By Kirk W. Kelsen
One basis for deciding whether we are in a “recession” or a “depression” is distinguishing how recessions become depressions. With the hindsight of history, we already know.
Parallels between America’s current economic crisis and the 1930’s Great Depression are instructive. Then, as now, hardship was preceded by a major banking upheaval. Then, as now, a regulatory blizzard followed. Then, as now, millions were displaced. And then, as now, the cause of the Great Depression was widely misunderstood. Many believe today that the 1929 stock market crash caused the Great Depression all by itself, that it was so severe it mysteriously destroyed wealth for another 13 years. To put that in perspective, the serious Carter-era recession should have, by this logic, precluded the Reagan recovery in 1982 and perhaps wreaked havoc until 1990. Not only is this argument absurd, it manifestly did not happen.
In Franklin Delano Roosevelt’s 1933 inaugural address he lectured that “[t]he only thing we have to fear is fear itself,” suggesting Americans suffered irrational neuroses. This is not at all true. Americans made entirely rational and prudent business decisions amidst considerable uncertainty. Though FDR is invariably cast as heroically facing down near-insurmountable economic travails, the less-flattering diagnosis is much more obviously true: he caused them.
With the New Deal, the Second New Deal, TVA (rural electrification), FERA (emergency relief), CCC (youth work program), AAA (farming subsidies), NIRA (industrial regulation and public works), PWA (public works), WPA (public employment), FDIC (banking regulation), and Social Security all exercising unprecedented Federal power, investor uncertainty was justified and profound. Roosevelt’s willy-nilly spending legitimized concern that personal fortunes would be entirely consumed. Capricious policies (often framed by class warfare) caused real fear, not “fear of fear itself,” fanning a bad recession into the Great Depression. Without doubt, the Crash of 1929 was extremely serious — almost as serious as the great unraveling that started in September 2008. The Great Depression from 1932 to 1942, however, was Roosevelt’s fault.
FDR’s maelstrom of tax and regulatory change notwithstanding, the Great Depression was not all bad news all the time. Unemployment, for instance, peaked early, hitting a Depression-era high of 25% in 1932 (though averaging more than 19% for FDR’s pre-war tenure). So there were employment gains in the years following FDR’s election. Similarly, stocks rebounded starting in 1933, doubling across 12 months (though plummeting again in FDR’s second term). These early upticks augured recovery that was not to be: America’s economy remained monumentally dysfunctional for another 10 years.
The Great Depression’s harshest rebuke is not that it was relentlessly bad; it’s that periodic good news always ended up turning worse again, like a false summit. The persistent reappearance of bad news in the 1930’s directly correlates with investor uncertainty created by Roosevelt’s incessant meddling. In short, it took a disastrous and transformative presidency to make a “depression” out of “recession” — even if not all months, quarters, and years were uniformly bad.
Today, just as then, almost one in four working-age Americans (or non-citizens, who also must be counted since they are part of the available work force) are unemployed. This 25% estimate includes those who previously were not in the workforce but who are looking now, presumably out of hardship. Tending to confirm this, a recent household survey found 22% unemployed. Conversely, the latest United States Bureau of Labor Statics (BLS) report puts the number at 9.9%. The disparity arises because the BLS number counts individuals receiving unemployment checks. No check? Not counted.
From what I can tell, the total number of unemployed in America today is at least 37.5 million, rising to over 65 million if the underemployed are included. These numbers sound too big to be true but can be pieced together from a variety of sources, including the BLS.
37.5 million unemployed out of 150 million potential workers — one in four. If this is correct, then where are the bread lines? First, Americans entered the current downturn far wealthier than ever before. Many survive today on fast-depleting retirement accounts and strained credit. Second, massive security nets — welfare, extensive unemployment benefits, disability payments, and school loans — have disguised or deferred the physical presence of otherwise visible hardship and deprivation. Government-backed programs, many themselves insolvent, are the “bread lines” of today.
Persistent high unemployment will not soon resolve: job creation currently lags population growth. About 145,000 jobs must be created every month to reach parity — not growth. 400,000 jobs would need to be created to replace by 2013 the jobs lost since 2007. Even with a sustained recovery starting immediately, it would take at least eight years to recover jobs lost during the last two.
One reason the job picture is so grim is that investors are confounded by Federal monetary policy. Under Roosevelt, just as it is now and was during Carter, Fed policy was an explicitly Keynesian effort to correct unemployment — not a stable-dollar course like Reagan pursued, or Thatcher for the British Pound. As Margaret Thatcher pointed out in her autobiography, The Downing Street Years, monetary policies must either “hitch their star” to a stable currency or pursue specific social outcomes, such as reducing unemployment. Never both, it must be one or the other.
