Inexact but telling comparisons to the Great Depression


For the majority of us, the credit crisis we are living through has come rather unexpectedly. And because it has been both a surprise to many and a traumatic experience to yet many more, we are all trying to contextualize it using past economic and historical periods. Unfortunately, this is a tricky exercise because it risks conflating the root causes and outcomes of the historical period with those of the present. But, we are going to still do it because the need to explain is so great (something I covered in The politics of economics in November).

For me, it is the Great Depression where I see the greatest lessons for us today, particularly given the parallels in complacency today and that witnessed in 1930 and 1931. So let me say a few words about where I think we are in this crisis and what this should mean to policy makers and citizens alike.

When I first wrote about what was then an impending credit crisis in March 2008, I spoke of its roots being in the accumulation of high private sector debt burdens due to easy money. What has become clear since that time is the level of fraud that also occurred due to the lax regulatory environment. So, in many ways, the pre-conditions of this crisis were very similar to those that created the great depression (low interest rates, high private sector debt, globalization, large current account imbalances, speculative mania, a financialized economy, lax regulation, cronyism and fraud).

What we are now being told is that the response in this particular downturn has been very aggressive and all-encompassing across the globe. The result, we are told is that we are out of the woods economically.

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But, is that really true? I would agree that we have averted the worst. However, I would argue that the global economy is still so fragile that complacency still risks a catastrophic outcome. 

I’m sure most of you who are familiar with my economic forecasting know that I was fairly bullish in the Spring of 2009.

And I even had to defend myself pretty vigorously because everyone else was so bearish (Through a glass darkly: the economy and confirmation bias in the econoblogosphere). So I am definitely not a perma-bear. I agree that the economy has improved markedly.

However, this Spring I have a more downbeat view and this owes in very large part to the complacency I now see out there. But, the thing that precipitated this post was this:

Government debt in Greece is just the first in a series of European debt bombs that are set to explode. The mortgage debts in post-Soviet economies and Iceland are more explosive.  Although these countries are not in the Eurozone, most of their debts are denominated in euros. Some 87% of Latvia’s debts are in euros or other foreign currencies, and are owed mainly to Swedish banks, while Hungary and Romania owe euro-debts mainly to Austrian banks. So their government borrowing by non-euro members has been to support exchange rates to pay these private sector debts to foreign banks, not to finance a domestic budget deficit as in Greece.

All these debts are unpayably high because most of these countries are running deepening trade deficits and are sinking into depression. Now that real estate prices are plunging, trade deficits are no longer financed by an inflow of foreign-currency mortgage lending and property buyouts. There is no visible means of support to stabilize currencies (e.g., healthy economies). For the past year these countries have supported their exchange rates by borrowing from the EU and IMF. The terms of this borrowing are politically unsustainable: sharp public sector budget cuts, higher tax rates on already over-taxed labor, and austerity plans that shrink economies and drive more labor to emigrate.

Bankers in Sweden and Austria, Germany and Britain are about to discover that extending credit to nations that can’t (or won’t) pay may be their problem, not that of their debtors. No one wants to accept the fact that debts that can’t be paid, won’t be. Someone must bear the cost as debts go into default or are written down, to be paid in sharply depreciated currencies, but many legal experts find debt agreements calling for repayment in euros unenforceable. Every sovereign nation has the right to legislate its own debt terms, and the coming currency re-alignments and debt write-downs will be much more than mere "haircuts."

These are the first paragraphs of Michael Hudson’s latest missive "The Coming European Debt Wars." Quite frankly, I do not think his language is hyperbolic. The Europeans need to confront these issues. We are facing a sovereign debt crisis. There are many ticking debt bombs beyond Greece. And we are way too complacent about it.

I have been optimistic about the near-term prospects for the global economy in large part due to the myriad pro-cyclical effects of recovery. Longer-term, however, there are some serious obstacles to a sustainable recovery.  This is not a garden-variety recession and recovery. It is a recession within a longer-term depression.  And while we are in a technical recovery, I believe much of the fundamental problems which triggered this downturn are still there, lurking.

The bust in Dubai and exogenous shocks

The problems are indeed still there. This is true with euro-denominated debt in Eastern Europe. It is even more true with real estate in Canada. And it is true yet again with commodity prices in China.

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Let me give you an example of the kind of complacency I am talking about from "Fixed income investors look to Africa" published today at Risk. While Greek bonds are imploding and spreads to German Bunds are skyrocketing, rates in Ghana reflect a relative calm.

