal Reserve Board is obviously concerned about deflation. In November 2002, Federal Reserve Board Governor Ben Bernanke made a now-infamous speech to a group of economists in Washington on his version of a remedy for deflation. Bernanke is quoted as saying:
"The U.S. government has a technology, called a printing press - or today, its electronic equivalent - that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
He was right, but his comments led investors to sell dollars and buy Euros and gold. Moreover, Mr. Bernanke forgot one minor detail: Germany, faced with huge deficits caused by reparations requirements after World War I, tried the same thing in the 1920s. Pictures soon appeared worldwide, showing people with wheelbarrows full of Reichmarks lining up to buy a loaf of bread. The country was still in a Depression, despite the printing presses having worked overtime. This led in large part to the rise of Adolf Hitler.
What else can the Fed do? They have already knocked the Fed Funds rate from 6% to 1.25%, the lowest rate since 1962, and it hasnt worked. Japan has knocked short-term rates down to 0.25%, and that country has been in a deep slump for most of the last 11 years. But well be lucky if we go down Japans road: at least Japan is a country of savers. We are a country of spenders.
The Trade Deficit
People tend to not care about the trade deficit since they dont see it. But its huge and getting worse. Moreover, when the last Great Depression started, the United States was the worlds largest creditor. Now, were the worlds largest debtor nation. In 2002, our trade deficit hit a record $435 billion, and were currently borrowing about $10 billion per week. For economists, the trade deficit is now 5% of GDP, a huge amount. All of this occurs despite a weaker dollar. The United States buys goods that are made overseas, because countries like China, India and Mexico have far cheaper labor costs than we do. When we buy their products, our dollars leave our shores and go to the sellers. The sellers have to do something with those dollars. Until recently, those sellers would typically repatriate the money by buying American stocks and bonds. Now, however, with declining stocks, low bond yields, lowering real estate prices and a falling dollar, those expatriate dollars have nowhere to go in America. Think about it: if you have a large amount of dollars, where would you put them right now? Foreigners have that same problem. Since theyre not investing here, investment in our infrastructure declines, which weakens our economic picture even more.
Budget Deficits And The National Debt
The only thing in existence that can afford to pile on debt and keep right on going is the U.S. Government. President Bush has proposed a budget for fiscal 2004 with a record $300 billion in deficit. Thats before the cost of a war with Iraq, which could add another $85 billion to the tab. Moreover, if the economy remains weak, the government will take in fewer taxes, causing the deficit to balloon even more. The current years debt gets added on to the already-staggering national debt, which is currently $6.7 trillion.
Who pays for all this debt? Tax receipts pay for part of it. Our kids and grandkids, however, will pay for the vast majority of it. In order to cover the debt, the government issues U.S. Treasury securities. Investors finance the debt by buying these securities. Their payments come from tax receipts.
At some point, however, the government wont be able to afford to pay on its obligations. The debt burden is too huge and has been caused by politicians of both parties who are more concerned for their own political lives than they are for the countrys welfare. They slip their pork projects into budgets in order to look good in front of the voters, even though our tax burdens are very heavy. And the voters are just as guilty, because we always ask the politicians, What are you doing for our district? This form of representative government goes on all over and will eventually leave bondholders high and dry.
Herbert Hoover will never be remembered as a great president. But he maintained a disciplined fiscal policy through the depths of the Great Depression. As a result, the federal government never defaulted on its obligations, even after Franklin Roosevelt took over and exacerbated deficit spending. It is too bad that the government will be starting off the next depression in such sorry financial state.
The governments coming default on its obligations will cause a financial calamity. There is no more secure a financial instrument than U.S. government bonds. In fact, every other bond in the world is measured against our own government bonds in terms of stability. All bonds will sell off when that happens. Interest rates will rise sharply, as investors demand higher yields in return for investing in risky government bonds. And current bondholders, typically senior citizens who live off of the interest, will be left high and dry.
