The Great Depression

It is our belief that in order to truly understand how our current economic situation has evolved and to decipher what to expect in the coming years, we should look first to history. What has transpired in similar circumstances in the past? What events triggered a crisis or lead to a market collapse? How did the the general public react? What were the consequences of the crisis? In that light, today we look briefly at the Great Depression. “The Great Depression” is a term, that given historical perspective will, in our opinion, no longer refer to the 1929 economic collapse in the United States, but will be used to describe what began in 2008 and is likely to continue for years to come.

Much has been written about The Great Depression. As a result, this analysis will be brief and, we hope, to the point.

A string of terrible days led to a more than 40 percent drop in the market from the beginning of September 1929 to the end of October 1929. The market continued to decline until July 1932, more than three years later, when it bottomed out, down nearly 90 percent from its 1929 highs.

The Great DepressionDespite the Florida real estate crash, a bubble which burst in 1925, Americans were overwhelmingly bullish about the stock market. The feeling was one of “can’t lose” invincibility. The stock market was guaranteed to make everyone rich. The first world war had been won, and industrialization was resulting in previously unimaginable luxuries. It was a good time to be American.

Since the stock market was believed to be a no-risk, no-brain world where everything went up, many people poured all their savings into it without learning about the market, the underlying companies or the risks involved. With the flood of uneducated investors, the market was ripe for manipulation and fraud. Investment bankers, brokers and traders banded together to manipulate stock prices and generate large personal gains. They did this by subtly acquiring large chunks of a stock between them and trading shares back-and-forth to each other for slightly higher prices with each trade.

When the public noticed the upward progression of price on the ticker tape, the masses would jump in and buy the stock driving its price even higher. The market manipulators would then sell off their overpriced shares for a healthy profit. This  process was repeated over and over as market insiders and even some dumb, but lucky, investors turned a profit by selling the manipulated, over-priced shares to someone who wanted to own a rising stock (i.e. the “greater fool” theory of investing).

Behavioral finance shows that the less an investor knows, the easier it is for him or her to be swept up in popular opinion (herd mentality). This behavior is a double-edged sword because ignorant investors are also easily spooked into panic. Both actions, joining and fleeing, have very little basis in the news or the quality of the market. Instead, the herd follows the cow that runs the fastest, trampling the market.

During the stock market craze before the Great Depression a number of academics, including Roger Babson, were predicting a crash if things didn’t “calm the hell down”. Sadly, for every Roger Babson, there many more bull-blinded market mavens guaranteeing the eternal rapid growth of the American stock market.

Babson had been predicting the crash for years. Babson was responsible for the “Babson Break”, a three percent market drop that followed his September 1929 warning – “Sooner or later a crash is coming, and it may be terrific”. That warning proved to be the beginning of the end.

The twelve-year worldwide depression came and ended only with the declaration of World War II. This stands as the worst financial blow to the USA ever. The crash itself, though large in its own right, was nothing compared to the ensuing graveyard market and devastating depression that followed.

A Tulip Is Just A Tulip, Isn’t It?

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

– Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

People think currency, such as the U.S. Dollar, is money. It is not. Historically money has an intrinsic value within itself. Think of gold and silver and other precious metals – they are money. Our paper and coins are fiat currency. A fiat currency is an arbitrary order, given by a body, typically a government, which has the power to enforce it. All currencies today are fiat currencies.

Here’s a dirty little secret: Fiat currency is designed to lose value. Its very purpose is to confiscate your wealth and transfer it to the government. Government monetary policy as implemented with our fiat currency – the U.S. Dollar – is a “hidden tax” on all of us. Consider this: every time the government prints a new dollar and spends it, the government gets the full purchasing power of that dollar. Where did that purchasing power come from. It was taken from the dollars you hold in your wallet, savings or investments. As each new dollar enters circulation it devalues all the dollars in existence because they are now more dollars chasing the same amount of goods and services. This causes prices to rise. This is the insidious stealth tax of inflation.

