Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 25-Jun-07
Bank of International Settlements foresees possible new 1930s style Depression

Web Log - June, 2007

Bank of International Settlements foresees possible new 1930s style Depression

Saying that "our understanding of economic processes may be less today" than it was in the past, the 2007 Annual Report of the Bank of International Settlements (BIS) notes that "that the run-up to the Great Depression had exhibited similar non-inflationary characteristics" to those seen today.

The report discusses how the growth of the global economy has continued at levels that are among the highest in history, and that, combined with historically low inflation, even the poorest countries have shared in this growing prosperity.

However, the report says that major currency imbalances and investors' extreme appetite for risk. It gives three specific threats, as summarized by the BBC:

Nigel Jenkins, currency strategist at Payden & Regal Global <font face=Arial size=-2>(Source: BBC)</font>
Nigel Jenkins, currency strategist at Payden & Regal Global (Source: BBC)

In response to the report, the BBC interviewed Nigel Jenkins, currency strategist at Payden & Regal Global, who said the following:

"The reason that we think that there won't be anything like the 1930s depression is that central bankers around the world have on the whole gotten this reduction of global liquidity pretty much right. You've got interest rates up to quite a normal level in the United States - we think they'll be stable there; the ECB [European Central Bank] has a little bit further to go - may 50 or 75 basis points further rate hikes by the end of this year; the Bank of Japan will be raising interest rates, but only at a glacial pace, and from a very low level. There is nothing in the economic data that suggests to us that global central banks really stand a chance of over-tightening interest rates, and it's the over-tightening of interest rates that would be the risk of the major downturn, and we just don't see that."

This response by Nigel Jenkins captures, in just a few brief, pithy sentences, everything that's totally wrong about today's mainstream macroeconomics. I don't blame Jenkins for this, because he's just quoting the standard stuff, but what he said is total nonsense.

It's to address stuff like this that last year I wrote my article on "System Dynamics and Macroeconomics," which shows how mainstream macroeconomics has failed to predict or explain anything, especially since 1995, and how this failure can cause similar results as in 1929. Mainstream macroeconomics has failed to predict or explain the stock market bubble of the late 1990s, or anything that's happened since the Nasdaq crash in 2000. And now we see Jenkins quoting the most banal claim of mainstream macroeconomics, the belief that the only thing that matters is interest rates.

But if you go back and look at the three items summarized above by the BBC, you'll see that Jenkins didn't address any of them. Why would stable interest rates prevent a loss of confidence in the American dollar, or a spike in confidence in the Japanese yen? How would stable interest rates protect firms that are swimming in debt from going under during a downturn? What Jenkins said makes as little sense as if he'd said, "Well, the birds have been chirping outside my office, and it's when the birds stop chirping that we have a risk of a major downturn, and we just don't see that."

The BIS report points out the huge credit imbalances in today's global economy, and says that "what's old is new again," as economists rediscover some concepts of a century ago:

"At the same time, in the early 2000s another perspective emphasising the role of quantitative aggregates, and especially credit, began to emerge. This perspective had distant roots in those theories of business fluctuations from the early part of the 20th century which had stressed the self-reinforcing processes that led to occasional booms and busts. It also borrowed from the intellectual tradition that highlighted the role of credit and speculative behaviour as a cause of financial instability. Finally, it retained elements of the more recent advances in economic theory, which emphasised how credit imperfections could amplify business cycles."

The report analyzes previous historical downturns, and finds them quite similar to the American economy today:

"Economic history is a useful guide in this respect. The Great Inflation in the 1970s took most commentators and policymakers completely by surprise, as did the pace of disinflation and the subsequent economic recovery after the problem was effectively confronted. Similarly, virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s, respectively. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a “new era” had arrived. Similar surprises can be noted at a more micro level. Around the time of the failure of LTCM in 1998, the firm faced price shocks in various markets that were almost 10 times larger than might reasonably have been expected based on previous history. As a result, its fundamental assumptions – that it was adequately diversified, had ample liquidity and was well capitalised – all proved disastrously wrong."

