Imagine that a new technology comes along that spawns a whole new industry. Not only is this industry a revolution in how people lead their lives, it’s immensely popular and generates a big pile of cash. The field starts out wide-open with many small entrepreneurs, but gradually they become rich as they are bought out by a few big players. Soon, the industry has consolidated and re-investment slows dramatically. Those who made big money start to put it into real estate, specifically in Midtown Manhattan, Florida, and Los Angeles.
When the technology that started it all starts to slow from its original growth, investment in real estate only escalates. Eventually, that also has seen better days and the soaring prices begin to crash back to earth. Banks start to fail when everything gets tight, and it is revealed that many of these banks relaxed their standards a bit too much in the frenzy. The reverberations are felt as far as Wall Street. Will the stock market take a hit over all this, or will the good times just keep rolling?
If that sounds familiar to you, it should. It’s not only a description of the late 1990s, it’s what happened in the USofA starting in 1918. That time, the new technology was the automobile, and the big players had names like Henry Ford and Walter P. Chrysler.
The situation we find ourselves in right now is remarkably like the one that the stock market was in by the summer of 1929. What most people don’t realize is that bank failures were not caused by the stock market crash – indeed, the rate of about 600 failures per year from 1925-1929 was already double the previous decade. The historic meltdown on Wall Street was one of many symptoms of a massive credit crunch that left the entire nation scrambling for cash. Eventually, without credit, everything ground to a halt. That’s what caused the Depression, when bank failures peaked at 4,000 in 1933.
There are key differences between today and 1929, however. The Federal Reserve was preoccupied with currency swaps back then because the Depression started in foreign markets that started absorbing our gold reserves in a panic. The Fed was also slow to act for other reasons, notably the desire to keep an even hand on the markets. But for all the net positives we can find in 2008 versus 1929, there is one large negative that limits the reach of the Fed – we are in an expensive war, and our spending habits have crashed the US Dollar to new lows against the currencies of all of our trading partners.
Where will our next round of credit come from? As long as the Fed can manage to print more money, they will. But with trillions of dollars in derivatives, the action taken to save the assets of Bear Sterns cannot be duplicated forever. At some point, the market has to function properly by itself. We cannot expect any more money to come into the market until it shows signs of righting itself.
I’ve said this many times, but it bears repeating; it’s my version of Gresham’s Law. Stupid money drives out Smart. What I mean by that is that once a bubble has clearly popped, no one will get back into the market until they are sure that they have a good reason. Those who played the bubble have to ride it all the way down before those who either stayed away or got out will come back.
Where does this leave us? The historical parallels are chilling. We know that the Fed is, appropriately, beginning to panic and take drastic action. That’s a start, and it’s more than happened in 1929. For the present time, however, we can’t do a lot more than try to enjoy the ride.
Hope you enjoyed that “New Economy” thang everyone was so excited about back in 1999, too.