As my previous two post illustrated here and here, governments are often to blame when creating inflation through fiat monetary policy. But remember, in the end we ultimately consent to our government’s rule. History is full of examples of greed leading a populace to do incredibly stupid things. As these incidents show we don’t need government to ruin our economy. We can do it just fine ourselves. Perhaps the best example of this lunacy is the tulip mania of 1637.

tulip_bulbs300x199

In order to truly understand the absurdity of this moment in history, you simply have to ask yourself: Would I pay $2 million for a tulip bulb? If so then please call me immediately on (810) 555-1393.  I have a limited supply of (insert worthless item here) for sale at to die for prices.

What many people don’t know is that tulips are not indigenous to Holland. They were first imported in 1593 from Turkey. They quickly became a status symbol for the wealthy. This developed into a craze, and subsequently a tulip exchange was established in Amsterdam.

Very quickly the mania turned into an economic bubble. Put in historical  perspective it is quite comical. In 1636 a single tulip bulb of the Viceroy variety was traded for the following:

  • 8,000 pounds of wheat
  • 16,000 pounds of rye
  • Four fat oxen
  • Eight fat swine
  • 12 sheep
  • 280 gallons of wine
  • Four tons of beer
  • Two tons of butter
  • 1,000 pounds of cheese
  • One bed
  • One suit of clothes
  • One silver goblet
  • 220px-Tulipomania

    At its peak in 1637 a single bulb of the Semper Augustus variety was sold for 6,000 florins. At the time the average annual wage in Holland was 150 florins. Tulip bulbs were selling for 40 times the average Hollander’s annual income. To  put that in perspective let’s assume the average U.S. salary is $50,000. That means that a tulip bulb in today’s dollars would cost you $2,000,000. Soon people began to realize how crazy the situation had become and the smart (if you can call anyone involved in this mania smart) money began to sell. Within weeks tulip bulbs fell to their real value, which was several bulbs for just one florin. The financial devastation that swept across  northern Europe as a result of the market crash lasted for decades.

Rome Is Burning

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some…..Those to whom the system brings windfalls….become profiteers.

-John Maynard Keynes

People think currency, such as the U.S. Dollar, is money. It is not. Historically money has an intrinsic value within itself. Think of gold and silver and other precious metals – they are money. Our paper and coins are fiat currency. A fiat currency is an arbitrary order, given by a body, typically a government, which has the power to enforce it. All currencies today are fiat currencies.

Here’s a dirty little secret: Fiat currency is designed to lose value. Its very purpose is to confiscate your wealth and transfer it to the government. Government monetary policy as implemented with our fiat currency – the U.S. Dollar – is a “hidden tax” on all of us. Consider this: every time the government prints a new dollar and spends it, the government gets the full purchasing power of that dollar. Where did that purchasing power come from. It was taken from the dollars you hold in your wallet, savings or investments. As each new dollar enters circulation it devalues all the dollars in existence because they are now more dollars chasing the same amount of goods and services. This causes prices to rise. This is the insidious stealth tax of inflation.

Rome supplanted Greece as the dominant power of the ancient world. During Rome’s centuries of dominance it achieved greatness in many ways. However, as with every empire in history, Rome did not learn from mistakes of the past. As a result they were doomed to repeat them.

Over the course of 750 years various leaders inflated the Roman currency supply by debasing their coinage to pay for war, public works and welfare. Coins were made smaller or a portion of the edge of gold coins were clipped off as a tax when entering a government building. The clippings would be melted down to make more coins. And, just as the Greeks did, the Romans mixed common metals such as copper into their gold and silver. And last but not least they invented the “art” of currency revaluation – they minted the same coins with a higher face value on them.

By the time emperor Diocletian took the throne in 284 A.D., Roman coins were nothing more than tin-plated copper or bronze. Inflation was raging.

In 301 A.D. Diocletian issued his infamous Edict of Prices, which imposed the death penalty for anyone selling goods for more than the government mandated price. The edict also froze wages. Prices, however, just kept rising. Merchants who could no longer sell their goods at a profit just closed up shop. People either left their careers to seek work where wages weren’t fixed or they just gave up and and accepted welfare from the state. In fact, the Romans invented welfare. Rome had a population of about one million and during this period of time the government was doling out free wheat to about 200,000 citizens – 20 percent of the population. Today in the United States nearly 43 million – about 14 percent of the population is on food stamps.