The federal government isnt the only government in deep fiscal mud. Once all of the states have updated their figures for the current fiscal year ending on July 31, 2003 for most states, the total deficit could come to $50 billion. Projections for deficits in fiscal 2004 reach as high as $80 billion. The deficit in California alone is projected to be $35 billion this fiscal year. The federal government is spending money it doesnt have by giving the states $100 billion in fiscal stimulus. As you can see, though, most of that will be eaten up by state government deficits. Many state constitutions require balanced budgets. This will require states to both raise taxes and cut spending. And the raising of taxes during difficult economic times results in an even worse problem.
Foreign countries share our misery when it comes to budget deficits. Despite a European Union mandate to the contrary, France's budget deficit is likely to have exceeded 3% of gross domestic product in 2002. Dont be surprised if Germany and other countries offer the same confession. Country defaults are not uncommon. The Asian Flu broke out in 1997. Russia defaulted in 1998. Argentina and Brazil defaulted in 2002. Last year, the Argentine economy fell 10%. The peso lost 70% of its value. And consumer prices rose 40%. Half the population lives in poverty, say press reports. Crime is rising. Columbia has been in a civil war for 30 years. Venezuela has an ongoing strike against its president. Latin America is an economic tinderbox, prone to elect extremist leaders and leaving its citizens to try any method possible and get to the Promised Land. When anybody or anything defaults on its debts, the debt collector also hurts. The International Monetary Fund (IMF), World Bank and several giant money-center banks have lost billions when those countries defaulted, and they continue losing money today.
Consumer Debt & Real Estate
As of December 2002, the latest month for which figures are available, total consumer debt stood at $1.722 trillion, just $4 billion below the record set in the prior month. Not surprisingly, a record 1.5 million bankruptcies were filed in 2002, the largest ever. As in the case of country defaults, somebody in addition to the debtor will hurt when a bankruptcy is filed. Those somebodies are the creditors, including banks, savings & loans, retailers and wherever else the debtor shopped before he dropped.
Home foreclosures are not yet hitting records, but it wont take long. Over 5% of all home mortgages are now delinquent, yet new construction spending rose 1.7% in January 2003. The amount spent during that period was $877.9 billion. It appears that somebody hasnt yet received the word that the economy is somewhere between the slow-growth and depression end of the scale, depending on the realism of the interviewee.
We all know how refinancing has kept one leg up under the economy. In fact, many of us believe that refinancing has been the only leg holding up the economy. Low interest rates, helped along by 12 Fed rate cuts, have given consumers the opportunity to pay off those high-interest credit cards. Unfortunately, though, the process didnt end there. Consumers bought houses and ran up credit card debts. Since their houses appreciated in value, consumers took out second mortgages or refinanced the firsts, giving them enough money in pocket to pay off the credit cards. But then they loaded up on the credit cards again, either because they had to have that big-screen television (made in Japan) or because they were laid off and simply needed the money to pay living expenses. Many of the mortgages were (and are) the 125% variety, whereby the bank lends the homeowner up to 125% of the value of the property. This shows the level of insanity that builds at the end of any bubble: at the end of the 1990s, lenders were hot to make stock loans. Now that the stock bubble has burst, lenders are looking for other items that have held their value relatively well. Residential real estate is one of the few items left.
Back in the 1990s, if you ever noticed a fixer-upper house with a for sale sign in front of it, bidders would appear from everywhere. Now those ugly houses are just sitting there. Why? There are three reasons. First of all, most insurance companies who covered those houses under a builders risk policy are no longer underwriting those properties, just because of the liabilities involved. That means any entrepreneur would have to fix up the house without insurance, and this is a very risky proposition. Second, many former entrepreneurs have been burned by falling rents and slowing sales and no longer have the capital or credit to fix up such houses. For the third reason, see The War On Terrorism below.
The commercial real estate bubble has burst already. Almost every commercial building has a for sale or for lease sign in front of it. For example, as of December 2002, 150 Class A office buildings in Denver stood empty. The situation has only gotten worse since then.
