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Does a Falling Money Stock Cause Economic Depression?
Mises.org ^ | April1 18, 2003 | Frank Shostak

Posted on 04/20/2003 5:21:01 PM PDT by sourcery

Does a Falling Money Stock Cause Economic Depression?

By Frank Shostak

[Posted April1 18, 2003]

Despite the aggressive lowering of the federal funds rate target from 6.5% in December, 2000 to the current level of 1.25%, U.S. economic activity remains subdued. Faced with a lackluster response to this aggressive monetary stance, it is tempting to draw parallels with the 1930's economic depression.

Most economists hold that such comparisons are not warranted. Following the writings of Milton Friedman, they are of the view that the policy makers of the Fed have learned the lesson of the Great Depression and know how to avoid a major economic slump.

In his writings Milton Friedman blamed central bank policies for causing the Great Depression. According to Friedman the Federal Reserve failed to pump enough reserves into the banking system to prevent a collapse in the money stock (Milton and Rose Friedman's Free To Choose). In response to this failure, Friedman argues, money stock, M1, fell by 33% between late 1930 and early 1933 (see chart).

According to Friedman, as a result of the collapse in the money stock economic activity followed suit. Thus by July 1932 year-on-year industrial production fell by over 31% (see chart). Also, year-on-year the consumer price index (CPI) had plunged. By October 1932 the CPI fell by 10.7% (see chart).

However, a close examination of the historical data shows that contrary to Friedman the Fed was extremely loose and pumped reserves into the system in its attempt to revive the economy (on this see Murray Rothbard's America's Great Depression). The extent of monetary injections is depicted by changes in the Fed's holdings of U.S. government securities. Thus on January 1930 these holdings stood at $485 million. By December 1933 they had jumped to $2,432 million—an increase of 401% (see chart). Moreover, the average yearly rate of monetary injections by the Fed during this period stood at 98%.

Also, short-term interest rates fell from almost 4% at the beginning of 1930 to 0.9% by September 1931 (see chart). Another indication of a loose monetary stance on the part of the Fed was the widening in the differential between the yield on the 10-year T-Bond and the yield on the 90-day Bankers Acceptances. The differential rose from -0.51% in January 1930 to 2.37% by September 1931 (see chart).

The sharp fall in the money stock between 1930 to 1933, contrary to Friedman, is not indicative of the Federal Reserve's failure to pump money. Instead it is indicative of a shrinking base of investable capital brought about by the previous loose monetary policies of the central bank. Thus the yield spread increased from -0.9% in early 1920 to 1.9% by the end of 1925 (an upward sloping yield curve indicates loose monetary stance). The reversal of the stance by the Fed from 1926 to 1929 burst the monetary bubble (see chart).

In addition to this, at some stages monetary injections were massive. For instance, the yearly rate of growth of government securities holdings by the Fed jumped from 19.7% in April 1924 to 608% by November 1924. Then from 0.3% in July 1927 the yearly rate of growth accelerated to 92% by November 1927. Needless to say that such massive monetary pumping amounted to a massive exchange of nothing for something and to a severe depletion of the pool of real funding, that is, the essential source of current and future capital needed to sustain growth.

As long as the pool of real funding is expanding and banks are eager to expand credit (credit out of "thin air") various nonproductive activities continue to prosper. Whenever the extensive creation of credit out of "thin air" lifts the pace of real-wealth consumption above the pace of real-wealth production the flow of real savings is arrested and a decline in the pool of real funding is set in motion. Consequently, the performance of various activities starts to deteriorate and banks' bad loans start to rise. In response to this, banks curtail their lending activities and this in turn sets in motion a decline in the money stock.

The fall in the money stock begins to further undermine various nonproductive activities, i.e. an economic depression emerges. In this regard after growing by 2.7% year-on-year in January 1930 bank loans had fallen by a massive 29% by March 1933 (see chart).

How is it possible that lenders can generate credit out "of thin air" which in turn can lead to the disappearance of money? Now, when loaned money is fully backed up by savings, on the day of the loan's maturity it is returned to the original lender. Thus, Bob—the borrower of $100—will pay back on the maturity date the borrowed sum plus interest. The bank in turn will pass to Joe, the lender, his $100 plus interest adjusted for bank fees. To put it briefly, the money makes a full circle and goes back to the original lender.

In contrast, when credit is created out of "thin air" and returned on the maturity day to the bank this amounts to a withdrawal of money from the economy, i.e, to a decline in the money stock. The reason for this is because there wasn't any original saver/lender, since this credit was created out of "thin air."

It follows then that the sole cause behind the wide swings in the stock of money is the existence of fractional reserve banking, which gives rise to unbacked-by-savings credit. (In the Mystery of Banking Murray Rothbard showed that it is the existence of the central bank that enables fractional reserve banking to thrive).

Observe that economic depressions are not caused by the collapse in the money stock (as suggested by Milton Friedman), but come in response to a shrinking pool of real funding on account of previous of loose money. Consequently, even if the central bank were to be successful in preventing the fall of the money stock, this would not be able to prevent a depression if the pool of real funding is declining. Also, even if loose monetary polices were to succeed in lifting prices and inflationary expectations (as suggested by Paul Krugman), this would not revive the economy as long as real funding is declining.