Diocletian put people to work by hiring thousands of new soldiers and funding numerous public works projects (I wonder if they were shovel ready?). This effectively doubled the size of the government and military. Today in the United State more that 1.9 million people, excluding the Postal Service, work for the federal government alone. When you include all branches of the federal government, and state and local governments the total approaches 22 million. See the Bureau of Labor Statistics website for details.

Of course all these additional government employees had to be paid and the government had to find a way to pay for its welfare programs. Deficit spending went into overdrive. When he ran short of funds, Diocletian simply minted new copper and bronze coins and further debased the Roman currency.

This resulted in the world’s first documented hyperinflation. At the time of Diocletian’s Edict or Prices a pound of gold was worth 50,000 denari. By 350 A.D. a pound of gold was worth 2.12 billion denari. The price of gold rose 42,400 times in about fifty years. Currency based trade came to a standstill. The Roman economic system reverted to a barter system.

To put this in perspective, fifty years ago the price of gold was $35 an ounce in the United States. If it rose 42,400 times, the price today would be just under $1.5 million dollars an ounce. That means, for example, that if a new car sold for $2,000 fifty years ago (which is about what they sold for), that same car would sell for $85 million today.

It was the deficit spending and currency debasement used to fund the military, public works and social programs that collapsed the Roman Empire. As with every empire throughout history the Romans thought they were immune to the laws of economics. They were not.

It’s Greek To Me

“The farther backward you look, the farther forward you are likely to see.”

- Winston  Churchill

People think currency, such as the U.S. Dollar, is money. It is not. Historically money has an intrinsic value within itself. Think of gold and silver and other precious metals – they are money. Our paper and coins are fiat currency. A fiat currency is an arbitrary order, given by a body, typically a government, which has the power to enforce it. All currencies today are fiat currencies.

Here’s a dirty little secret: Fiat currency is designed to lose value. Its very purpose is to confiscate your wealth and transfer it to the government. Government monetary policy as implemented with our fiat currency – the U.S. Dollar – is a “hidden tax” on all of us. Consider this: every time the government prints a new dollar and spends it, the government gets the full purchasing power of that dollar. Where did that purchasing power come from. It was taken from the dollars you hold in your wallet, savings or investments. As each new dollar enters circulation it devalues all the dollars in existence because they are now more dollars chasing the same amount of goods and services. This causes prices to rise. This is the insidious stealth tax of inflation.

Throughout history fiat currencies have been used in place of gold and silver as “money” and the outcome has always been the same. It is a pattern that has repeated itself since the first great fiat currency crash in Athens, Greece in the 5th century BC.

Athens was the worlds first democracy. The Greeks had the worlds first free market economy and the first working tax system. For many years Athens shone brightly. They are considered one of the great civilizations of all time. Those amazing architectural public works, such as the Parthenon, attest to that. But as we know their civilization fell long ago. What happened? Why did such a great and powerful civilization fall? The answer lies in a pattern we see time and time again throughout history: too much greed leading to too much war.

Athens flourished for many years. Then they became involved in a war that turned out to be longer and more costly than they anticipated (sound familiar?). After 22 years of war, their resources waning and their money spent, the Athenians came up with a clever way to continue funding the war. They began to debase their currency. In a stroke of (what probably seemed like) genius the Athenians discovered that if you take in 1,000 coins in taxes and mix 50 percent copper in with your gold and silver then you can spend 2,000 coins! The coins no longer had their intrinsic value in gold or silver but possessed a new value set and backed by the government. By government order Greek citizens were compelled to accept the new currency. Does this sound familiar? It should, it’s called deficit spending and our government does it every second of every day.

Because of this currency manipulation for the first time a “fiat” currency was born – a currency that was not comprised entirely of gold and silver. Over the following years the Greeks continued to debase their currency and eventually it became nearly worthless. Within a few years the war that had started the whole process was lost. Athens never again enjoyed the glory or prosperity they once knew, and they eventually became nothing more than a province of the next great power – Rome.