Sunday, September 27, 2009

Will We Stop 1929 from Repeating?

The Great Depression was a financial event. There was no war, earthquake or hurricane. The financial system ruptured and just about died. People stood in line to withdraw their saving from the banks. Thousands of banks collapsed. People, worldwide, lost their life savings. It was contended that the runs on the banks are what brought the system down. Upon closer examination, it’s easy to extrapolate the banks eventual demise from the poor economic conditions. The money borrowed could not be paid back by the unemployed. Many people were forced to live off of their savings (if they had any left).

In order to stem bank runs, the government came up with FDIC insurance. The Glass Segal act put this into effect January 1, 1934. This was after the horses escaped and the barn door was locked. If your bank met muster, you qualified for insurance and if it didn’t, you were toast. It didn’t cost the government a dime.

Let’s bracket that date January 1, 1934; either 100% of the population had collectively lost 80 percent of their wealth, or 80 percent of the population lost everything and 20 percent lost nothing. Almost everyone fell somewhere in-between the two categories. There was an obvious destruction of savings that was catastrophic in nature. This money wasn’t destroyed; it had been spent very foolishly over the previous 10 years on consumption. If you paid one million dollars for a dog or a wedding, you got your money’s worth, although I would argue that.

Fast forward to today. Bank deposits worldwide are insured. No one has lost a dime. The last part of the Kondratieff wave has to do with the contraction of the money supply and the repudiation of debt. The US Treasury is expanding the money supply while debtors have no problem walking away from their obligations. The most important thing to realize about the last part Kondratieff cycle is the end result. It destroys the obscenely rich and returns financial systems to a more normal functioning state. Bernanke is trying to preserve the status quo. The Fed is going to print us into prosperity.

Food prices have double this year. It is a little hard to see in some cases, the giant size potato chips bags, now fit in a lunch box. And then there is the specter of deflation. Autos and homes are just not selling.

Even if you have a job, your wages are not increasing, but your cost of living is increasing. So you dip into your savings, which seem to have lost a lot of buying power. Maybe that’s what deflation is all about, you spend until you are broke and then do without.

In 1930 there was no money to short the dollar on a carry trade. Bernanke has fixed that (it’s a little like a bank selling hand guns in the main lobby). The World(and probably Goldman Sachs) has shorted the American dollar. After getting rid of our clunker, we can now drive to the poor house in style. It kind of sets your mind at ease, doesn't it?


ca said...

Jim --

Some are calling for a brief run up in the dollar before the final collapse. Any thoughts on this?

Also, in the last post, you spoke or converting cash certificates to tangible products. I've seen various ideas as to what constitutes tangible products -- gold, tools, oil stocks, farmland, etc. I was wondering what you see as viable tangible products?

Anonymous said...

"There was no war,..."

The 'war' comes after the collapse, not before it.

Hide your 12 year-old male children.

Anonymous said...

I'm not sure sure about this 'final collapse' scenario. There has to be something to replace the dollar, and right now there is not. It is like the stock market. We all know it is a rigged market benefiting business and government insiders, yet we continue to play the game by saving for retirement.

Tyrone said...

In case you haven't already seen it...

US Dollar to be cut in half over next 14 years

Jim in San Marcos said...

Hi Ca

I'm looking to transfer my 401K bond holdings into stocks if the stock market were to take a big drop. Nothing exotic, cigarettes, consumer oriented, oil, natural resources to name a few. Stocks are tangible assets.

Real estate could be dangerous, it is highly visible for tax purposes. In a collapse, the house would be yours free and clear, and so would the new taxes.

I do have gold and silver, but I wouldn't recommend gold it is really up there in the stratosphere. Silver is a better buy (historically it was in a 15 to 1 ratio with gold). The only drawback is the weight. 1,000 ounces of silver is about 90 pounds. Home ownership is the equivalent of about 175 ounces of gold (IMHO).

I like to fly and sail, so I just might pick up a boat or a plane if the price is right. They both seem to keep their value with age.

I wouldn't try to out think what will happen, the government will change the rules. I learned that shorting the bank stocks. And remember FDR banned private ownership of gold (you might not want to store gold in a bank)HINT HINT.

The only real problem with a currency collapse could be the logistics of getting food to the cities for a couple of weeks. Why deliver it if you are not sure you will be paid and with what? You might want to have a months supply of goodies in the pantry.

When this mess hits the fan, I don't think you and I will be much concerned. It is the super rich with 10 million or better that will be killed in a collapse, not to mention the well to do retired.

