Submitted by Brendan Brown, the Head of Economic Research at Mitsubishi UFJ Securities International via Mises.org
The profound question which transcends all this day-to-day market drama over the holidays is the nature of the economic slowdown now occurring globally. This slowdown can be seen both inside and outside the US. In reviewing the laboratory of history — especially those experiments featuring severe asset inflation, unaccompanied by high official estimates of consumer price inflation — three possible “echoes” deserve attention in coming weeks and months. (History echoes rather than repeats!)
Will We Learn from History — And What Will Soon Be History?
The behavioral finance theorists tell us that which echo sounds and which outcome occurs is more obvious in hindsight than to anyone in real time. As Daniel Kahneman writes (in Thinking Fast and Slow):
The core of hindsight bias is that we believe we understand the past, which implies the future should also be knowable; but in fact we understand the past less than we believe we do – compelling narratives foster an illusion of inevitability; but no such story can include the myriad of events that would have caused a different outcome .
Whichever historical echo turns out to be loudest as the Great Monetary Inflation of 2011-18 enters its late dangerous phase. Whether we’re looking at 1927-9, 1930-3, or 1937-8, the story will seem obvious in retrospect, at least according to skilled narrators. There may be competing narratives about these events — even decades into the future, just as there still are today about each of the above mentioned episodes. Even today, the Austrian School, the Keynesians, and the monetarists, all tell very different historical narratives and the weight of evidence has not knocked out any of these competitors in the popular imagination.
The Stories We Tell Ourselves Are Important
And while on the subject of behavioral finance’s perspectives on potential historical echoes and actual market outcomes, we should consider Robert Shiller’s insights into story-telling (in “Irrational Exuberance”):
Speculative feedback loops that are in effect naturally occurring Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere….. The path of a naturally occurring Ponzi scheme – if we may call speculative bubbles that – will be more irregular and less dramatic since there is no direct manipulation but the path may sometimes resemble that of a Ponzi scheme when it is supported by naturally occurring stories.
Bottom line: great asset inflations (although the term “inflation” remains foreign to Shiller!) are populated by “naturally occurring Ponzi schemes,” with the most extreme and blatant including Dutch tulips, Tokyo golf clubs, Iceland credits, and Bitcoins; the less extreme but much more economically important episodes in recent history include financial equities in 2003-6 or the FANMGs in 2015-18; and perhaps the biggest in this cycle could yet be private equity.
Echoes of Past Crises
First, could 2019-21 feature a loud echo of 1926-8 (which in turn had echoes in 1987-9, 1998-9, and 2015-17)?
The characteristic of 1926-8 was a “Fed put” in the midst of an incipient cool-down of asset inflation (along with a growth cycle slowdown or even onset of mild recession) which succeeds apparently in igniting a fresh economic rebound and extension/intensification of asset inflation for a while longer (two years or more). In mid-1927 New York Fed Governor Benjamin Strong administered his coup de whiskey to the stock market (and to the German loan boom), notwithstanding the protest of Reichsbank President Schacht).
The conditions for such a Fed put to be successful include a still strong current of speculative story telling (the narratives have not yet become tired or even sick); the mal-investment and other forms of over-spending (including types of consumption) must not be on such a huge scale as already going into reverse; and the camouflage of leverage — so much a component of “natural Ponzi schemes” — must not yet be broken. The magicians, otherwise called “financial engineers” still hold power over market attention.
Most plausibly we have passed the stage in this cycle where such a further kiss of life could be given to asset inflation. And so we move on to the second possible echo: could this be 1937-8?
There are some similarities in background. Several years of massive QE under the Roosevelt Administration (1934-6) (not called such and due ostensibly to the monetization of massive gold inflows to the US) culminated in a stock market and commodity market bubble in 1936, to which the Fed responded by effecting a tiny rise in interest rates while clawing back QE. Under huge political pressure the Fed reversed these measures in early 1937; a weakening stock market seems to reverse. But then came the Crash of late Summer and early Autumn 1937 and the confirmed onset of the Roosevelt recession (roughly mid-1937 to mid-1938). This was even more severe than the 1929-30 downturn. But then there was a rapid re-bound.
On further consideration, there are grounds for skepticism about whether the 1937-8 episode will echo loudly in the near future.
In 1937 there had been barely three years of economic expansion. Credit bubbles and investment spending bubbles (mal-investment) were hardly to be seen. And the monetary inflation in the US was independent and very different from monetary conditions in Europe, where in fact the parallel economic downturn was very mild if even present. And of course the re-bound had much to do with military re-armament.
It is troubling that the third possible echo — that of the Great Depression of 1930-2 — could be the most likely to occur.
The Great Depression from a US perspective was two back-to-back recessions; first the severe recession of autumn 1929 to mid-1931; and then the immediate onset of an even more devastating downturn from summer 1931 to summer 1932 (then extended by the huge uncertainty related to the incoming Roosevelt Administration and its gold policy). It was the global credit meltdown — the unwinding of the credit bubble of the 1920s most importantly as regards the giant lending boom into Germany — which triggered that second recession and snuffed out a putative recovery in mid-1931.
