Continuing with last week’s article, we left off after reviewing that stock market declines, on their own, have not caused recessions. Generally, some other factors must be present, or mistakes must be made to cause an economic calamity.
Within three years of the crash in 1929 bank failures were rampant as the Fed made another big mistake. Not only did they let the money supply shrink as the economy was entering recession, they did not live up to their mandate to be the "lender of last resort,” making loans to banks when depositors needed to withdraw their funds. The situation became really bleak when the banks, not being backed up by the Fed, started hoarding deposits and did not make loans to consumers and businesses that would have promoted economic growth.
The series of monetary mistakes was calamitous and could have easily been prevented or reduced by the Fed being accommodative, rather than restrictive. Let’s fast forward to 2008. We have a serious credit crisis on our hands related to banks having illiquid investments on their balance sheets which are restricting their capability to lend. Sounds somewhat similar to the 1930s, doesn’t it? What are the Federal Reserve and U.S. Treasury doing about it?
Rather than restricting the money supply, today’s Fed is promoting the growth of the monetary base as quickly as they can. Federal deposit insurance (which did not exist in the 1930s) for deposits at banks has been expanded to a level of $250,000. The Treasury Department’s Financial Stability Program will soon begin buying equity stakes directly in banks and purchasing illiquid assets from banking institutions, freeing those firms up to begin lending again. This scene is being repeated around the world as a coordinated global effort by central banks and governments.
It appears inevitable that we will experience an economic recession and it may last into 2009 according to many business leaders and academics. However, the possibility of a full scale depression lasting many years seems very remote. Periodic recessions are not fun, but they are a part of the economic cycle, and we have become somewhat spoiled, until now, with only a few very shallow business slowdowns in our memories.
The Chairman of the Federal Reserve Board of Governors, Mr. Ben Bernanke, is one of the foremost experts on the economic conditions of the Great Depression. There is probably no one better to help us navigate the waters we are in now. Many taxpayers take a dim view of the perceived "rescue" of financial firms. I’m not condoning the risky strategies employed by large institutions that led us to this mess, and I hope they all lose their jobs (with no golden parachutes on exit), but the reality is that with no rescue package, the average person would suffer a lot more than the fat cats. It is imperative that this program be allowed to work, and in fact it should be very profitable for the taxpayers over the next several years.
There were other factors, other dominoes if you will, contributing to the severity of the Great Depression including a lack of global trade due to high tariffs, a severe drought in the Midwest which caused farmers and entire surrounding communities to default on loans, making the banking situation even worse. Today, global trade is not perfect, but is widespread. We have no food shortages or widespread regional economic meltdowns exacerbating the economic slowdown, at least at present. There are few guarantees in economics, or in life, but I don’t believe we are headed for Depression #2.
I hope you find this information helpful.
Tom Breiter is President of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.