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Op-Ed: The Second Great Depression?

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Unnerving parallels between now and then.

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Tighter credit, higher taxes and higher tariffs

Ben Bernanke, a self-proclaimed expert on the Great Depression, concluded that missteps by the Fed in 1930 and 1931 caused the Depression. After the stock market crashed, speculators began selling dollars for gold in 1931. This caused the value of the dollar to plummet. The Fed raised rates and reduced the money supply by 30% to prop up the dollar. Investors began withdrawing their dollars from banks.

By the end of 1932, 9,000 banks failed. People hid their cash under their mattresses. Bank deposits were uninsured, so when banks failed, people lost their life savings. Businesses failed; panic and fear gripped the nation. The remaining banks hoarded their cash, refusing to make loans to businesses.

Instead of stimulating the money supply, the government attempted to protect American businesses by passing the Smoot-Hawley Tariff in June 1930. This bill increased taxes on imports, which led to retaliation by other countries and contributed greatly to the worldwide downturn. World trade declined 67% by 1933. Herbert Hoover increased the top tax rate from 25% to 63% in 1932.

All these missteps led to a downward spiral in the economy. In 1930, the GNP declined 9.4%; unemployment rose from 3.2% to 8.7%. In 1931, the GNP declined a further 8.5% and unemployment surged to 15.9%. 1932 was the worst year of the Depression, with GNP down 13.4% and unemployment reaching 23.6%.

Thus far in the current crisis, no one can accuse the Fed of failing to provide liquidity or reduce interest rates. The discount rate has been reduced from 4.75% to 2% in the past year. In the last 9 months, the Fed increased their balance sheet by over $1 trillion. The government has committed in excess of $1.3 trillion of taxpayer money to keep the financial system from imploding.

The question that has yet to be answered is whether a severe recession or possible depression is inevitable regardless. The country has a national debt of $9.6 trillion, annual deficits of $600 billion, unfunded future liabilities of $53 trillion, a trade deficit of $600 billion, inflation of 6%, 2 wars costing $12 billion per month, and a weak currency. Therefore, we have entered an extremely dangerous period without strong economic fundamentals.

In the last few years, Congress has become much more protectionist. The sale of US ports to Abu Dhabi was blocked. The acquisition of a US oil company by China was also blocked. Worldwide trade negotiations recently broke down with no agreement reached. Free trade is being threatened.

In 4 weeks, the country will likely elect Barack Obama; Congress will be overwhelmingly in the hands of the Democratic Party. Mr. Obama has made it clear that he will increase taxes on corporation and those earning more than $250,000. His plans include health coverage for all Americans and major spending initiatives on education and infrastructure. With colossal deficits, a protectionist Congress, tax increases coming, and gigantic spending initiatives, the next 4 years will be exceptionally difficult for the US. economy.

The parallels to the early 1930s are eerie.

Morass of Uncertainty

The $820 billion bailout package won't fix what's wrong with this country. Hank Paulson will buy bad assets from any financial institution for some yet to be determined price.

Many smart people have concluded that the plan will not work. The banks need a direct infusion of capital to begin their recovery process. The American taxpayer will never see a dime of that $820 billion paid back. When was the last time a government program actually worked?

Corrupt politicians, Washington bureaucrats, Wall Street fat cats, and clueless commentators have failed to realize that the jig is up. Our entire financial system has been built upon deception, lies and debt. The only thing keeping the system afloat was blind faith in our government and financial leaders to do the right thing. That trust has been shattered into a billion pieces.
No positions in stocks mentioned.

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