Again, note that contrary to popular thinking, depressions are not caused by tight monetary policies, but are rather the result of previous loose monetary policies. On the contrary, a tighter monetary stance arrests the depletion of the pool of real funding and thereby lays the foundations for economic recovery. Furthermore, the tighter stance reveals the damage that was done to the capital structure by previous monetary policies.

Have we learned the lesson of the Great Depression?

Do central banks have all the necessary tools to prevent a severe economic slump similar to the one that occurred in the 1930's? Most economists are adamant that modern central banks know how to counter the menace of a severe recession.

But if this is the case why has the central bank of Japan failed so far in reviving the Japanese economy? The Bank of Japan (BOJ) has used all the known tricks as far as monetary pumping is concerned. Thus interest rates were lowered to almost zero (see chart) while BOJ monetary pumping as depicted by its holdings of government securities increased by 323% between January 1990 and March 2003 (see chart).

It is likewise in the U.S. For over two years the Fed has been aggressively lowering interest rates and yet economic activity remains subdued (see chart). For instance, in relation to its long-term trend industrial production remains in free fall (see chart). The Fed's holdings of government securities have increased by 189% between 1990 Q1 and 2002 Q4. The yearly rate of growth of these holdings jumped to 14.1% in Q4 2002 from 9.8% in Q1 (see chart).

Moreover, a steep fall in the personal income to personal outlays ratio indicates that the pool of real funding is under pressure (see chart). Note that during the 1930's the fall in this ratio wasn't as steep as now (see chart).

We suspect that there is a strong likelihood that if the economy does not rebound soon, the Fed will lower interest rates further and will intensify its monetary pumping. This, however, will only further prolong the economic misery.


TOPICS: Business/Economy
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1 posted on 04/20/2003 5:21:01 PM PDT by sourcery
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To: Tauzero; Starwind; arete; David; Soren; Fractal Trader; Libertarianize the GOP; zechariah; ...
FYI
2 posted on 04/20/2003 5:21:47 PM PDT by sourcery (The Oracle on Mount Doom)
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To: sourcery
bump
3 posted on 04/20/2003 5:27:55 PM PDT by bribriagain
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To: sourcery
if the economy does not rebound soon, the Fed will lower interest rates further and will intensify its monetary pumping. This, however, will only further prolong the economic misery.

He left out the big hitter, depression.

Interesting scenario. There is one big item that is not even mentioned, Mortgage Debt.

What role will this interloper play. It's certainly not the same as 29 with this factor.

Anyone want to take a slice at that ?

4 posted on 04/20/2003 5:42:21 PM PDT by imawit
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To: sourcery
bump for later reading
5 posted on 04/20/2003 5:58:30 PM PDT by BlackVeil
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To: sourcery
Excellent article. Thanks! I've always been rather critical of Milton Friedman's analysis of the Great Depression - this collects many of my loosely conceptualized objections.
6 posted on 04/20/2003 5:59:15 PM PDT by AntiGuv ()
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To: sourcery
Paper money,paper money. It's only imitation.
7 posted on 04/20/2003 6:02:36 PM PDT by eternity (From here to...)
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To: bvw; Tauzero; Matchett-PI; Ken H; rohry; headsonpikes; RCW2001; blam; hannosh4LtGovernor; ...
As long as the pool of real funding is expanding and banks are eager to expand credit (credit out of "thin air") various nonproductive activities continue to prosper.

The system hasn't been permitted to clear itself of the 90's bubble. Instead, the excesses and nonproductive activities are now being supported to present the illusion that all is well. In the mean time, the underlying economy becomes weaker and weaker.

Richard W.

8 posted on 04/20/2003 6:20:53 PM PDT by arete (Greenspan is a ruling class elitist and closet socialist who is destroying the economy)
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To: arete
Agreed. Which would suggest that when it does finally tank it will be very nasty indeed. Kind of like having a potentially fatal disease, and instead of treating it right away you cover the symptoms with pain medication. Eventually the problem becomes much worse.

This is one of those deals where I hope I'm wrong but I fear I'm right.
9 posted on 04/20/2003 6:23:34 PM PDT by Billy_bob_bob ("He who will not reason is a bigot;He who cannot is a fool;He who dares not is a slave." W. Drummond)
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To: Billy_bob_bob
What if "Made in America" became important for national security. Could a boycott of Chinese products bring manufacturing, along with good paying jobs, back to the USA?
10 posted on 04/20/2003 6:41:19 PM PDT by marbren
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To: sourcery
I want a 3% 30 year mortgage. Then the FED can start raising rates.
11 posted on 04/20/2003 6:47:27 PM PDT by AmericaUnited
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To: marbren
What if Walmart said we will sell nothing made in China.
12 posted on 04/20/2003 6:56:56 PM PDT by marbren
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To: sourcery; arete; NYTexan; rohry; sarcasm; hinckley buzzard; Soren; imawit; steve50; litehaus; ...
This is an important article and certainly an excellant post.

The underlying proposition here, advanced generally by present day fed economists, the monetarists (led by Dr. Milton Friedman), and the popular media, is that the depression was caused by failure of the Monetary Authorities (the Fed) to provide sufficient liquidity in the form of money supply.

The first, perhaps most important point made by the author, Frank Shostak is that this is just plain wrong on the record--it's another one of those self serving propositions that when said often enough, is accepted as fact even though a cursory examination of the real data demonstrates that it is a fraud.

Many years ago, when I was in college, the cause of the Great Depression was still a contentious issue--the lead, and best economics professor at the University was an accused card carrying Communist in the 30's because he believed that the depression was the necessary result of internal faults in the free enterprise system.

