By Francis Lee for the Saker Blog
The boom to bust economic cycles always seem to bring out the manic behaviour of the market participants who believe that this is the chance of a lifetime to make some real cash. But it was Sir John Marks Templeton an American-born British investor, banker, fund manager, and philanthropist who was moved to comment: ‘’This time it’s different.’’ He was of course being ironic.
In the Autumn of 1929 the prominent Yale economist, Irving Fisher, opined that ‘stock prices have reached what looked like a permanently high plateau.’ A few weeks after this somewhat premature pronouncement the Dow Jones Industrial Average (the US stock market) was down by one third. By the summer of 1932, the Dow closed down nearly 90% lower than its 1929 pinnacle. Fisher and many others had made the mistake of thinking that the long bull-market of the 1920s (the roaring 20s) had assumed an unstoppable momentum and would go on rising forever; an end to boom and bust if you will. Unfortunately, such sentiments have remained, as surely as summer turns to winter; and this will always be the case when a free-market capitalist system – a system underpinned by a tendency toward cyclical instability – founders on the rocks of these cycles. *
Throughout the 1920s the Dow Jones Industrial Average (DJIA) had risen inexorably; this was in part due to the new technologies and production methods – Fordism – which were allowing scope for considerable economies of scale and therefore increases in output so that a mass consumer society was to come into being. Moreover, modern management and marketing techniques could keep this consumer boom humming along in perpetuity, or so it was asserted. This situation of optimism and, as Keynes put it, rising animal spirits, was conducive to the general propensity to invest in stocks and bonds. Everyone was playing the market; the party was in full swing even in this era of prohibition. Something of the flavour of the times is captured in the novels of F Scott Fitzgerald, The Great Gatsby, and This side of Paradise.
Of course this situation was never going to last, bubbles never do, no matter how big or irreversible they may seem at the time. It should also be noted that it is precisely when the bubble phenomenon and attendant growth levels reach their most febrile and bloated state that the correction becomes imminent. And so it turned out.
The impact on the real economy of the stock market crash was that by 1933 unemployment had reached 25% of the American workforce and the economy had contracted by 30%. Worse still the catastrophe had spread to Europe as a result of the Vienna Bank of CreditAnstalt’s failure in 1931. Unemployment levels rose inexorably in both Europe and the United States. Now the writers of the age were John Steinbeck graphically illustrating the conditions of life in 1930s America in The Grapes of Wrath. The UK also felt the chill winds of depression best expressed in the literature of Arthur Greenwood’s Love on the Dole, or George Orwell’s documentary, The Road to Wigan Pier, which was his account of his travels in the depressed regions of the North of England during the 1930s
On the other side of the pond F.D.Roosevelt was elected US president in 1933 and immediately started to use active fiscal policies to create jobs and stimulate the economy. This did meet with some partial success as unemployment fell and output expanded. However in 1937/38 there was a fresh downturn and unemployment began to rise again. Moreover the geopolitical situation was beginning to change, with the seeming rise of militarism in both Germany and Japan which eventually was to push America into WW2. Of course this was led by massive military spending and a precipitous fall in US unemployment.
As an interesting sidebar worth noting is how the US economy moved into high gear in order to meet the exigencies of WW2. According to the (very orthodox) British Marxist economist Michael Roberts:
‘’The US war economy did not stimulate the private sector; it replaced the free market and capitalist investment for profit. Consumption did not restore economic growth as Keynesians (and those who saw the cause of the crisis as underconsumption) should expect, instead, it was investment in mainly weapons of destruction.
In many industries corporate executives resisted converting to military production because they did not want to lose consumer market share to competitors who did not want to convert. Conversion thus became a goal pursued by public officials and labour leaders. Auto companies only fully converted to war production in 1942 and only began contributing to aircraft production by 1943. The bombing of Pearl Harbour was an enormous spur to conversion. From the beginning from preparedness in 1939 through the peak of war production in 1944, the war economy could not be left to the capitalist sector to deliver. To organize the war economy and be sure that it needed the goods for war, the Federal government created an array of mobilization agencies, which often purchased goods, closely directed those goods’ manufacture, and heavily influenced the operation of private companies and whole industries.
The military services were largely able to curtail production destined for civilian consumption (e.g., automobiles and many non-essential foods) and even for non-war related but non-military purposes – textiles and clothing. The Department of the Treasury introduced the first general Income Tax in US history, and War Bonds were sold to the public. Beginning in 1940, the government extended the Income Tax to virtually all citizens and collected it by deduction from wages at source. Those Americans subject to Income Tax rose from one million in 1939 to forty-three million in 1945.
