Nicholas von Hoffman: Crash Test
As American finance is being twisted and reshaped almost hourly, many worry that we're in for an encore of the galvanic upheavals of 80 years ago. Is this a gruesome economic Groundhog Day?
There are important parallels but also major differences. The America of 1929 was energy self-sufficient. It was a muscular industrial society that imported few necessities. A businessman would have been hard pressed to get a foreign-manufactured safety pin into the country. We owed no foreign nation money; they owed us. We were at peace. The size of the military establishment was about right for a nation that did not believe in pre-emptive war and had no enemies.
We had a new president who, at least on paper, was ideally prepared for the economic holocaust. Herbert Hoover was the only president to distinguish himself as a businessman. In 1907, he started his own company, opening offices in New York, London, San Francisco, and Russia. By 1913, he had some 175,000 employees and was running mining operations around the world. Generations before the term "global economy" was coined, Hoover was practicing it.
By the standards of his time, Hoover was an interventionist, not inclined to remain inert while calamities rained down, although many in both parties thought differently 80 years ago. Secretary of the Treasury Andrew Mellon's recipe for dealing with the Depression was "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Ultimately, Hoover liquidated Mellon by making him ambassador to the United Kingdom.
Mellon was of the short, sharp retraction school, which believes an unhampered liquidation of the financially weak blows debt out of the economy fast and enables a quick recovery. The Mellon hypothesis still has adherents, but the politics are too awful for an administration to contemplate since this approach risks throwing 20 million people out of work in months if not weeks.
The 1929 crisis was a stock-market disaster. The 2008 crisis is a bond-market disaster. Yet they have important elements in common. Through much of the 1920s, the Federal Reserve made easy credit available to the nation's banks, which lent money to masses of people to buy stocks on margin. As long as the stock was worth more than the loan to buy it, all was well. The more people got into the market, the higher the prices of stocks went and the easier it was to use the stocks they had borrowed money to buy as collateral to borrow more money to buy more stocks that they did not pay for. Stock prices rose for so long that people came to believe that in the new, modern economy of the 1920s, prices could only go one way. Substitute the word "house" for the word "stock," and you see what the great grandchildren of 1929 did in the 2000s.
When the price of stocks purchased with borrowed money fell to a point where they were worth less than the loan, buyers had to come up with the money to make up the difference. If they couldn't, the stockbroker from whom they had gotten the loan took the stock and sold it. The same happened with mortgages and the bonds or collateralized debt obligations (CDO's) into which the mortgages were packed. Today, purchasers have to put down 50 percent of the price of a stock they buy on margin, but the investment banks that bought CDO's were putting up as little as 0.3 percent and borrowing the rest.
Thus the underlying mechanics of disaster in 2008 are similar to those of 1929. But there are differences. In 1929, there were no derivatives, those complex deals or arcane side bets that multiply potential losses of billions into trillions. We can thank computers for them....
Read entire article at American Conservative
There are important parallels but also major differences. The America of 1929 was energy self-sufficient. It was a muscular industrial society that imported few necessities. A businessman would have been hard pressed to get a foreign-manufactured safety pin into the country. We owed no foreign nation money; they owed us. We were at peace. The size of the military establishment was about right for a nation that did not believe in pre-emptive war and had no enemies.
We had a new president who, at least on paper, was ideally prepared for the economic holocaust. Herbert Hoover was the only president to distinguish himself as a businessman. In 1907, he started his own company, opening offices in New York, London, San Francisco, and Russia. By 1913, he had some 175,000 employees and was running mining operations around the world. Generations before the term "global economy" was coined, Hoover was practicing it.
By the standards of his time, Hoover was an interventionist, not inclined to remain inert while calamities rained down, although many in both parties thought differently 80 years ago. Secretary of the Treasury Andrew Mellon's recipe for dealing with the Depression was "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Ultimately, Hoover liquidated Mellon by making him ambassador to the United Kingdom.
Mellon was of the short, sharp retraction school, which believes an unhampered liquidation of the financially weak blows debt out of the economy fast and enables a quick recovery. The Mellon hypothesis still has adherents, but the politics are too awful for an administration to contemplate since this approach risks throwing 20 million people out of work in months if not weeks.
The 1929 crisis was a stock-market disaster. The 2008 crisis is a bond-market disaster. Yet they have important elements in common. Through much of the 1920s, the Federal Reserve made easy credit available to the nation's banks, which lent money to masses of people to buy stocks on margin. As long as the stock was worth more than the loan to buy it, all was well. The more people got into the market, the higher the prices of stocks went and the easier it was to use the stocks they had borrowed money to buy as collateral to borrow more money to buy more stocks that they did not pay for. Stock prices rose for so long that people came to believe that in the new, modern economy of the 1920s, prices could only go one way. Substitute the word "house" for the word "stock," and you see what the great grandchildren of 1929 did in the 2000s.
When the price of stocks purchased with borrowed money fell to a point where they were worth less than the loan, buyers had to come up with the money to make up the difference. If they couldn't, the stockbroker from whom they had gotten the loan took the stock and sold it. The same happened with mortgages and the bonds or collateralized debt obligations (CDO's) into which the mortgages were packed. Today, purchasers have to put down 50 percent of the price of a stock they buy on margin, but the investment banks that bought CDO's were putting up as little as 0.3 percent and borrowing the rest.
Thus the underlying mechanics of disaster in 2008 are similar to those of 1929. But there are differences. In 1929, there were no derivatives, those complex deals or arcane side bets that multiply potential losses of billions into trillions. We can thank computers for them....