The report notes that "many will say that our understanding of economic processes has improved thanks to this experience," but quickly discards it, pointing out that economists have no idea whatsoever how to predict or explain trends in excess capacity, import prices, wages, or even perceived inflation. They're saying, in much more diplomatic words, exactly what I'm saying: That mainstream economists don't know crap about what's going on in the world.

"Indeed, in the light of massive and ongoing structural changes, it is not hard to argue that our understanding of economic processes may even be less today than it was in the past. On the real side of the economy, a combination of technological progress and globalisation has revolutionised production. On the financial side, new players, new instruments and new attitudes have proven equally revolutionary. And on the monetary side, increasingly independent central banks have changed dramatically in terms of both how they act and how they communicate with the public. In the midst of all this change, could anyone seriously contend that it is business as usual?"

This 244 page report contains a wealth of historical and analytic information. I've only had a chance to skim through it today, but I'll be drawing on it more in the future.

Meanwhile, I'd like to post excerpts from a "Living History" article from the Salt Lake City Tribune, written by oral historian Eileen Hallet Stone:

Depression brought a prosperous Utah to its knees

"In 1929, a crowd gathered downtown on Main Street and watched haplessly as the ticker tape on the Salt Lake Tribune Building tumbled. After a record high of national prosperity, the stock market collapsed and the country spiraled into one of the worst economic downspins in American history.

During the Great Depression of the 1930s, banks and businesses failed, factories and stores closed, farm prices dropped, benefits dried up and unemployment soared. Twelve million citizens were suddenly jobless and without savings. Thousands lost their homes. For nearly a decade, the popular song "Brother, Can You Spare a Dime?" wailed the nation's despair.

"I don't think there's one person out of a thousand now that would believe what we went through," said Theodore "Pete" Houston of Sandy, who worked in steel mills, logging camps and stone quarries before the Depression cut him to the core.

In 1933, Utah's unemployment rate was the fourth highest in the nation. One of three Utahns was out of work. Those employed suffered dwindling hours and severe pay cuts. Others peddled wares, went door-to-door seeking labor in exchange for food or became shoeshine "boys." Families moved in together. Teenagers took to the road - a few less mouths to feed. And passing transients clamoring to work in the cities were run out of town.

Breadlines, soup kitchens and "city-operated shelters" opened along the Wasatch Front. They were branded "Hoover cafes" by a populace increasingly frustrated with President Hoover's inability to stem the depression.

"We were lucky to find jobs raking leaves, digging ditches or cleaning streets," Houston said. "Many people couldn't find work and went hungry for days. It was hardest on the kids. Imagine, children living on a crust of bread." ...

In the 1930s, Utah marriages and births went into a slump. Divorce rates rose. With scarce jobs, married men were first to be hired, unmarried men feared dismissal because they were single and working single women, most of them teachers, were forced to resign if they married.

As the depression deepened with no respite in sight, some lost faith in the American system, their future and themselves.

In 1929, Jack Findling had a charitable bent and was a leader in his community. ... Then the bottom fell out.

"My grandfather lost a lot of money, and found no way whatsoever to recoup his losses," said Joanne McGillis, who was a toddler when he died. "He had always helped others. Now he felt like an albatross around his family's neck. He ended up committing suicide."

Bereft of assets, broke and broken-hearted, Findling's wife, Esther, sold their home, furnishings, and possessions. She struggled to keep open the store.

"They were devoted to each other," McGillis said. "Nana was devastated. She worked hard. She never remarried."

"Once I built a railroad, I made it run, made it race against time. Once I built a railroad; now it's done. Brother, can you spare a dime?"

Generational Dynamics predicts that this is about to happen again, and the time may not be too far off. The Bank of International Settlements seems to agree. (25-Jun-07) Permanent Link
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