My only advice, invest in your kids, before the government spends your hard earned savings.

Whatdayathink? Anything close to what you are doing?

Jim in San Marcos said...

Hi Anon 12:21

I have a 16 year old son and I myself went to Viet Nam. The war in Afghanistan scares me.

With the threat of "nuclear solutions," war seems removed a bit. A war would screw up the food supply so bad, that half of the world could die just from starvation. Not a pretty thought.

Thank you for your comments.

Jim in San Marcos said...

Hi Anon 4:55

Gold could be the final statement. It could replace the dollar. Of course,------maybe it already has. Shhhhh

Jim in San Marcos said...

Hi Tyrone

Thanks for sharing the link. He raises several good points. I agree, but I don't think we have 14 years, maybe 6 months!

Thank you and take care.

dearieme said...

If prices fall far enough, I think I'll buy France.

ca said...

Jim --

Thank you for the detailed response.

My parents were teenagers during the Depression and the one thing my mother always repeated throughout her life was "if you can't afford to pay in cash, you can't afford it." The vivid descriptions of what they lived through remain with me to this day. In a way, this prepared me for the volatile period we will be confronting over the next decade.

My husband and I are both 60 and medical professionals. Unlike many of our peers, we live in a small townhouse and drive 12 year old vehicles. We were both raised in major cities, but several years ago moved to a rural community. We have a small plot of land on which we grow food -- intially for our own enjoyment, soon to be a necessity.

I will also buy stocks if they fall far enough and reflect their true value. I agree that taxes on everything will increase, so real estate is an added burden.

I agree that the government will change the rules as we progess through this debacle. While, on one hand, gold is a good hedge, on the other hand I believe the laws will be changed to penalize anyone who holds it, e.g., higher taxes.

It appears that this whole event is going to take much longer to play out than I anticipated.

Jim in San Marcos said...

Hi Ca

You struck a harmonic chord when you said "this whole event is going to take much longer to play out than I anticipated."

I have been saying the same thing for a couple of years now. What is holding up this house of cards? It should have fallen apart 5 years ago and it is still ticking like a Timex watch.

It kind of looks like common sense doesn't pay much of a return (wallet wise).

To quote the religious pundits, I think, "The End is Near."

Jim in San Marcos said...

Hi Dearime

I like your musing, "If prices fall far enough, I think I'll buy France."

I'm sure, that who ever owns it now, would be more than willing to sell it to you.

I have just been informed that I can't put a toll booth on my latest purchase, the Brooklyn Bridge. So you might have a problem putting hotels on France.

Just love these board games, it almost makes you want to run for office and play the real thing.

Rob in NS said...

it’s a little like a bank selling hand guns in the main lobby

Good Analogy Jim

Could you explain for us common folk how the carry trade works. I've read that Canuck buck has better outlook than some but I have my doubts. I think it is swirling in same bowl as all the rest.


Jim in San Marcos said...

Hi Rob

The carry trade is where you borrow money very cheaply and are able to loan it out elsewhere at a very good rate.

From 1990 to about 2002 there was the Japanese Carry Trade. Their banks were paying zip in interest on deposits. It was a no brainer for a Japanese bank to sell Yen and buy dollars and then purchase Treasury bills. At the same time if the Yen dropped in value to the dollar, you made even more on the transaction IF YOU WERE IN JAPAN.

If you were on the other side of the transaction, it was symbiotic in nature. the US Treasury had someone to finance our debt at 6%. A win win for everyone. The Japanese over 12 years were able to refurbish their banking system courtesy of the carry trade.

Right now with the Treasury paying only 2% interest on T-Bills, the Japanese carry trade is not profitable, when you consider the currency exchange fluctuation risk. The real risk now is when the Japanese start recalling their Yen. The dollar will drop, which in turn will accelerate the repatriation of Yen.

Any banking system operates on the carry trade. Depositors are paid say 2% and the banks loan out 30 years at 5%. That's how the Saving & Loan debacle of the 1990's occurred. Interest rates rose sky high and their depositors at 2% evaporated, but the long term 30 year 5% notes didn't. Kind of sounds like we are driving down that road again.

Rob in NS said...

Thanks Jim

So the real crunch for banking system is going to come when interest rates rise and depositors start demanding higher interest to keep money on deposit. All those fixed rate 5% mortgages aren't going to pay enough to make banks profitable. I guess that is where Fannie and Freddie come to rescue. If that happens it would be the Mother of all bailouts and a big depreciation in currency.