Doomed to Repeat History?

A profoundly unpopular Republican President, widely viewed as a massive failure by the populace is succeeded by a charismatic Democrat just as the country peers down the precipice of a deep and prolonged recession, following a historic crash in the stock markets. Unemployment is soaring, and deflationary forces rear their ugly head. The new President promises to put Americans back to work with sweeping public works projects, and leverages new technology to reach out to the citizenry weekly with his message of hope and change, delivered with the skill of a master orator known for his consistently poised and calm temperament.

Yep, Franklin Delano Roosevelt started his presidency in ways that should seem familiar to every American today. Oh, I’m sorry… did you think I was talking about Obama?

Santayana said that “Those who cannot learn from history are doomed to repeat it.” Are we going to see ourselves sink deeper into a depression and stay there for a decade or more before the country returns to a period of prosperity? Or, to quote FDR’s predecessor Woodrow Wilson, is prosperity “Just around the corner?” Nobody knows for sure, but one thing is for certain: the deck is stacked very much against a lasting recovery in the short term.

In the last quarter of 2008, we saw another wave of residential foreclosures, and it was devastating to the economy. What’s next? Commercial foreclosures, starting in Q2-2009. I expect to see examples of huge buildings in urban centers being foreclosed, and construction projects cancelled midstream because the budget no longer exists to complete them. Analysts have estimated that New York’s Financial District will see vacancy rates reach 50-60%, well below break-even. Even the symbol of American prosperity, the shopping mall, has fallen on hard times, and many will likely close their doors in 2009 and 2010.

At about the same time, we will see the next wave of residential real estate foreclosures and failed loans, especially in higher end homes above the 419K limit for Fannie Mae coverage. The first wave of credit card failures is starting now, caused by job losses and salary contraction. If nothing is done to prevent it, this combination of events creates a “perfect storm” that would make the last few months look like the roaring twenties. These times are being described by the financial press as a “credit crisis” or “crisis of liquidity.” However, I think they are wrong… liquidity issues exist w hen an entity has a shortage of cash, but sufficient resources and future income to dig themselves out given a shot of liquidity. However, I just don’t see it that way. We don’t lack liquidity, we lack solvency.

A great example is the U.S. auto industry. They are asking for loans to carry them a few more months, but what happens then? Absent major concessions from the unions, they simply don’t have a viable business model. There is no way for them to return to profitability, so if we give them a shot in the arm in the form of a cash infusion, we’re just postponing the inevitable. We need to face up to the fact that they are insolvent, and act accordingly.

The banking industry is similar. The massive deleveraging that has occurred has resulted in the uncountable reduction in the amount of money in the system. I have doubts in even “Helicopter Ben” Bernanke’s ability to print enough money to compensate and reduce the deflationary forces in the next 12-18 months. People don’t realize how much money the banking system has borrowed from the Federal Reserve in the last 6 months. I think some historical comparison is useful.

Borrowing from Federal Reserve by Depository Institutions (in Billions) 

In the chart above, you can see total borrowing of depository institutions from the Federal Reserve from the Fed’s inception in 1919 through December of 2006. You see a peak in the early 20s to fund World War 1, and then a smaller peak in 1929 following the great stock market crash. There’s a spike in the early 70s that corresponds to the financial crisis of that decade, and then a huge, $8 billion spike in the 80s to deal with the Savings and Loan crisis. With the exception of the S&L crisis, borrowing never hits $4 billion. (The spike in the late ’90s was precautionary borrowing in advance of Y2K in case there were bank runs.)

Now, let’s add 2007 to the mix.

Borrowing from Federal Reserve by Depository Institutions (in Billions) 

As you can see in the chart above, we had to double the scale, as borrowing in Q4 of 2007 approached $15 billion. N ow, let’s add 2008.

Borrowing from Federal Reserve by Depository Institutions (in Billions) 

Yeah, I had to increase the scale by an order of magnitude—instead of 8 billion, we’re looking at almost 700 billion. And these numbers only go through November, because the Fed hasn’t released December numbers yet. In case you’re wondering, these numbers came from the St. Louis Federal Reserve’s web site—you can download and play with them yourself in Excel format here.

If you adjust for the Consumer Price Index (CPI) to cover inflation, it doesn’t change the picture at all.

What I’m trying to communicate here is that this crisis is simply on a completely different scale than anything that came before it.

Historically, no nation has ever recovered when their debt exceeded their GDP by greater than 6%. In 2008 the United States crossed that threshold, and we are on track to exceed 10% in 2009. I don’t see how we can expect a recovery before the end of the next decade.