I took Economic Cycles from a visiting Harvard economics professor who parroted the same lines. However one class session was conducted by an individual who had been on the Fed staff in the 30's. He said the modern monetarist line is nonesense--"What do people think we were doing back then anyway? Did they think we were asleep? Did they think we were not reading the data?"

As a committed believer in the free enterprise system, I spent a lot of time researching to develop my own political economic understanding of what really happened.

This article only refutes the popular legend. The issue however is what in fact is the cause of the economic condition that led to the great depression and is leading to the greater depression today. The answer is clear--the data is readily available; and the analysis is simple.

The depression of the 1930's was caused by the excessive liquidity created by the fed in the 1920's. As the author points out excess liquidity resulting from injection of bank reserves gets into the economy through the debt process. In the 1920's, the principal engine was stock market margin debt--everyone was in the stock market, creating a bubble with margin debt. When it became clear that underlying values (earnings) did not support prices, prices collapsed leaving the debt to be repaid from other sources.

How does debt result in deflation? Debtors of any class, government, business, or individual, have limited liquidity. That is why the debt (borrowed liquidity) was needed in the first place. Debtor liqudity may come from tax revenues, business earnings, or monthly earned income--but it is limited. The portion of available periodic liquidity commited to payments on debt curtails liquidity for other purposes--instead of buying a new car this month, the debtor makes a payment on his new house.

There is no reliable data on what the real limits are--how much of current income can be paid on residential mortgage debt, or credit cards or whatever without creating a deflationary economic environment. Historically, mortgage lenders had rules of thumb however we have now exceeded those limits significantly.

Point is that in the macro economy, you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments. Buyers disappear.

In the business environment, pricing power disappears and prices begin to drop; so do profits. Tax revenues drop because they are based on economic activity (income and spending). Jobs disappear; or compensation on continuing employement drops.

Deflation becomes imbedded--because new debt is incurred, not to buy additional assets but instead to make payments on existing debt.

Mortgage debt and the housing market? What has happened is that the users of residential real estate no long have enough current liquidity to pay for the right to use the asset at current market prices which have been inflated by excess available credit to marginally qualified buyers. There are other factors at work in the housing market--property taxes and insurance, both based on the inflated bubble price and taxes raised to support expansionary economy levels of government activity that no longer are required. So we have skipped payments; interest only months; rising default rates and mortgage foreclosures. Monthly payments are made with additional credit card debt. A general decline in market prices is probably not too far ahead.

This is a fair summary of the current economic environment. As Shostak points out, the historical experience is that additional lending has been counterproductive (in the US in the 30's; and in Japan). Reason why is of course set out above.

How do we get out of this mess? Well you have to see how people get additional liquidity other than through the debt process. You have to expect new jobs to be created and employment to go up; compensation has to go up; business income has to go; tax receipts must go up. If anybody sees any positive signs on any of these items, or if anybody can see any reason why any of these things might happen, they should post immediately. I don't.

13 posted on 04/20/2003 7:12:12 PM PDT by David
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To: David
You seem to have some idea of what's going on. I'd appreciate your opinion of my analysis.
14 posted on 04/20/2003 7:56:09 PM PDT by B-Chan (Catholic and Monarchist)
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To: David; Torie; Fractal Trader
An exceptional post, the only notable element which I see unremarked is that excess liquidity creates excess capacity which then diminishes the returns on further capital investment to the point of unprofitability. Until such point that capital investment once again reaps sufficient profits to justify capital formation, the downward deflationary spiral continues. JMHO.
15 posted on 04/20/2003 8:00:52 PM PDT by AntiGuv ()
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To: David

Worst Stock Market Crashes
The 10 worst stock market crashes in U.S. History.

1932 - 1933 Stock Market Crash
The 10th worst stock market crash in U.S. History.

To find out 10th worst market crash, I had to dig back in the DJIA records all the way back to the 1930s. This crash barely beat out the 1987 stock market crash (loss of 36.1%) - a crash that most of us are more familiar with.

Date Started: 9/7/1932
Date Ended: 2/27/1933
Total Days: 173
Starting DJIA: 79.93
Ending DJIA: 50.16
Total Loss: -37.2%

==================================

1916 - 1917 Stock Market Crash
The 9th worst stock market crash in U.S. History.

If the 1930s sounded like a long time ago, well to find the 9th worst market crash, I had to go back to the WWI era.

It's difficult to break even after a 40% loss. On a $1,000 investment, your portfolio went down to $600. To get back to $1,000, it would have to go up 66.7%!

Date Started: 11/21/1916
Date Ended: 12/19/1917
Total Days: 393 Starting DJIA: 110.15
Ending DJIA: 65.95
Total Loss: -40.1%
====================

1939 to 1942 Stock Market Crash
The 8th worst stock market crash in U.S. History.

Although this stock market crash only took the 8th spot, it is the longest one on our list, lasting nearly 3 years! With WWII and the attack on Pearl Harbor, the markets had a very tough time.

Date Started: 9/12/1939
Date Ended: 4/28/1942
Total Days: 959
Starting DJIA: 155.92
Ending DJIA: 92.92
Total Loss: -40.4%
==============================

1973 - 1974 Stock Market Crash
The 7th worst stock market crash in U.S. History.

Another long market crash - one that many people still remember (think Vietnam and the Watergate scandal). This crash lasted for 694 days before bottoming out.