With such a large pool of tax-payers the US government took in $45 billion in 1945, a huge increase over the $8.7 billion collected in 1941, although still far short of the $83 billion spent on the war in 1945. Over that same period, Federal tax revenue grew from approximately 8% of GDP, to more than 20%. All told taxes provided about $136.8 billion of the wars total cost of $304 billion. To cover the remaining $167.2 billion. The Treasury expanded its Bond purchasing programme, which served as a valuable source of revenue for the government. By the time War Bond sales ceased in 1946 85 million Americans had purchased more than $185 billion worth of securities, often through automatic deductions from the pay checks.’’ (1)
Whatever the US economy was from 1933 until 1971 it certainly was not in the classical sense a free-market. The reversion to economic orthodoxy began circa 1971. This saw the return of economic orthodoxy of the marginalist school of the 1870s, which became popularised with the Thatcher-Reagan period and inspired by the monetarism of Milton Freidman and the Chicago School. But the theory was based upon a number of dubious assumptions – most importantly the abolition of boom and bust – a ‘theory’ which did not hold in either theoretical and policy terms as growth was to slow down in both the US and Europe to a snail’s pace and punctuated by ever more violent downturns.
Since the turn of the 20th to 21st century we have experienced a triple whammy of financial and economic collapses; the dot.com boom at the turn of the 1995/2000 century, the great property bubble of 2007/2008 and now the ongoing blow-out of 2020/2021. It should be noted that each successive downturn was more encompassing and deeper than those which preceded it. What gave rise to these financial bubbles was the biggest credit and property bubble in the history of capitalism. The boom from the early 90s until mid-2007 and then even worse to 2020 were all essentially floated on a sea of debt. In 2008 the collapse of the market in mortgages were advanced to almost anyone who wanted them regardless of their ability to pay; individuals spent freely on credit cards without a thought for the morrow. Their debts could be rolled over or compensated by increasing asset prices (property). So as consumers borrowed against the ongoing increase in their house prices, banks would lend them more. So we had an upward spiral: the increasing level of credit led to an increase in property prices and the increase in property prices led to an increase in the availability and uptake of credit; the classic bubble scenario. Worse still the mortgages held by the banks were repackaged (securitised) into new financial products, Mortgage-Backed Securities (MBS) and Collateralised Debt Obligations (CDOs) and often sold on to other financial institutions: Hedge Funds, Pension Funds, Insurance Companies and so forth. Okay so far, so good, the party roared on.
However the weak link in the chain was the American sub prime market. A group termed NINJAS, No Income, No Job, No Assets. This group began to default, and the banks were found to be holding assets of very dubious value. This initial default was the detonator which burst the house price bubble in all of those countries which had experienced a property boom – particularly the US, UK, Iceland, Ireland, Spain, and Australia.
The meltdown also started to affect countries who had not experienced a property boom but whose banks had foolishly purchased mortgage-backed derivatives (MBSs and CDOs). Banks in Germany, Switzerland, the low countries, Iceland, and more especially Eastern Europe, began to feel the heat. Many banks (and even countries – Iceland) were now insolvent and had to be rescued by the governments or loans from the International Monetary Fund (IMF).
Enter the credit crunch. Credit dried up even though property prices were falling. Since the US and UK economies had been essentially based upon the property market it was inevitable that the banking and property collapse would impinge very directly on the real economy. At the time of writing unemployment was rising very sharply, and deflation with falling (or static) prices and wages. Retailers were under the cosh with falling sales, and bankruptcies and boarded up shops were an increasingly common sight. We were already in a recession. Moreover there were to be further eruptions to come in the murky world of Credit Default Swaps and Derivatives. These were totally unregulated and highly leveraged markets involving literally tens of trillions of dollars.
The only question remaining was how long and how deep this financial/economic downturn would turn out to be.
The aetiology of the 2008 crash went as follows:
When a market bubble explodes the market participants which are most vulnerable are those which have expanded most rapidly and are the most highly leveraged. As real estate prices declined in the summer of 2008, Lehman Bank (2) was subject to two runs – investors and hedge funds sold their shares, both those they owned and those they could borrow, and the owners of Lehman’s IOUs were reluctant to renew their loans to the firm as they matured. Both groups were concerned that Lehman was slowed in raising capital to counter the decline in its net worth from the fall in the value of its mortgage-related securities
When Lehman’s failed, the credit markets froze, liquidity disappeared. Trading volumes declined sharply. There was the traditional rush to cash that occurs when the financial environment suddenly becomes uncertain; the firms which were in a position to extend were extremely reluctant to do so because they wanted to increase their liquidity and their holdings of cash and the firms like Lehman that relied extensively on borrowed short-term funds to finance their assets found that it was extremely difficult – and extraordinarily expensive – to refinance their maturing IOUs (3)
What an ignominious end to the fatuous claim ‘no more boom and bust’. The shame was that it was all so predictable. And the mortifying part was the extent that the government of the day colluded in and made possible this bubble creation by the financial and banking sector.