An increasing number of international investors are turning to the developing markets of Africa, as risk premiums on traditional emerging market issuers dwindle. Ghana has been identified as an attractive prospect.

While returns on investments in African countries such as Nigeria and Kenya have declined, yields on Ghanaian bonds remain high.

“International investors are moving down the risk curve, and capital is reaching African shores,” says Antoon de Klerk, an emerging markets analyst at Investec Asset Management in Cape Town. “Ghana looks attractive, especially against Nigeria where rates are extremely low. We’re seeing big positions being taken in Ghanaian sovereign bonds.”

Africa deserves a better look from investors. 100%. But this is nuts. The 10-year in Ghana is trading at 6.3%.  I guarantee you this is a bad deal.

According to Gadio, yields will likely decline further, leaving a rapidly closing “window of opportunity” for investors. “In Ghana inflation was extremely high in 2009, so the yields went up as far as 25%. The three-year bond issued in January 2010 drew substantial international demand. But now that inflation is going down, rates have started to fall rapidly. There’s probably a three- or four-month window for international investors to buy Ghanaian bonds, but after that, the quality might be gone. Yields are decreasing by 50bp or so at the short end of the curve during each auction. Accordingly, it makes sense to buy Ghanaian securities as soon as possible.”

It’s liquidity seeking return, folks. Ich sehe Schwarz.  But, this is the environment we are living in.  Compare what Hudson is saying and what’s going on in Greece to the buy now happy talk for Ghanaian bonds. Clearly, someone is wrong and I’m guessing it’s the complacent ones.

Then, you have David Rosenberg out today, doing his best to imitate "News from 1930" blog. He runs a spate of quotes from the 1930 press:

A good friend of ours at UBS, Robert Procaccianti, periodically emails us his pithy market thoughts, and yesterday he sent us the following. Great digging into some now infamous quotes after the 1929-30 bear market and the widespread view at the time that the worst was over because, of course, Mr. Market said so … erroneously as it turned out.

“[1930 will be] a splendid employment year.” — U.S. Department of Labor, New Year’s Forecast, December 1929

“I am convinced that through these measures, we have reestablished confidence.” — Herbert Hoover, U.S. President, December 1929.

“While the crash only took place six months ago, I am convinced we have now passed through the worst — and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.” — Herbert Hoover, U.S. President, May 1930.

“This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan … that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years.” — R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929

“The Wall Street crash doesn’t mean that there will be any general or serious business depression … For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game … Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before.” — BusinessWeek, November 2, 1929

“…despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation…” — Harvard Economic Society (HES), November 2, 1929

“The end of the decline of the Stock Market will probably not be long, only a few more days at most.” — Irving Fisher, Professor of Economics at Yale University, November 14, 1929

“For the immediate future, at least, the outlook (stocks) is bright.” — Irving Fisher, Ph.D. in Economics, in early 1930

“… the outlook continues favorable…” – Harvard Economic Society Mar 29, 1930

If that doesn’t hit home, I hope yesterday’s post from News from 1930 does:

Canada’s banking system offers interesting comparison with the recent epidemic of bank failures here. From 1900 to the present there have been only 4 chartered bank failures in Canada in which depositors were not eventually paid in full. Three of these were before the war, the fourth since; total deposits were $17.5M. In the US there have been 7,000 bank failures since 1914 involving liabilities of about $3B; in the last year alone, 1,345 with total deposits of $865M.

Tuesday, April 7, 1931: Dow 169.72 -2.71 (1.6%)

That doesn’t mean all is well and fine in Canada anymore than it did in 1931, does it? Everyone thinks Canada is protected because 20% down is required for a conventional mortgage. Please read the last paragraphs of my post "Lehman chief warns of more big bank failures" and it should be evident that some mortgages are very leveraged in Canada.

The point is not that doom is coming but rather that complacency is high and this makes a calamitous outcome all the more likely. The Europeans are complacent about their sovereign debt problems. The Americans are complacent about their private sector debt problems. Investors are complacent about the medium-term outlook for stocks and bonds. And policy makers are complacent about how quickly politicized rhetoric escalates. And when [people are complacent they don’t do anything to address underlying problems – issues which often re-appear in a more critical state.

So, returning to the Great Depression comparisons, I am concerned we are on the brink of another credit crisis with the situation in Greece as the trigger. I think of 1931 or 1937 as two specific periods in which complacency ensured a sub-optimal outcome.  Let this not be another.


Breakfast with Dave, 8 Apr 2010 – David Rosenberg, Gluskin Sheff

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