Date Started: 1/11/1973
Date Ended: 12/06/1974
Total Days: 694
Starting DJIA: 1051.70
Ending DJIA: 577.60
Total Loss: -45.1%
================================

1901 - 1903 Stock Market Crash
The 6th worst stock market crash in U.S. History.

This is the oldest crash to make the list

Date Started: 6/17/1901
Date Ended: 11/9/1903
Total Days: 875
Starting DJIA: 57.33
Ending DJIA: 30.88
Total Loss: -46.1%
==================================

1919 - 1921 Stock Market Crash
The 5th worst stock market crash in U.S. History.

This crash followed a post war boom (Stock prices rose 51%). After the crash bottomed out in August of 1921, this decade saw tremendous growth in the stock market and the economy (often called the roaring twenties).

Date Started: 11/3/1919
Date Ended: 8/24/1921
Total Days: 660
Starting DJIA: 119.62
Ending DJIA: 63.9
Total Loss: -46.6%
========================================

1929 Stock Market Crash
The 4th worst stock market crash in U.S. History.

Although this is the shortest market crash observed, it was a deadly one. Investors saw almost half their money disappear in just two months. This crash kicked off what we now know as the "Great Depression."

Date Started: 9/3/1929
Date Ended: 11/13/1929
Total Days: 71
Starting DJIA: 381.17
Ending DJIA: 198.69
Total Loss: -47.9%
=================================

1906 - 1907 Stock Market Crash
The 3rd worst stock market crash in U.S. History.

This crash was called the "Panic of 1907." The U.S. Treasury department bought 36 million dollars worth of government bonds to offset the decline (and remember, $36 million translates to a much bigger number in today's dollars).

Date Started: 1/19/1906
Date Ended: 11/15/1907
Total Days: 665
Starting DJIA: 75.45
Ending DJIA: 38.83
Total Loss: -48.5%
====================================

1937 - 1938 Stock Market Crash
The 2nd worst stock market crash in U.S. History.

Just when investors thought the market was finally good again, following a recovery of almost half of the great depression losses, the market plunged again due to war scare and Wall street scandals.

Date Started: 3/10/1937
Date Ended: 3/31/1938
Total Days: 386
Starting DJIA: 194.40
Ending DJIA: 98.95
Total Loss: -49.1%
============================

Worst Market Crash Ever (1930 to 1932)
The worst stock market crash ever in U.S. History.

This is the grand daddy of them all. Investors lost 86% of their money over this 813 day beast. This market crash combined with the 1929 crash, makes up the great depression.

If you had $1000 on 9/3/1929 (beginning of the 4th worst crash, it would have gone down to a whopping $108.14 by July 8th, 1932 (end of the worst crash) or an 89.2% loss. To recover from a loss like that, you would have to watch your portfolio go up 825%! The full recovery didn't take place until 1954, 22 years later!

Date Started: 4/17/1930
Date Ended: 7/8/1932
Total Days: 813
Starting DJIA: 294.07
Ending DJIA: 41.22
Total Loss: -86.0%
========================================

http://mutualfunds.about.com/library/weekly/aa102802k.htm

16 posted on 04/20/2003 8:01:32 PM PDT by yankeedame ("Oh, I can take it, but I'd much rather dish it out.")
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To: Billy_bob_bob; arete
" Which would suggest that when it does finally tank it will be very nasty indeed."

.....yes, and my hunch is that the triggering event will be a rate cut....we've had 12 already with lack luster results.....the Fed is running out of ammo and if they keep cutting eventually people will say "nothings working....I'm getting out while I still can"....IMHO that's when the stampede will begin....I expect it will be much worse than the great Depression for 2 reasons....a)people didn't have big debt back then...b)about 40% of the population lived on farms so they could make do to some degree.

Like you Billy Bob, I hope I'm wrong about this

Good luck to everyone!

Stonewalls the Ant

17 posted on 04/20/2003 8:01:35 PM PDT by STONEWALLS
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To: sourcery
Bookmarking
18 posted on 04/20/2003 8:05:17 PM PDT by terilyn
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To: imawit
"Anyone want to take a slice at that ?"

When forclosures start snowballing and there is no sale for them by the banks they will be turned over to HUD.

My fear is that HUD won't sell or auction them off but will keep them and they will become low cost housing.

Deep down I suspect that this has been a government plan for many years in the making and that the ultimate goal is to have almost everyone living in government housing, dependant on government and therefore guarnteed sheep for a socialist america!
19 posted on 04/20/2003 8:06:30 PM PDT by dalereed
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To: David
Thanks
20 posted on 04/20/2003 8:12:17 PM PDT by cowtowney
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To: David
Excellent post!. "When it became clear that the underlying values did not match prices, prices collapsed..." Sounds like the 90's, doesn't it?
21 posted on 04/20/2003 8:19:39 PM PDT by plusone
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To: David
You put it quite succinctly.

you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments. Buyers disappear.

Not only this but the bubble and re-bubble going on by the FED cause dollar devaluation and with more bucks being lent out, lenders will want higher interest rates when they know they will be getting back dollars that buy less because inflation has set in. That $1 hamburger & fries is now $6.75. This added activity leaves the economy no where to turn.

22 posted on 04/20/2003 8:20:12 PM PDT by imawit
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To: marbren
Could a boycott of Chinese products bring manufacturing, along with good paying jobs, back to the USA?