Is a “New New Deal” the answer, casting Obama as a modern FDR? CNBC’s Andrew Busch cautions against such a strategy:

The New Deal was actually a combination of socialism and cartelization of industry with price controls. These policies failed to stimulate growth and helped plunge the economy into the “Depression within a Depression” in 1937. It wasn’t until these policies were reversed and the NRA was relegated to a minor role in the government that growth returned in 1938. The other major issue was the Federal Reserve. They mistakenly stuck to the gold standard and was forced to raise reserve requirements that cut off the legs of the recovery.

Bottom line, buckle up… we’re in for a choppy ride, and it’s going to get a lot worse before it gets better. In a future post, I plan to take a look at some of the demographic trends that will make a recovery before the 2020’s even harder to pull off.

NOTE: This post was moved from my old site to my new one… hence I’ve pasted the comments below.

Sunday, 1 Feb 2009 02:11 by Brandon This is an excellent post and your thoughts are valid. The type of growth that we had over the past few years was built upon debt and completely unsustainable. As Ron Paul has stated many times, easy credit resulted in “malinvestment” and the only way I can see to correct this problem is to liquidate the investments whether it be bad loans, real estate, credit card debts, etc. What’s disturbing is that the government seems determined to prop up the Ponzi scheme through debt and more spending. I’m afraid to see what is going to happen when our country can borrow no more and begins to crack under the burden of massive deficits.

Sunday, 1 Feb 2009 02:20 by Joseph R. Jones Ron Paul also said that if we reduced government spending to 2001 levels, we could afford to completely eliminate personal income tax, and the IRS. Methinks that would provide a more effective stimulus than anything else I’ve heard proposed.

Sunday, 1 Feb 2009 05:11 by Alfred Hill, CPAretired From what I am reading and my own experience, yes, the problem worldwide is solvency, not liquidity.  Further, because so much of these “specific performance contracts” are either (1) not on the financial statements or (2) carried at fictitious values (not at mark-to-market), no one trusts a counterparty; hence, won’t trust payment will be received.  There is now (at the last report I saw) almost $500 Billion on deposit at the Fed Res from banks, who are afraid to lend.  There is plenty of money.  The public still has not been informed about the total amount of fraudulent derivatives written by the big banks, of which securitized mortgages and CDOs examples.  These are going to continue to collapse in stages over the next several years.Since at some point the public is going to set up guillotines, you see why a presidential candidate who said those on Wall Street who misrepresent need punishment was anathema to those on Wall Street who own the networks, including notoriously GE. The “Uncle Tom” Candidate obediently appointed the “right” people to Treasury, just as Clinton did and Bush did.  See the proof!

I read often.  It references good information from a small group of wealthy commentators who are angry and comment for free.  I thought these three graphs offer very good perspective.  However, the inflation adjusted graph uses a flawed Consumer Price Index as explains.

See three graphs at .

Take a look at inflation, unemployment and economic growth computed as it was before the method was changed by Bush I and Clinton:

FDR devalued the dollar by 70% against gold, confiscating savings, from those on fixed incomes and from all creditors.  This amounted to partial bankruptcy of government indebtedness by 70%.  Gold on the international government-to-government basis changed from $20.70 per ounce to $35 per ounce. It is expected that will happen again, but at what value for gold?  These graphs suggest how the huge amount of indebtedness is expected to be paid - in short, IT WON’T, instead like FDR there will again be a large partial bankruptcy of dollar indebtedness (Chapter 13) if not a complete collapse (Chapter 7) of use of the USA paper dollar.  By lying about inflation, unemployment and economic growth the financial powers and Congress have been able to run the shell game for a couple of more decades.

Yes, there was a shortage of currency early in the 1930’s but the root of the financial collapse was laid in the late 1920’s when the USA Fed Res adopted a deliberate policy of supporting the British Pound and its attempt to return to a gold standard - encouraged by Winston Churchill.  The mistake was using the pre WWI value of gold/pound notes - not at current value with a pound that had deflated about 50%.  The pre-WWI standard was the mistake primarily of the autocratic Chairman of the Bank of England.

Some day, to restore confidence in a different USA dollar and other nation’s (a) paper and (b) digital money, there will need to be some “peg” to an independently valued commodity, maybe gold, or maybe a basket of commodities.   This is to control the quantity issued.  Withdrawing supply when prices of the commodities rise and providing more supply when the prices of the commodities fall.  Thus, there will be an elastic supply.  However, bankers and politicians will have to give up robbing the public.

Sunday, 1 Feb 2009 07:40 by Tamara Wilhite I agree that we will see a huge wave of foreclosures and business collapses. The concern is whether or not the attempt to correct for deflation will not work or whether we will see hyperinflation (from currency devaluation).

Sunday, 1 Feb 2009 08:38 by Amitesh Kumar First of all would like to thank you for providing this useful post.The points outlined by you are extremely genuine and makes sense.Undoubtedly in the coming days we are going to witness an even more worse situation with more and more businesses closing.