All areas of the country, with the notable exception of California, are experiencing either flat or declining residential real estate values. And now, even lofty California is beginning to see things turn lower. Properties are vacant longer. The days of the buying frenzy, where buyers bid above the asking price in order to get the property, are either gone or on their way out. Bidding frenzies occur at the end of every bubble, as we saw three years ago before the bottom fell out from under stocks. he bursting of the real estate will be severe, since it will involve many more people than did the stock market bubble and it involves an illiquid asset. Prices declined 50% during the Great Depression. That should be a conservative figure this time around: look for an even more severe decline in the bubble markets such as California.
Rents and prices will drop over the next few years. And debts that arent paid off will be discharged, hurting the banks and other lenders even more.
For many people, the only way to make money during hard economic times is to sue somebody. Whether the claim has any merit is irrelevant. In American society, if you get sued, you lose. It doesnt matter if the claim is completely baseless. The defendant always loses. His reputation is slung in the mud. He spends fortunes defending himself. Even if he wins, he is still stuck with the bill of attorneys fees and possibly court costs on top.
Most plaintiff personal injury attorneys (attorneys representing those who file the lawsuit) take their compensation on a percentage basis, somewhere between 25% and 40%. In other words, if you sue someone for $100,000, the attorney on a 35% contingency plan will get $35,000 of your award if you win. If you lose, the attorney gets nothing. In fact, the attorney loses money in such a case, since the attorney typically pays all of your costs, including court fees and investigative costs, up-front, in the hope that they will be able to settle the case or win at trial. Most attorneys who draw compensation from contingency fees arent really looking to go to trial. What they want is a settlement. The settlement will pay them and the client the fastest, since many courts have backlogs of 2 or more years.
Look at it from the other side. If you are sued, your attorney wont take his compensation on a contingency-fee basis. Your attorney will want an hourly fee. Who pays that fee? You do. Even if you win the case, youve lost all that money in paying for an attorney, your share of court costs, investigations, etc. Thats why most defendants are prompted to settle a case, even if the case against them is completely without merit. Plaintiff attorneys know this all too well. So, if they can find out ahead of time that the defendant has money or other assets, its worth the attorneys while to bring suit. Many attorneys bring suit even if it is without merit, since the system as its established rewards such dubious efforts.
If you think that this type of system doesnt affect you, think again. Even if you have never been involved in a lawsuit, you are paying for the legal system we have. How? If you have insurance, you are paying higher insurance premiums because your insurance company has to figure costs of litigation, even spurious lawsuits, into the premiums you pay. When someone spills hot coffee on herself at a fast-food restaurant and sues, the prices will go up. When baton-twirlers sue their school after being cut from the majorettes, your property taxes will go up in order to pay the costs of that lawsuit. When a woman gets a $2,699,000 judgment against a grocery store for falling on her back while opening a jar of pickles, you will pay higher grocery prices. When a burglar breaks into your house and sues you when youve shot him, youll pay, along with your insurance company and others who are insured with the same insurance company.
When your doctor gets sued, her malpractice premiums skyrocket, regardless of the suits merit. Most gynecologists pay annual insurance premiums well in excess of $100,000, and some pay over a million dollars per year. Not only do you pay higher fees for office visits, but also doctors will order all sorts of seemingly unnecessary tests as a result, so that, if you ever bring a claim, the doctor can safely say she ordered all precautionary steps to protect you. Frivolous lawsuits drive future doctors into either foregoing medical careers or going into specialties without such a high incidence of lawsuit filings, such as dermatology. The next time you want to have a baby and you cant find a doctor who will deliver it, now youll know why.
