The Coming Great Depression
Feb 10, 2009
Below is an excerpt from
a commentary originally posted at www.speculative-investor.com
on 5th February, 2009.
In our 3rd December 2008 commentary
we explained that the probability of an imminent great depression
was uncomfortably high. Our reasoning, in a nutshell, was that
the recent credit bubble was much bigger than any previous credit
bubble of the past century and that the policymakers of today
were blundering much more rapidly and on a much grander scale
than their counterparts of the 1930s.
We can't over-emphasise that the Great Depression did not become
"great" due to the economic problems signaled by the
1929 stock market crash, but, instead, due to government policies
undertaken to counteract the economic problems. The policy errors
we are referring to do NOT include the Fed's so-called failure
to prevent the money supply from shrinking, but do include government
actions designed to boost prices, expand credit, create employment,
and re-distribute wealth. These actions delayed necessary adjustments,
and as a result it took more than 15 years for the economy to
do what it should have done in 2-3 years. As Franklin Roosevelt's
own Treasury secretary, Henry Morgenthau, lamented in an address
to Congressional Democrats in May of 1939:
"We have tried spending
money. We are spending more than we have ever spent before and
it does not work. And I have just one interest, and if I am wrong
... somebody else can have my job. I want to see this country
prosperous. I want to see people get a job. I want to see people
get enough to eat. We have never made good on our promises ...
I say after eight years of this Administration we have just as
much unemployment as when we started ... And an enormous debt
Quote taken from
Burton Folsom's book "New Deal or Raw Deal?"
It is commonly believed that
the Second World War finally ended the Great Depression, but
this is not true -- the Depression didn't finally end until government
controls were eventually relaxed after the War. Preparing for
and fighting WWII made sure that everyone had a job, but minimal
unemployment does not necessarily go hand-in-hand with economic
strength. In the former Soviet Union there was very little unemployment,
but living standards were "third world". Herein lies
the problem with treating job creation as a primary goal of economic
As noted above and in our earlier commentary on this topic, government
today is unfortunately enacting the same policies that made the
Great Depression "great". Additionally, policymakers
have stepped-up their efforts and appear to be more committed
than ever to the path of increased spending, monetary pump-priming
and economic intervention. As a result, we think the probability
of a great depression has risen to the point where such an outcome
is almost inevitable.
At this point it is appropriate for us to address a couple of
related issues. The first is the perceived problem of falling
The famous economist J. M. Keynes didn't understand the link
between the boom/bust cycle, fractional reserve banking and the
central bank's manipulation of interest rates. He therefore relied
on mysterious changes in something he called "animal spirits"
to explain how booms would evolve into busts. Many of today's
economists operate from within a similar faulty framework, and
thus believe a key to turning the economy around is boosting
the confidence of consumers and businesses. They don't seem to
appreciate that the problems are REAL, as opposed to figments
of our collective imagination. A loss of confidence, leading
to less spending on current consumption and a consequential increase
in saving, is a RATIONAL response to the current economic REALITY.
By putting a hallucinogen in the water supply you could probably
make people feel more confident and thus cause them to go out
and spend freely for a while, but how could this possibly help
given that the current predicament involves too much debt, too
little savings, and a mismatch between production and consumption?
Obviously it wouldn't help; it would just make a bad situation
Policies that encourage people to increase their borrowing and
spending are, in effect, encouraging people to dig themselves
into deeper financial holes, but such policies are now 'all the
rage' in the world of economic policymaking. For example, one
week's US Government schemes puts in place a financial incentive
for people to borrow money to buy new cars. This scheme will
cause damage to the extent that it actually does what it is supposed
to do, but fortunately for the US economy it probably won't work
(it probably won't lead to many additional car loans).
In sum, the problems are real. Confidence will naturally return
after savings and production have adjusted to the new reality,
while policies that convince people to ignore reality and behave
less prudently in the short-term will only exacerbate the problems.
The next issue we'll cover is the implication of increasing the
money supply. Many people, including the Fed Chairman, believe
that the economy can be helped through its 'rough patch' via
Those who share the Fed Chairman's belief should explain in detail,
using good economic theory as opposed to Keynesian "animal
spirits", how counterfeiting money can possibly strengthen
the economy. One of the main considerations is that years of
monetary inflation prompted massive investment in projects that
should never have seen the light of day, leading to the situation
where the economy's capital structure doesn't mesh with the needs
of consumers. As far as we can tell, creating more money out
of nothing couldn't possibly alleviate this problem.
Some will argue that monetary inflation 'works' (does good) by
pushing up asset prices and thus reducing the debt burden, but
let's think this through. If there's enough monetary inflation
to push up asset prices then lenders will start demanding higher
interest rates due to anticipated currency depreciation. Also,
the cost of living will rise. At the same time, the aforementioned
mismatch between production and consumption -- the root of the
high and climbing unemployment rate -- will remain in place and
probably become even more pronounced due to additional mal-investment.
So, rather than having their financial burdens lessened by falling
prices and low interest rates, those without jobs and those with
excessive debt loads will have to deal with higher living and
The bottom line is that the government can't improve the situation
by creating money out of nothing, but it can CHANGE the situation.
Specifically, it can make sure that the depression will be the
inflationary kind rather than the deflationary kind. The inflationary
kind is potentially worse because under this scenario the economy
is less able to repair itself and you don't get the benefits
that would otherwise be conferred by a falling cost of living.
Unfortunately, the actions being taken by today's policymakers
skew the odds in favour of an inflationary depression.
Finally, forewarned is forearmed. Our economic outlook could
prove to be too pessimistic, but if you prepare for a depression
-- by, for example, getting out of debt and building up substantial
reserves of cash and gold -- and things turn out better than
expected, you won't lose much. On the other hand, you will probably
lose a lot if you prepare for a rosy scenario and a depression
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