If we could get the government officials to even consider that American jobs were important then it might work. How do we change the Socialists in the government?

23 posted on 04/20/2003 8:21:35 PM PDT by B4Ranch (Most of us are wasting rights other men fought and died for.)
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To: marbren
Personally, I think it's critical that China be forced to alter its fiscal policies (esp. yuan currency appreciation) or otherwise become subject to protectionist measures. Unfortunately, I see minimal impetus in that direction so far as American policymakers are concerned...
24 posted on 04/20/2003 8:25:14 PM PDT by AntiGuv ()
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To: B4Ranch
"How do we change the Socialists in the government?"

First you have to get a Supreme Court that believes in the Constitution.

If that ever transpires, you need someone with enough money and a smart attorney to sue the federal government to eliminate all programs that aren't authorized by the Constitution, including Social Security and Medicare!

25 posted on 04/20/2003 8:26:31 PM PDT by dalereed
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To: dalereed
That's a scarey thought!
It would diminish property values like a plague!
26 posted on 04/20/2003 8:32:59 PM PDT by NYTexan (back to the bunker...)
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To: David
What all of this analysis misses is that money supply contracted after the stock market crash in 1929, and then protectionism ensued. In a global economy, and with a Fed that won't contract the money supply, I really don't see the analogy. Debtors are balanced by creditors, and the key is to let the money flow between them on a global basis. Granted, if loans are imprudent, there is economic waste, which must be paid for. But in the modern economic era, that need not lead to a depression.
27 posted on 04/20/2003 8:39:02 PM PDT by Torie
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To: David
How does debt result in deflation? Having read these words several times I find myself still puzzled by the wording/meaning of this question. Is the question: "How does deflation effect debt?"

Debtors of any class, government, business, or individual, have limited liquidity. That is why the debt (borrowed liquidity) was needed in the first place. Debtor liqudity may come from tax revenues, business earnings, or monthly earned income--but it is limited. First off, every thing in the universe is limited, however unimaginable those limits might be. Second, government revenues, business earnings, et. al. are indeed limited when speaking in context of the here and now. We borrow-- for a car, a house, whatever-- and the banks lend us money on the carefully considered assumption that we will be worth more tomorrow,or next year, than we are today. Businesses and governments borrow and are loaned money, via stocks and bonds, on basically the same assumption.

There is no reliable data on what the real limits are--how much of current income can be paid on residential mortgage debt, or credit cards or whatever without creating a deflationary economic environment. Speaking in the vast macro-economic sense, yes that is true; but, in reference to individual, business and, yes, even government "debtor liquidity" there are, of course, available,.e.g. Moody's, Morningstar, etc.

Point is that in the macro economy, you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments... Again, this is based on the assumption of a static condition: That he who has $5 today, will have $5 tomorrow and $5 next week, maybe less but never than a penny or two more.

In the business environment, pricing power disappears and prices begin to drop; so do profits. True enough, to a point. Prices drop simply because they must in order to the company to maintain it's place in the market- but prices can only drop to a point. When profit derived from these lower, unsubstantiated price cuts (Spacely's Sprockets cut prices not because they found a better,cheaper way to make sprockets but simply because they had to) reach a certain point the company simply stops making the products. Only the federal government can continue to make something, be it goods or services, at a loss.

Deflation becomes imbedded--because new debt is incurred, not to buy additional assets but instead to make payments on existing debt. Which can not be lowered-either by fiat or allowed to drift downward. The cause of this is, in a word: contracts. No matter if it is in re: a union pay agreement, a purchasing order for a business, or a 30 year mortgage.

So we have skipped payments; interest only months; rising default rates and mortgage foreclosures. Monthly payments are made with additional credit card debt. A general decline in market prices is probably not too far ahead. This is because, as the old saying goes, "water seeks its own level". If, for whatever reason, real estate/housing prices are out of wack with reality the Free Market, if allowed to work, will bring them down (or raise them up) to their true level.

This is a fair summary of the current economic environment. As Shostak points out, the historical experience is that additional lending has been counterproductive No doubt, no doubt, but then you come to the sticky question of "additional lending", according to whom? by whose standards? By whose defination?" etc., etc., but that, as they say, is for another day.

How do we get out of this mess? Well you have to see how people get additional liquidity other than through the debt process. You have to expect new jobs to be created and employment to go up; compensation has to go up; business income has to go; tax receipts must go up. If anybody sees any positive signs on any of these items, or if anybody can see any reason why any of these things might happen, they should post immediately. I don't. IMHO, it's call "politics". Elections are not too far off and it is to the benefit of not a few to make sure the kettle stays hot and well stirred

28 posted on 04/20/2003 8:56:48 PM PDT by yankeedame ("Born with the gift of laughter and a sense that the world was mad.")
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To: David
Ditto to everything you said. And I believe the mortage mortgage market is even more ripe for a fall. Beyond the gross inflation, freddie and fannie are neck deep in derivatives and the growth rates simply cannot be maintained. It appears that the entire country forgot the lessons of the depression:
  1. Don't trust banks (or government)
  2. Anomalous growth is never real or sustainainable.
The collapse of the world economy will not be quiet.
29 posted on 04/20/2003 8:59:19 PM PDT by antidisestablishment (Our people perish through lack of wisdom, but they are content in their ignorance.)
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To: AntiGuv
If Wal-Mart were to implement a MADE IN USA only policy, would the American consumer be able to afford the goods? I look around my house and I'm hard pressed to find much made here. I'm an average Joe who buys the best product at the best price.

