Op-Ed: The Second Great Depression?
Unnerving parallels between now and then.
This country has been living in false prosperity since the early 1980s: The huge McMansions, luxury cars, high tech gadgets, granite kitchens, second homes and exotic vacations were all purchased with debt. These “assets” are depreciating rapidly, and consumers and companies are selling them desperately to pay down their suffocating debts.
The psychology of this country has begun to change from conspicuous consumption to forced liquidation and saving. The most recent flow of funds data shows that total credit market debt is $51 trillion; our GDP is $14.3 trillion. Debt as a percentage of GDP is now 356%; during the Great Depression, it was 260%. This massive buildup of leverage is just beginning to unwind; the pain will be tremendous when it gains momentum.
There's no consensus regarding the causes of the Great Depression, but some common themes are clear. I will try to evaluate today’s environment versus the conditions that existed in the 1920s.
1. Expansion of the money supply during the 1920s
According to the Austrian School of Economics, the Great Depression was mainly caused by the expansion of the money supply by the Federal Reserve in the 1920s, leading to an unsustainable credit driven boom. Both Friedrich Hayek and Ludwig von Mises predicted an economic collapse in early 1929. In the Austrian view, it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and capital goods.
Alan Greenspan reduced interest rates to 1% for over a year in 2003. This act led to a speculative frenzy in real estate, $3 trillion of equity withdrawal by consumers and tremendous overconsumption built upon a foundation of debt. This speculative frenzy was exacerbated by the “Masters of the Universe” on Wall Street, with their CDOs, MBSs, and other magic potions that made bad loans appear good.
The Bush administration’s decision to not enforce any existing oversight of the banks also contributed greatly to the current situation. Realistically, the current conditions are worse than they were prior to the Great Depression, based on the speculation that has occurred in the last 8 years in stocks and real estate.
2. Excessive debt leading to false prosperity
By 1929, the richest 1% owned 40% of the nation’s wealth. The top 5% earned 33% of the income in the country, while the bottom 93% experienced a 4% drop in real disposable income between 1923 and 1929. The middle class comprised only 20% of all Americans.
Society was skewed heavily towards the haves but, by 1929, more than half of all Americans were living below a minimum subsistence level. Those with means were taking advantage of low interest rates by using margin to invest in stocks. The margin requirement was only 10%, so you could buy $10,000 worth of stock for $1,000 and borrow the rest.
There are some disturbing parallels between what was happening during the 1920s and what's been happening in America in the last 10 years. Today, the richest 1% own 21% of the nation’s wealth. The bottom 50% experienced a 4% drop in real disposable income over the last 8 years. During the dot-com boom, small investors used massive margins to speculate in companies with no earnings.
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