This is insane. President Bush is trying to remedy the problem by capping punitive damage awards. That, in my opinion, is the wrong solution. Many lawsuits do have merit, and many defendants do deserve to lose big. What we really need is to stop the frivolous lawsuits from being filed in the first place, and we can eliminate most of them by adopting loser pays laws. If you lose a lawsuit, you will pay everything. That way, anyone who thinks of bringing a lawsuit will think twice. Plaintiff lawyers will also think twice, since they are fronting the costs of suit in hopes of making a profit later. If they dont collect, the plaintiff attorneys will lose big. A loser pays law will discourage many such attorneys from bringing suit in the first place. Conversely, anyone who is sued will think twice about defending the suit. If the case has merit and the defendant faces not only damage awards but also costs of litigation on both sides, the defendant will be prompted to settle. If, however, the case has no merit, the defendant knows he has a high likelihood of being compensated when the case is decided in court.
Truly legitimate lawsuits are put on ice for two years or more in our nations clogged court systems. Watch how fast cases would be settled and how fast insurance premiums would drop if the frivolous lawsuits were cleared out of the way. But that wont happen anytime soon.
The War On Terrorism
This is one wrench that we cant get out of the cistern. Even the capture of Khalid Sheikh Mohammed, who masterminded the attacks of September 11, 2001, couldnt turn around a lackluster stock market. You can rest assured of how terrorism will affect the equities markets: if terrorism occurs, the markets sell off. If no terrorism occurs, the markets are neutral.
All governments are required to drain precious funds in an area which was unfathomable thirty years ago. That means less funds are available for needed spending and saving elsewhere. The incorporation of terrorism planning means fewer freedoms for honest, law-abiding citizens. A case in point is the Patriot Act of 2001, the rushed-through, unconstitutional legislation that gave the FBI and Justice Department broad new authority to use wiretaps, electronic eavesdropping, and a number of other information-gathering techniques on all of us. Now a successor version, officially called the Domestic Security Enhancement Act of 2003, dubbed Patriot II is making its way through the cloakrooms of Congress and will take away even more of our privacy. The goal may be laudable, but the methodology stinks. When the government, using terrorism as its excuse, limits the very fabric of freedom and privacy upon which our country was founded, Osama bin Laden has won himself a victory he couldnt have imagined when he saw the television on 9/11.
Think about this: the weapons of choice for the 9/11 hijackers were razor blades. Does that justify the government abridging our Constitutional rights? In my opinion, any act including the word Patriot should apply just to non-citizens.
We are currently gearing up for a war against Iraq. Although our government alleges that that Iraq has weapons of mass destruction (WMD), it has shown us only the al-Samoud missiles as evidence. We also know that Iraq has used WMD in the past, both against its own Kurdish population and against Iran. However, it is very sobering to find that United Nations weapons inspectors have found no other weapons, despite the so-called information-sharing agreement they have struck with the U.S. intelligence community. Even if we win a quick victory before Saddam Hussein can blow up his oil fields or use WMD, millions of more enemies will rise to take his place. As many as a million military personnel would be stuck in Iraq as an occupying force, and when would we leave? Moreover, the United States and Great Britain would foot the bill for everything, since no other nation would commit troops to such an operation. Finally, the last thing any Arab neighbor would want is a democracy in Iraq.
A far greater threat to our country and the world is North Korea. Unlike Iraq, North Korea actually tells the truth about half the time. It was honest in saying it was pulling out of the nuclear non-proliferation treaty. It was honest in saying it was restarting the Yongbyon nuclear reactor. Then, theres the other half: where it alleges that the reactor will just be used to produce electricity. In reality, North Korea has no capacity to deliver any electricity from that reactor to other parts of the country. And, when a government would rather let its citizens eat grass and tree bark while it feeds its military and MWD projects, we cannot believe that it would have the desire to supply its citizens with electricity. North Korea has violated agreement after agreement, and it just doesnt care. Why? Because it has nukes. Thats why were pursuing a diplomatic option with North Korea while pursuing war preparation with Iraq. Any real trouble with North Korea will devastate our economy even more.