By the way, I don't see the economic slowdown at my local Wal-Mart supercenter. Shopping there can be a hellish experience due to the large crowds.
30 posted on 04/20/2003 9:55:44 PM PDT by okiesap
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To: okiesap
I don't think Wal-Mart deciding to buy only American-made goods would have much effect on the unemployment rate in this country.
31 posted on 04/20/2003 10:10:54 PM PDT by B-Chan (Anglican Use Bump!)
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To: okiesap; arete; razorback-bert
"If Wal-Mart were to implement a MADE IN USA only policy, would the American consumer be able to afford the goods?"

...that's a good point, and the corollary to it is...If Wal-Mart were to implement a MADE IN USA only policy, would the American economy be able to keep them supplied?.....for example, I'm not sure there's enough textile capacity left in this country to keep Wal-Mart in soft goods.....

Good luck to everyone!

Stonewalls

32 posted on 04/21/2003 5:34:33 AM PDT by STONEWALLS
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To: imawit
" It's certainly not the same as 29 with this factor."

The details are never exactly the same. This fact facilitates bullish rationalization, guaranteeing the gross mistakes will be the same.
33 posted on 04/21/2003 9:03:25 AM PDT by Tauzero
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To: sourcery; Onyxx
Bump for later read.
34 posted on 04/21/2003 9:37:20 AM PDT by Unknown Freeper
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To: sourcery
Despite the aggressive lowering of the federal funds rate target from 6.5% in December, 2000 to the current level of 1.25%, U.S. economic activity remains subdued.

Yes, but what was happening BEFORE "December 2000"? The Fed was tightening the screw to fight imaginery inflation even after the shares started to fall.

35 posted on 04/21/2003 9:41:15 AM PDT by A. Pole
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To: yankeedame
Deflation becomes imbedded--because new debt is incurred, not to buy additional assets but instead to make payments on existing debt.

Bump

36 posted on 04/21/2003 9:45:03 AM PDT by A. Pole
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To: sourcery
Great article. I wonder why the Fed rate was raised to 6.5% just six months before the 2000 election, after the spigot had been open most of Clinton's two terms in office.

That must have been just the whiplash needed to start the next presidency off with a record economic slump.

37 posted on 04/21/2003 11:20:23 AM PDT by meadsjn
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To: David; dalereed; Tauzero; arete
Did some more thinking about this over the weekend.

Let's say the article was correct on the reasons and influences for the 29 crash.

There is a really big difference today from that. That episode was caused by financial and monetary frailty and mismanagement. Many of those factors are extant today. The major difference being that loans were margin and the equities behind those margins tanked

Today there are more loans and debt against equities such as real estate. This equity will not tank as fast as stocks will. The 29 crash was a series of daily crashes which in the end had a snow ball effect and a stampede. This won't happen with housing.

Housing takes a while. Not everyone will need to sell right away nor can houses be sold right away. Even defaults take a while. Should this happen, the mortgagees then have some equity of some value also and not everyone will have to sell either or default either.

Looks to me like the financial side of mortgages will suffer first and collapse before the mortgagors will. And, should the mortgagees take their equity in the form of homes, this will collapse but there will still be those who can hold on to their homes and live in them while the mortgagees have much reduced equity.

Interesting scenario. Any further factors or actions resultant thereby ?
38 posted on 04/21/2003 12:02:03 PM PDT by imawit
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To: B-Chan
I'm beginning to come around to your position: employment is the key.

I think you could have a stock market crash without it necesarily taking the economy into recession. So I think that even if employment picked up, I'm not so sure that the stock market would immediately turn around.

I note also that there was a big round of tarrif hikes in 1929/30 that was effectively a tax on business. Plus government deficit spending was competeing with business for capital. So it looks like you had several factors holding back new job creation in the 30's.

[z]
39 posted on 04/21/2003 12:12:31 PM PDT by zechariah (The Lord is with you, Mighty Warrior!)
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To: David
Excellent analysis as usual.

Richard W.

40 posted on 04/21/2003 1:24:43 PM PDT by arete (Greenspan is a ruling class elitist and closet socialist who is destroying the economy)
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To: okiesap
If Wal-Mart were to implement a MADE IN USA only policy, would the American consumer be able to afford the goods?

Sure, b/c Target, K-Mart, HomeDepot, Sears, Penney's, et. al. would continue to stock Chinese/foreign(made) goods and in the process nail Wal-Mart to the wall, e.g. Wal-Mart would offer a 13 gallon white plastic trash can MADE IN USA for $5.45, while down the street Target would offer the same 13 gallon white trash can, made in Mexico, for $3.99.

41 posted on 04/21/2003 3:12:40 PM PDT by yankeedame ("Born with the gift of laughter and a sense that the world was mad.")
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To: imawit
Reply to your #38:

The significant thrust of the article is to respond to the monetarist economist conventional wisdom that the events of 1929 were caused by a failure of sufficient liquidity. That is a simple factual data issue. The conventional wisdom is simply wrong--not supported by the data. Facts are that the fed pumped money to the maximum extent possible and money supply went down because no one borrowed the money.

My point is that not only is the Conventional Wisdom which dictates the lower interest rate cheaper reserve banking answer wrong, but that the real cause of deflations and depressions can be seen in Fed policy errors that resulted in increased debt and debt service.