No matter. Of course nothing was learnt and the taxpayers and governments around the world were instrumental in bailing out the financial sector. Billions of monies were made available for the rescue of a delinquent financialised system that showed no signs that it had learnt anything. It was like listening to a cracked record as the 2008 crisis gradually morphed into the even deeper 2020 crisis. The Corona pandemic was simply the pin waiting for a mega-bubble – it found one. But what else did we expect? The Powers That Be (PTB) in the Western World may be appropriately compared to the ‘Bourbons’ a group of Royalists restored to power in France involving the restoration of the monarchy in 1814 by the Quadruple Alliance, Louis XVIII became King (1814–24) and was described by Charles-Maurice Talleyrand the French Diplomat, as ‘having learnt nothing and forgotten nothing.’ Such a description aptly fits our own ’Bourbons’.
These are early days in terms of the current economic situation in the world economy, particularly the western economies led principally by the USA. The present situation seems extremely unstable with large and unpredictable movements of capital in its various forms. The period of low to zero to negative interest rates in addition to massive printing and injections of Fed monies, has apparently become the bell-weather of the Fed’s monetary policy. The policy which, to a certain degree, was able to stabilize the 2008 debacle, but over time and in other areas of the economy the Fed policies have begun to unravel. The Bond Market has seen a rise in interest rates – which is a function of prior Fed monetary policy – a policy which worked at the time but which now in turn is causing negative feedback chaos in the stock markets. Rising bond yields are a negative input to the stock market as many companies finance growth through debt. If interest rates increase, then loan repayments increase which will hurt earnings. Rising interest rates are especially alarming for (REITS) Real Estate Investment Trusts and utilities as these companies use debt extensively and higher bond yields will hurt their valuations. Moreover the huge volumes of newly minted monies being injected by the Fed cannot help but to engender an inflationary push to the economy. The Fed clearly knows this but is toying with the idea that inflation is necessary in order to have any impact on debt levels – levels which are reaching ominous dimensions. In an economy which mollycoddles its inefficient businesses, economic stagnation becomes the norm and debt facilitates this policy.
Taking a leaf from Joseph Schumpeter we can say that there is no alternative to the disruptive part of the economic renewal, but there are ways of mitigating the human costs through assisting people into better jobs, this presumes though that those good jobs in new sectors and industries are being created. In preventing a business cycle shakeout the policies of the governments and central banks are strengthening the economy but making it more depressed. In operationalising low interest rates zombie economies are created. Weak businesses survive, directing cash flow to cover interest on loans that cannot be repaid but that banks will not write off. With capital tied up banks reduce lending to productive enterprises, especially small and medium-sized ones (SME’s), which account for a large proportion of economic activity and employment. Firms do not dispose of or restructure unproductive investments. The creative destruction and reallocation necessary to restore the economy does not occur.
Instead of economic renewal and growth, low interest rate returns, and central bank monetary methamphetamine have encouraged asset price bubbles, which in turn create conditions for a future financial crisis which is now coming into view.
Where we go from here is anybody’s guess; but It seems that the one lesson from history we learn is that we don’t learn from history.
*This crisis tendency has been noted by such notables as
(i)K.Marx, who ascribed such crises as the long-run tendency of the rate of profit to decline.
(ii) Joseph Alois Schumpeter who argued that capitalist crisis therefore is not an anomaly to be eschewed, it is not an aberration to be corrected, it is not a temporary setback waiting to be remedied: crisis is the very essence of capitalism; capitalism is permanent crisis.
(ii) J.M.Keynes on the long-term decline in the marginal efficiency of capital
(1) Michael Roberts – The Long Depression 2016 – p.57.
(2) Lehman Brothers Holdings Inc. was a global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), with about 25,000 employees worldwide. It was doing business in investment banking, equity and fixed-income sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking. Lehman was operational for 158 years from its founding in 1850 until 2008.
(3) Kindleberger & Aliber – Manias, Panics and Crashes 2011 – p257.