Look at the war on terrorism from the insurance standpoint. When the terrorists flew those airplanes into the World Trade Center, insurance companies had an enormous amount of claims to pay. Warren Buffetts company, Berkshire Hathaway, had to shell out more than $2 billion in 9/11 claims. Most insurance companies themselves buy insurance, a process called reinsurance. That process protects them against devastating losses such as what happened on September 11, 2001. Nonetheless, it causes all premiums to rise. Moreover, many insurance companies have since excluded coverage for terror-related incidents, while others include new riders (and extra premiums) for those who want to maintain coverage in the event of a terror-related incident.
Unlike past wars, the war on terrorism will never end. There are no defined boundaries, no finite set of enemy leaders or foot soldiers. It will be a continuing drain on governments and economies around the world into the foreseeable future.
The Good News
After reading all this bad news, you must think that there is nothing you can do but stick all your money under the mattress, load the .45 and store canned goods. That neednt be the case at all. The worlds most famous stock trader, Jesse Livermore, earned $100 million on Black Tuesday, October 29, 1929 by shorting stocks. Joseph P. Kennedy, the father of a future president, earned his third fortune by doing the same thing in the Great Crash. Opportunities to earn a fortune are even greater now: data is available at the touch of a keystroke, unlike during the Great Depression. You can now invest in mutual funds whose performance goes up when stock indices go down. Its easy to short stocks, and its even easier to short exchange-traded funds (ETFs), since those funds have no up-tick rule. You will always find at least one asset that performs well, even during tough economic times. Gold, for example, gained strongly during the Great Depression, as it has since 2001. Bonds have performed very well. The entire energy complex is hitting highs not seen since the Gulf War. Any asset can turn abruptly, as we all know, so check with a financial advisor before investing in any of them.
Speaking of financial advisors, the worst thing you could do is to seek out an advisor who is in the buy and hold category. Find one who is independent and realistic. If you want to make your own financial decisions, fine. Just have a sound basis for making your decisions, realize when you have made a mistake, cut your losses short, and let your profits run.
If you bought a tech stock at $100.00 per share and its now at $4.00, youre tempted to wait it out. Dont. Youve made a mistake. Get over it. Take a loss, pick up your marbles and move on to another game. New opportunities present themselves every day in the investment world. Jesse Livermore knew that, as did Joe Kennedy. Do you?
© 2003 John Finger The Money Management Firm, Inc. firstname.lastname@example.org
Thank you Chicken Little
"Gee who should I call......?"
Remind me never to let this guy touch my money. He knows nothing about economics.
The chart below would seem to deflate that statement handily.
You must not read "Financial Sense' too often. This is par for the course.
Don't worry. With a work ethic like this, this country will come out smelling like a rose...
I don't know anybody who voted for Al Gore.
Does that mean he didn't get any votes?
This is the dumbest article in the financial realm I've ever read.
There, I feel better now.
I also think people have had it pretty good for so many years that a little hardship freaks them out. Decisions we as individuals AND the go'ment make affect us all....and for a long period of time. And have you noticed, when we are in the middle of an up cycle, some cannot see that eventually, a down cycle is going to happen....no matter what....
Do some searching through the archives of the San Jose Mercury News. Immigrants in CA are living in garages and 3-4 families in a house. They're not building new houses.
True. And a more reasonably-defined "break-even" would be 30-40 years. On the other hand, if someone isn't expecting to retire for 30-40 years, that may not be so much of a concern. Obviously for people who will need their money sooner than that, having enough invested in other things to last until the cyclical bear is over is a very good idea.
I don't agree w/ the parts about deflation (WHAT deflation? Has he priced health insurance lately?) However, the part about housing is spot on. The economy *is* being fueled by home equity loans. There *is* an insurance problem with buying shells & fixer-uppers. The middle class *is* being squeezed into higher & higher-priced markets (meaning they're taking on big mortgage debt, even if the borrowing rates are low), and at some point there is going to be a housing correction. Coming on top of unemployment / underemployment, it is going to hit some people very hard, and will reverberate through the whole economy.
I knew that was where this article was going!