Your point about the difference in collateral today versus 1929 is correct--in 29, the collateral was margined stock equity and today, the principal collateral is real estate.

And it clearly makes some difference. But we differ a little in what those differences are. Common stocks are the subject of a daily quotation report--values are the trading prices on the margin--so everyone knows exactly what today's trading price is. In real estate, it is not quite so clear. I would argue that in fact, real estate is tanking but the price ranges and geographical locations in which price declines are occuring are diverse. I further differ with you on the future although that is just an opinion--I think we will ultimately see the cascading decline in values in residential real estate when owners recognize that values have slipped away from them.

Your argument that won't happen is based on two prositions: One, there is residual equity that will permit the owner to continue to hold through the slide; and two, mortgagees won't foreclose because they would rather get something out of the debt and have the property in REO.

I think existing equities are very very thin, in large part because of the refi boom. And historically lenders have taken the property back because of their experience that when they don't, maintenance stops and the value of the collateral deteriorates.

In most markets, we are working our way through the time period where the seller can wait to market the property at a high price--we are seeing deferred monthly payments; interest only; and deals where financing on the new house is structured to carry the debt service on the old house during a marketing period. That time is coming to an end.

I also think the current stock market values indirectly support real estate values. Owners continue to view their stock mutual fund portfolios as having some retained value--so they continue to hold the real estate for sale at above market prices. When the stock market declines, real estate values will follow.

42 posted on 04/21/2003 3:28:31 PM PDT by David
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To: sourcery
Bump!
43 posted on 04/21/2003 3:39:25 PM PDT by Incorrigible
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To: yankeedame
OK I want to address a couple of issues raised by your well thought out response in #28.

"How does debt result in deflation? Having read these words several times I find myself still puzzled by the wording/meaning of this question. Is the question: 'How does deflation effect debt?'"

No. My analaysis is that excess levels of debt are the primary cause of deflations like the one which occurred in 1929 as a result of the margin debt creation of which was facilitated by the fed in the mid 20's; and like the current situation which is the result of excess debt at every level, credit card consumer; mortgage; government and business, facilitated by fed policy in the early and mid 90's.

The excess debt requires commitment of current liquidity wherever it comes from, to payment for past spending and acquisitions rather than current utility. Entities (individual and otherwise) are using current cash flow to pay for spending that occured some time ago. Thus current spending is curtailed.

Deflation results because entities can no longer cause increases in money supply because they don't have excess liquidity to make monthly payments on new debt because all excess liquidity is commited to old spending. Deflation further results from retirement of existing debt--the amount of debt retirement comes out of the money supply. So money supply sinks and you get deflation which ultimately progresses into depression in the extreme version.

The 1990's experience is more serious than the 1920's version because the amount of debt is much greater and the excess exists in more segments of the economy.

Your description of the assumptions that lead entities to incur debt and lenders to make the loan is correct. And the default in that assumption is what has caused the problem. If incomes, profits, tax revenues and values continued up, there would be increasing liquidity to make payments on existing debt plus pay for additional purchases. Problem is that incomes, profits, tax revenues and values are now going down--the Fed made a serious policy error and facilitated the creation of so much excess debt in the 90's that current liquidity is curtailed to a degree that has resulted in layoffs, lower compensation, loss of pricing power and the like resulting in a major deflationary period which is now becomeing a depression.

I am not sure what you mean by your concluding point. In order to get out of this without a major adjustment shock--2 out of every 3 houses in foreclosure; Dow at 1200; municipal bond defaults; you need to be able to see how incomes and revenues go up and available liquidity is generated other than through borrowings. Since I don't see that happening, I think the political answer ought to be to look for a way to resolve the illiquidity problem.

We could amend the Bankruptcy Act to permit debtors to elect to hand over all their net collateral assets in a speeded liquidity proceeding to the creditors. We need a legal mechanism to get through the procees that took us from 1930 to 1949 the last time. We need a sound money system so that creditors and debtors alike can be sure that when their liquidity problems are resolved, they can go back to work free from concern that government policy will rob them of the proceeds of their endeavors.

44 posted on 04/21/2003 3:56:41 PM PDT by David
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To: Torie; arete; NYTexan; rohry; sarcasm; hinckley buzzard; Soren; imawit; steve50; litehaus; ...
"What all of this analysis misses is that money supply contracted after the stock market crash in 1929, and then protectionism ensued. In a global economy, and with a Fed that won't contract the money supply, I really don't see the analogy."

With all due respect, I think that is probably not correct.

It is a fact that the money supply contracted after the stock market crash of 1929. But it is also a fact that the money supply is probably contracting (when we agree on what the measure of the real money supply is) today, when the Fed is running the printing press as fast as it can with no letup in sight.

It works that way because in order for printing press money (additional bank reserves or cheaper bank reserves) to get into the money supply, the reserves must be the base for additional net lending. Didn't happen in the 1930's; not happening today either.

Reason why, today, is because borrowers and potential borrowers don't have available additional excess liqudity to make payments on additional net borrowings. A little different from 1929 because in 1929, the cycle came to an end because stock values collapsed and could no longer serve as a base for additional borrowing. The measurable deflation results in part because of debt retirements as it did in the 1930's. Although much debt retirement in the 1930's resulted from foreclosures which are just getting started today.