With trillions outlaid in “stimulus,” America is committed to the latter course today.
Predictably, Moody’s announced this month that the United States AAA credit rating will be cut in 2012 for the first time in history unless current and projected Federal debt is reduced dramatically. It looks instead like debt will explode when anticipated State insolvencies are transferred to the Federal government, whether as loans to States or by some sovereign bankruptcy proceeding yet to be devised. A lower credit rating will force America to pay substantially more interest to entice buyers of its debt if, in fact, an adequate market for downgraded United States Treasuries even exists.
Worldwide, sovereign debt is being serially repudiated. Private institutional buyers are being told they are going to get a “haircut.” Portugal, Ireland, Italy, Greece, and Spain (the “PIIGS”) are in process of defaulting. The Chinese government recently suggested it will bail out Spain (as part of its move to diversify from the U.S. Dollar), appearing to make China the funder of this century’s Marshall Plan.
Meanwhile, to ward off deflation, the dollar is being intentionally devalued because it is the only thing the Fed has left to do, the last arrow in its quiver. And the Federal Reserve, which actively promoted the multiple asset bubbles of the last 20 years, will be unable to manage the inflation genie it is un-bottling.
There are two ways to default on a loan. One is to not pay it back, as millions of former homeowners are discovering. The other is to devalue the currency you pay it back with, and this is what America is doing. So China, one-time buyer of American dollars, will get a “haircut,” too.
In reply, China is unloading dollars as fast as their economy will allow, but it won’t be fast enough. China struggles today with both inflation (at an official rate of eight percent) and their own asset bubble in an all-cash real estate market. With uncertainty on the rise, China’s ruling class is hedging its dollar exposure by snapping up commodities at a dizzying rate, and conducting some international trade in non-dollar currencies. The Chinese Yuan has become fashionable lately for world-trade because, as with any monetary system, its legitimacy is based on the issuer’s sustained and perceived future productivity. Unsurprisingly, China’s expected productivity is about to rival America’s.
With the Yuan ascendant, the world is voting that Chinese long-term problems are less ominous than America’s have recently become. The United States is ceding the dollar’s default status as the international reserve currency and there is little in the short run that America can do about it. This is a grave threat to American prospects and worldwide financial surety.
The significance of the United States Dollar as global reserve currency is not generally appreciated by most Americans, perhaps because only other countries see the impact first-hand. If Germany, for instance, wants to buy oil it must first buy dollars because oil is a dollar-denominated commodity — ie, it is only traded in dollars. Or rather, it was: Russia, itself a major oil producer, recently announced trades that will be transacted in non-dollar currencies, particularly the Yuan.
Until now, if America really needed to buy any major commodity — including crude oil, gold, wheat, cattle, orange juice, coffee, sugar, etc., all priced and traded only in U.S. Dollars — the Federal Reserve could always just print more dollars. True, printing money inflates commodity prices worldwide until they reach parity with the newly-devalued dollar — but America would still be able to purchase them. In the future, if America must first buy the Yuan at whatever price the Chinese say and then buy commodities, significant control over purchasing power and domestic economic stability is lost.
Which brings us back to uncertainty. Predictions that recovery will soon grow the world out of this crisis are less valid than predictions it won’t because nobody knows. No one is sufficiently certain. Rapid-fire federal and state regulations make would-be investors uncertain. Uncertain businessmen limit risk by remaining liquid, which means they don’t invest (eg, Apple’s $40 billion cash reserve). Investors that don’t invest slow the exchange of money, which means money is not in motion. And money not in motion is like having no money at all, or nearly so. Perhaps we soon shall be regaled with another “nothing to fear but fear itself” Presidential bromide.
Atop her dynamic and productive people, America’s County, State and Federal governments squat like rogue leviathans excreting tens-of-thousands of new laws and regulations every year. Choked by bureaucracy and debt, The United States of America is in no position to save the world from this crisis this time. Nor should anyone expect that the world will be inclined to save The United States.
In other words, there is uncertainty. Not mysterious, fear-of-fear-itself uncertainty; but rational uncertainty. Uncertainty with a clear and historically-informed basis and a known etiology. And with this odd certainty of uncertainty, The Great Depression II.
Perhaps respected investor Harry Shultz’s comment in his final newsletter this month states it best:
“Roughly speaking, the mess we are in is the worst since the 17th century financial collapse. Comparisons with the 1930’s are ludicrous. We’ve gone far beyond that.”
Far beyond, indeed. The future does not look bright.