Sunday, 1 Feb 2009 08:42 by Gareth Howell Interesting post. I’ve heard quite a few commentators compare our current crisis with Japan’s ‘lost decade’ during the 90s, and at least laud the considerable action being taken by the fed and others.I can’t comment on the 6% of GDP factor, but the principle of borrowing to invest (in this case in education, traditional and digital infrastructure among others) seems like a sound strategy. At least the bet is on our collective ingenuity and ability to create the next wave of valuable goods and products. Perhaps I’m naively optimistic about the value of innovation?

On currency devaluation, I’ve heard some folks lament that it may be a ‘race to the bottom’ as importing countries seek to ease their trade deficits and export reliant countries seek to prop up their economy.

Sunday, 1 Feb 2009 09:34 by Matt As I read this article I continue to have a profound lack of understanding of our governments new “bailout” policy.  We got ourselves in trouble as a society by building wealth based upon our tremendous amounts of debt.  Now our government is attempting to solve this problem by adding unprecedented amounts of new debt.  We must allow ourselves to hit bottom because only then will we truly see a lasting recovery

Sunday, 1 Feb 2009 11:05 by Antonio Ronga This is an excellent, very well thought out post.  I don’t think anyone expects that this problem is simply going to disappear.  However, while I agree that public works projects are far from a complete solution, I think they are a part of it.  I think in the end we need a complete shift in the way our economy works.  Clearly the ground rules and policies we employed in the past cannot lead to long term financial stability.

Monday, 2 Feb 2009 01:22 by khushe Thanks for suggesting the solution for this ongoing problem of foreclosures and falling economy.The examples taken are also good.I hope that the global economy recovers fast from this crisis.

Monday, 2 Feb 2009 07:36 by Annie I think the recent bank failures have highlighted just how bad things are from the banks’ standpoint.  No one is saving money, and almost all of the “money” that passes through the banks’ accounting systems these days is going out in the form of loans and credit lines.  As a result, the banks keep leveraging themselves more and more.  These “reverse mortgages”, for instance, look good on paper, but with advanced medical techniques, people are living longer and longer, diminishing the profitability of these arrangements. In addition, printing more money will not really help, since a lot of the “money” circulating today does not really exist in paper form; your company is paid by direct deposit by their customers, they pay you by direct deposit, you pay for your stuff with a debit card; no real money. Someone needs to wake up and smell the coffee.

Monday, 2 Feb 2009 10:22 by Nemesis Monetary policies aside, if history is to repeat, shouldn’t we also be looking forward to worldwide political instability and the rise of authoritarian governments, big wars (note to self: need more rifle ammunition), and a recovery built on massive industrial development? Absent an analogue to WW2, what inspires your expectation of a ten-year timeframe for recovery?

Monday, 2 Feb 2009 11:00 by Manoj Tripathi I fully agree with you that the task is daunting for Obama and positive thinking is not going to wish the ills of the economy away. A lot of tough decisions have to be taken. A lot of wasteful expenditure has to be cut down and funds diverted towards development. People will have to learn to live with a little less. Sacrifices have to be made by one and all. There is no magic formula available with Obama.  The general public has to strengthen Obama’s hands to make the magic work. Things have to be done on a war footing to turn the economy around. Soft populist measures are not going to help. Everyone has to brace for tough times ahead.It may take a decade as you say, it could be earlier if things are done with a sense of urgency and not in a casual manner.I feel people have to be taught the value of savings. Living on credit has to be curbed. People should stop using credit cards and building up their debt as they are likely to get caught in the debt trap.

Wednesday, 4 Feb 2009 08:53 by Joseph R. Jones @Alfred: I think you’re discounting the amount of deleveraging that has occured– trillions in “wealth” has disappeared (regardless of how fictional that wealth was to begin with) and hence we’ve actually seen a contraction, not expansion of the de facto money supply. In the short term (likely through 2009) I suspect deflation will continue to be the trend, and then I expect a sudden and prolonged reversal of at least 10% or greater inflation.@Gareth: agreed, the parallels to the “lost decade” are striking. I’m with you on the power of innovation– indeed, this has been a huge component of our success as a nation.

@Nemesis: WWII was widely credited with pulling us out of the Great Depression, a similar catalyst may be required. I’m not saying that things will turn around in the ’20s, I’m just saying it’s less likely for them to turn around in the early teens.

One wonders what the global reaction would be if the U.S. were to suddenly decide to default on its massive debt like the former Soviet Union– would countries like China respond with force? An alternative is massive hyperinflation ala Argentina earlier this decade. A national debt in the tens of trillions is less of an issue if a loaf of bread costs $100K.

Wednesday, 4 Feb 2009 09:03 by Joseph R. Jones @Alfred: I believe FDR devalued the dollar vs. gold from 32 to 24 an oz– that’s not 70%. Also, while I agree the shadowstats numbers are a better statistic than CPI, it doesn’t really change things much.