Point is that the only way that can be reversed is if incomes go up; if tax revenues go up; if business profits go, creating additional liquidity flow to pay for new net marginal acquisitions. I don't see any way that can happen.

"Protectionism"? Well I was taught, like you, that Smoot- Hawley (the tarriff act) was one of the primary causes of the depression. I no longer think that is true either.

No doubt that in an expanding economy, free trade benefits the largest part of a domestic economy--the only losers are domestic suppliers at prices higher than the free trade world price.

But in a deflation/depression, a little protectionism probably does not make very much difference one way or another. The "Smoot-Hawley caused the depression" argument is another afterthought that was devised to defend the fed against responsbility for the great depression. Real bottom line is that deflation is a monetary phenomonon resulting from defective Fed policy. We don't have protectionism now and deflation is becoming embeded and will become a Greater Depression in the near future.

We don't have protectionism today and we have the problem; I don't think Smoot-Hawley had much to do with the depression we got in the 30's either.

45 posted on 04/21/2003 4:26:46 PM PDT by David
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To: David
Sounded good and logical although researh references would have been nice, until you stated...tax revenue increase. More money in the hands of the government only reduces the the national deficit. Congress will spend no matter what. If the money is left in the hands of the earners, they will spend the money for what they need and or capital improvements /investments etc. Remember,PERPENSITY TO SPEND? The difference of spending less the revenue brought in by tax = deficit. The less revenue, the more money in cuirculation. I.E. money supply is increased - the reverse of deflation.

Under Reaganomics we went to a supply side economy for many things. That type of tax incentive eventually resulted in an "Honest Dollar" and more revenue with an expanded economy. We need Bushonomics and an end to tax on interest income and dividends paid to individuals etc.

It was Greenspan who admitted in 2003 he failed to slow the econmy in 1997 and caused the stock market bubble to Burst. It was Greenspan who failed to cut interest rates when Poppa Bush ran for election and the economy had faltered. It was Greemspan who stated in Jan. that we do not need a tax cut, just as he couldn't spur the economy with any more significant interest cuts. We need a Milton Friedman; we need someone whose ideals aren't politcal disguised as neutral. Greenspan goes for a prostrate operation tomorrow. I wish him well but can't help thinking...one slip and we will have a robust economy. We are just a "hair away".

46 posted on 04/21/2003 6:41:41 PM PDT by Henchman
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To: Henchman
There is a difference between increased tax revenues and and an increase of the percentage of GDP consumed by taxation. An increase in the former may be tolerable as long as the amount of tax collected is falling as a percentage of GDP.
47 posted on 04/21/2003 6:54:54 PM PDT by sourcery (The Oracle on Mount Doom)
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To: sourcery; arete
The term "credit out of thin air" is a bit misleading. The extension of credit is, like derivatives, based on an estimate of future payback. It's not a static analysis, and it depends significantly on estimates of growth, interest rates, education, productivity, and many other intangibles. I'd agree that many existing portfolios have not been "repriced" to take into account the significant reduction in growth potential.

As far as liquidity, tax cuts are perhaps the "last best hope" of avoiding a Japan-like deflation, mostly because of the impact on the margins.

As far as economic depression, that may be a bit overblown. Certainly some industries are harder hit than others (such as IT), some grow (don't I wish I knew which ones!), many will remain flat, and some are seemingly recession-proof (funeral homes and taverns spring to mind).

Comparison to 1929 is complicated by changes in many aspects of economic activity. Agriculture is no longer labor-intensive; immigrants seem to have already filled all the lower paying jobs (the old "something to fall back on" job); you've got extensive government intervention (huge transfer payments, elaborate regulatory and statutory obstacles, - never mind the moral hazard of the many government-provided safety nets).

I agree with the idea that if it does come, it will be uglier. For one thing, the social fabric has changed - you've got changes in work ethic, familial and community interdependence, and the "trust" aspect - I can't imagine massive numbers of drifters being given odd jobs around the house in return for a meal and a night's sleep in the barn.
48 posted on 04/21/2003 7:09:14 PM PDT by P.O.E. (God Bless and keep safe our troops.)
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To: David
We don't have protectionism now and deflation is becoming embeded and will become a Greater Depression in the near future.

Deflation and devaluation are two terms being tossed around alot lately, almost as if they are interchangeable. By running the fiat presses do you think the Fed. can use devaluation of the dollar to help offset deflation of prices, at least for the short term?
49 posted on 04/22/2003 5:33:48 AM PDT by steve50 (neocons, the "new coke" of conservatives)
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To: Henchman
Reply to your #46: " until you stated...tax revenue increase . . . . "

That point is not addressed to commentary about appropriate levels of taxation and spending but to the pure monetary measuring stick issue--at the moment, governments at every level do not have enough tax revenue to pay existing commitments.

That is the result of the deflationary economic contraction in the general economy.

The country is still generally in denial--"the stock market bottom is in"; "real estate has real value and can't go down"; "recovery in the second half"; denial that the real problem is an imbeded deflation resulting from excess levels of debt.

So my point is, ok, what does it take to make the denial analysis work--what makes the stock market go up; keep the real estate bubble from collapsing; and see a general economic recovery? What would you expect to see if the denial argument was going to be correct?

And one of the things you would see very early is increasing tax revenues at the state, local, and federal income tax levels. Fact we are not seeing those revenues is the most important indicator that those in denial will not be correct.

50 posted on 04/22/2003 5:39:24 AM PDT by David
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