It is possible to imagine such a two-stage process in the present instance.
Equity market tumble accompanies a pull-back of consumer and investment spending in coming quarters. The financial sector and credit quakes come later as collateral values plummet and exposures come into view. In the early 1930s the epicentre of the credit collapse was middle Europe (most of all Germany); today Europe would also be central, but we should also factor in Asia (and of course China in particular).
And there is much scenario-building around the topics of ugly political and geo-political developments that could add to the woes of the global downturn. Indeed profound shock developments are well within the normal range of probabilistic vision in the UK, France and Germany — a subject for another day. And such vision should also encompass China.
Brendan Brown is the Head of Economic Research at Mitsubishi UFJ Securities International.
Admin, your articles on these topics are MUCH better… Chip
I read articles like this but ???? I’m still buying water ,food ,meds, gold , silver , guns and ammo as my investments .
The depression is already here and many are living it. The difference from the past is that it is a depression in the midst of prosperity. Both these conditions are held together by the nature of the matrix.
If the market crashes will the distribution system crash? Will the banks close? Will everything shut down?
I think not.
We have built a system that is very integrated by the computer and the internet that has the capacity to quickly adapt to changing conditions in the market place. We are all interconnected to it.
If the market crashes many will lose great sums of digital money. Pensions will probably be lost to many. Many billionaires and multi-millionaires will loose digital value to possibly zero. But all the cows in the fields, the crops in the ground, and our manufacturing capacity will still be there. In other words assets in hard material terms are still there.
The difference between 1929 and 2019 is the computer age. The government and the banks can keep the system going. All assets would become reorganized under government supervision and the financial system will change.
The public panic will force this change.
It seems that a great jubilee is coming. This will be a good thing. Something much overdue.
Money is the oil that keeps commerce flowing just like oil in an engine keeps it from seizing up. When people panic they are open for change. An unlike 1929 a system is in place that makes changing course possible.
The great reset that is coming may cause people to come together because it will affect the whole kettle. By eliminating the debt in the system a new financial system can be built that responds to needs rather than wants. Physical infrastructure can be built that provides jobs and satisfies needs.
It is said that money is the root of all evil. But used wisely it can be the root of much good.
The current financial system is obsolete. Human prosperity requires that the current system be changed. Since the status quo won’t do it then nature will.
It is always darkest before the dawn. Get ready for an exciting ride. The time for change is here.
hmm…and when the interweb goes down then what
when they can’t get Doritos petrol and their gadgets won’t work the zombies will freak
The asset bubble is in all types of Government debt.
The willingness of the people to pay it back has ended with the Yellow Vest movement.
The Yellow Vests are mostly communists. They don’t mind paying high taxes as long as they get something back from it.
What pissed them off is their centralized government brought in all these immigrants who do not contribute anything and are supporting them with the Yellow Jacket’s tax money; leaving the Yellow Jacket’s with the short end of the stick.
I would be pissed too if I were in their shoes.
YOU are in their shoes, you just don’t know it.
Oh yes I know it but but unlike them can still pay my monthly bills and have some extra left over.
Tried to do something about it years ago but found I did not have the support of others like the Yellow Vests do.
So much talk about the stock market. Reminds me of the 07-08 crap. I am working and doing my best and other people are gambling and I end up paying the price. So much crap that is beyond my control. I have a piece of dirt and a shack. I am considering moving there in preparation for the shit storm that is coming.
I have recently experienced the joy of having the bank empty my account without my permission. I see it as a sign of the future. One day the bank doors will be shut and the ATM won’t work. Invest in things like food and ammo. Learn to grow food. Be out of debt.
Holy cow, what happened that the bank saw fit to empty your account?
Fact: if you owe Federal taxes or child support …. the bank will “empty” the account if ordered to by the government. (Don’t ask me how I know this.)
We will retest 26,000 at least once. I don’t know what other people invest in but oil and gas stocks, AT&T and similar big dividend payers trading at PE of 5-6, BRK-B at PE 7-8 are screaming buys regardless of boom or bust overall. It is to the investor a market of stocks taken individually.
I find this guy questionable as he refers to the FANMG’s as opposed to the FANG’s. No one with any investment knowledge places Microsoft in the same category as the FANG’s. I don’t think Netflix belongs in there either but of course without it we would never be allowed to call them the FA_G’s.
I am expecting what a couple of analysts call a “tear your face off rally” very soon while also expecting wild ass volatility. Volatility can be your friend.
” (History echoes rather than repeats!)”
Aw, good lawd, did he just say that? Eye roll. Double eye roll. Triple eye roll.
I know the shitstorm will get here, probably, eventually ….. but predicting a date is stupid bullshit. Then again, maybe it sells prescriptions.
The article was boring and I quit early on. If this was presented in a meeting I would have nodded a lot. It seems to me that comparing 1929 to today (except in very general generalities) seems really really really stupid. Am I wrong in this?
no, it was a snoozer
are generalities anything more than general
Probably, but what the hell do we know anyway?