This is my second diary on the preamble to the Great Depression. I became interested in this for obvious reasons, and my main goal was to learn if conditions now resembled those present before the economic meltdown. The short answer is, they do, much more than I realized. There are of course differences, but in this diary I am going to focus on the similarities and what it might mean for our future.
I have broken out my comparison of the period to the present with purple boxes to try to help make the prose more clear. It's long, but I hope people find it useful.
More below
The politics from 1920 to 1932 were eerily similar to that of 2000-2005. During the Harding administration, Andrew Mellon cut taxes and came up with the trickle down theory, the progenitor of supply side economics, it worked then about as well as today. From 1920 to 1929, the maximum progressive tax on income went from 65% to 33%
There was a technological revolution based upon the achievements of scientific and technical laboratories. And a stream of new products hit the market: radio, foam rubber, light bulbs, movies, the Model T, etc. Energy became cheaper with the conversion to an oil economy. These are the things that partially fueled the economic expansion of the 1920s.
When Harding died of a heart attack, Calvin Coolidge took over. Coolidge attacked unions, and did away with regulations on business. He named people sympathetic to business interests to regulatory commissions, for example William E. Humphrey, a former attorney for the lumber industry to the FTC. Coolidge pushed through 3 tax cuts that became a windfall for the rich, with some rich people paying no income tax at all. Low interest rates helped people borrow money and drove the economy. Many prospered
However, there were many who did not come out well. There was a large divide between the rich and the poor, to levels not seen until 2000-2005. Farmers especially had trouble. Tractors brought about large productivity gains, leading to food surpluses and crashing prices. Many farmers lost everything.
I see many parallels here. The government was run by people who catered more than usual to the rich, and ended up giving away the treasury to them. Changes in society were throwing many people out of work. Then it was farmers, now it is manufacturing jobs and IT. A large pool of people are accumulating that are not sharing in the prosperity, this builds resentment and is a political powder keg. This was one of the keys to the landslide victory of Roosevelt in 1932. Can it be repeated? I think so.
There are also many parallels in the financial sector. The depression was preceded by a period of financial speculation. First in 1919-1920, the scheme of Charles Ponzi of the Old Colony Foreign Exchange Company in Boston, unfolded. Ponzi took money in and promised a return of the money in 90 days with a 50% commission. He claimed to be able to make these startling sums by trading it on foreign exchange markets. In reality, money coming in the front door was used to pay those cashing in their 90-day notes, and he was pocketing the rest. As long as inflows exceeded outflows, the business was growing, and he could keep this going. Of course, eventually public officials started asking questions, and newspaper reporters began investigations, causing the inflows to slow. Ponzi eventually defaulted and most of the people involved lost money.
Note the pattern because it comes up so often in irrational financial situations. An investment scheme is hatched that claims to make big money and is advertised to would be investors. Early on, money is made by a few, who draw in others, inflating the scheme. The press gets wind of the money being made and initially files positive reports. The scheme continues as long as there is more money coming in than money flowing out. This is a very important point, the key seems to be predicting when the money stops and the bubble bursts. There is always a key event that causes the collapse.
A similar speculative frenzy was the real estate market in Florida. It began with a few rich industrialists buying land and developing it as a playground for the wealthy. Others soon realized they could develop land and sell it to the newly prosperous and chilly middle class in the Northeast and Middle West. A large amount of advertising enticed clients with the sunny days and bathing beauties of Florida. This precipitated a mass migration to Florida and sent land prices rising. The rapid increase in property value drew speculators who would turn property sometimes fives times in a day. The whole frenzy depended on new buyers coming into the market willing and able to pay the ever rising prices. This eventually faltered because builders could not meet construction deadlines as a result of a railroad embargo. Major capitalists such as DuPont, bailed out of projects, making other investors nervous, the IRS decided to start taxing these profits and finally a hurricane in 1926 literally knocked down development near Miami. Speculators panicked and began selling their property for whatever they could get, driving down prices These factors wiped out many investors, when payments for taxes and loans far exceeded the bewm lower, market value of the land.
Finally there is the stock market boom and bust of the 1920s. Liberty bonds and Victory bonds, sold during WW I, started the investment craze and it introduced average Americans to the idea of investing money. This program was a great success, for the government, which obtained much needed cash for the war, and the people who bought the bonds, who earned a nice return on the money they invested. Flush with their cash from the redeemed bonds, many looked for a place to park their money, and the stock market obliged. Up until this point, most corporations obtained their financing in the form of loans from banks. But in the 1920s corporations discovered how to sell stock to the general public. To broker many of these deals, brokerage firms sprang forth to hawk the latest stock like one would sell a car or washing machine. This is all well and good, and a tremendous innovation in financing business. It provided ready capitol for expansion and provided jobs. However, things became overheated. What really made the stock market dangerous was margin trading, taking a loan from the brokerage firm, with the promise to pay it back after the stock made a profit. In the rising market of the 20s, people became heavily leveraged in anticipation of the market always going up. Margin rates got as high as high as 10 to 1, debt to recoverable cash. The infusion of new people buying stock, combined with leveraging, naturally pushed stocks higher and fed the frenzy. More people were drawn in and incredible rises in stock prices were seen.
Of course, eventually this was doomed to fail. Many reasons are given for the crash of 1929. Poor economic indicators (lower car purchases and slowing building construction) in the summer of 1929 made many investors nervous about a economic slowdown. The failure of the financial empires of Clarence Hatry and Samuel Insull in England, owners of coin-operated vending machines, made investors nervous about other companies financed heavily with debt. Rumors spread of smart investors leaving the market, and finally the Federal Reserves actions to try to slow the frenzy in margin trading. But the most important reason appears to me to be that the stock market in the late 20s was nothing more than a sophisticated Ponzi scheme. In order to continue, new money has to come in to buy shares at ever higher prices. Eventually those participating ran out of money and the entire thing collapsed.
This is similar to what happened in 2000 in the stock market, but as Jerome a Paris has pointed out, Greenspan forestalled any serious payback by dropping interest rates so low. However, he only postponed the problem, pushing it into real estate. While the crisis in Florida in 1927 was probably more heated than what is occurring today, the current housing bubble is much more wide spread. And there are certainly many speculators. Again, note how Florida real estate unraveled when inflows stopped. With rising interest rates I think that time is coming for the current bubble. With the large amount of debt that people are carrying, similar to the heavy leveraging seen in the stock market of 1929, many people are going to lose everything. The real estate crisis will greatly suppress consumer spending. Add on top of that the massive slowdown that is certainly going to occur in construction and real estate and it is a double whammy to the economy.
There were many skeptics who warned of the coming crash before 1929, but they were ignored or ridiculed. The optimists talked about a "new" economy, where the old rules didn't apply. Sigh, sound familiar? We heard it in 1999 and we are hearing it again today about real estate.
Given all of these factors, I am pretty much convinced we are headed for a second depression. The choices seem to be to be either inflation above 10% or deflation, either of which will be devastating to the average American. It is going to be painful, but lets hope this tough medicine will snap Americans out of their stupor and bring about a sorely needed cleansing of this countries soul.
I have also heard the argument around here and in the newspapers that this will only affect the foolish who have overextended themselves. I don't know. Before the crash of 1929, only 1.5 million people were involved in the stock market, with only 600,000 active traders. That is less than 1% of the U.S. population at that time. However, their misfortune affected a significant amount of money and this rippled through the rest of the economy. I think the current financial situation is more wide-spread and will have just as devastating a