“The only thing you should remember is that everyone else is either reckless or inept. Usually both.” Margaret Thatcher in The Iron Lady
I have become a bit obsessed lately with the word sequencing. In business cycles sequencing is the timeline of events and how things morph from one phase to the next. We are watching one business cycle right now that is in the far reaches of the extension of credit, the bubble being blown, the expansion period seemingly never ending some might say reckless. Which is one hundred percent a repeat of history. To truly understand the Great Depression, you must understand the decade before and the psychology of the times. The 1920s were a time of excess. Think about how successful businesses today would be if they paid no income tax and how rich working people could be with basically no income tax. The disposable income of that era was one of the highest of any era. It was private and productive capital being spent, and people were awash in it. The Jazz Age saw new technology being embraced as invention was the new and tradition was being replaced. Music was new, architecture was new, aviation was new, sports, film, radio industries as entertainment was new, actually leisure itself for the non-aristocracy was new in a way. The middle class was new.
In 1929, the bubble had been blown to otherworldly heights. People were rich, not just the rich as the middle class grew. Credit has been offered to one and all to buy appliances, cars, and stocks. Credit is not extended during pessimistic times, but on the contrary. People must believe that they can succeed to a) want to take on credit and b) a banker willing to extend credit must be optimistic that the credit can be paid back. Credit is a two-party speculation. People speculated and won. The country was the richest it had ever been, and the country was new to being rich as the United States were now the largest economy in the world. The crash in 1929 was said to have been a surprise, but that is because in general, people are always unprepared and that is what people always say afterward. People that need to be rescued when a hurricane hits always say “That hurricane came out of nowhere.” No, you were warned but decided not to leave amigo. To understand where we are or might be today, it is instructive to go back and look at where we were just 95 years ago. Not because it will play out exactly like the Great Depression did, but the sequencing will be exactly the same in the business cycle. How big the bubble might be will be different, how much credit was extended might be different, how governments react with stimulus might be different, but the sequencing, that will be instructive to learn about.
But if we study the Great Depression, we remember it as a time of no money, deflation. That would come later because at the end of the 1920s, credit was seemingly everywhere. The expansion phase of a business cycle is fun, people are happy because they can buy and enjoy and don’t have to worry about paying back, yet. This would be a similar situation as giving college kids credit cards today. The kids are foolish and apt to spend too much, and the bankers take advantage of that. But let’s not forget that the kids were foolish. The population at that time wasn’t aware of extended credit en masse to the consumer. Credit was a line of buying at a store that allowed someone to buy until harvest came and then you settled the affair. It was borrowing against current labor that would result in future cash flow. It was for necessities: milk, flour, lard. Credit wasn’t new, but contractual credit on individual items was. It soon became for radios, vacuum cleaners, and other non-necessities. This ability to buy more than what a person had saved for allowed businesses to grow far more rapidly than normal. The extension of credit was and will always be the easiest way to generate more business activity. The buyer needs funds with which to buy. Credit allows the pull forward of future transactions because instead of saving up for a car and making the purchase in the future, the purchase is made today and will be paid off in the future and interest will be paid. Interest will play the key as the banker and financial institution would start sticking their beak into almost every transaction from then until today. Saving up to buy something eliminates the banker and the interest that comes with it.
In the book A Nation of Torment, Edward Robb Ellis describes how easy it was, “To become a capitalist, to use money to make money seemed tantalizingly easy. Americans learned they could borrow money to speculate in stocks. This was possible by getting “broker’s loan” and to buy “on margin” –Two phrases that became commonplace. If a man got a tip on a certain stock and decided to buy $1,000 worth of it, he was able to do so with only $100 in cash. He gave the cash to a broker. This sum was the margin—the customer’s proportion of the total purchase price to be paid by the broker. In turn, the broker borrowed the other $900 from a bank- a broker’s loan. The broker then bought $1,000 worth of the chosen stock and gave the bank the stock certificates as collateral.” Well, it isn’t difficult to see if the stock goes up 10% or $100 that the customer would receive double their money minus a few fees. This was good business in a market that seemingly only goes up. A market that seemingly only goes up, sound familiar? This is financial leverage. Today we see real estate investors pitching this idea like it is only a one way street as well. If you buy a house today for 10% down let’s say $20 grand on a $200,000 house and just wait three years and that house is worth $300,000 and then sell it your $20k just turned into $100 grand. See how easy this is…Bull markets, inflationary markets, expanding credit markets feed the need for leverage because it is true. Fortunes can be made.
The Federal Reserve had existed for only a short time back then but was aware of this situation. People had been buying other non-necessities. Stocks and investment in these businesses also grew as people buying was a force that needed to be fed, and credit grew on the business front as well. Businesses borrowed more and became larger. The Fed began to take the discount rate higher in 1928 and had moved from 4% to 5%. People didn’t let higher interest rates stop them, they just paid the interest and kept putting their money in the market. Ellis writes “Roy Young was governor of the Federal Reserve Board with his office in the Treasury building in the nation’s capital. One day he leaned back in his chair- laughing, laughing, laughing. When a friend asked what was so funny, Young replied, “What I am laughing at is that I am sitting here trying to keep 120 million people from doing what they want to do.”
He was referring to the nation’s population and their love affair with blindly putting their money in the market and winning. The Federal Reserve Board of New York was the strongest of the 12 member banks and was urging that rates go to 6%, but the Board declined because it might hurt business. Ellis writes, “Board members were still sensitive to charge that in 1921 they had ruined farmers by pricking the bubble of inflated commodity prices. Now, in 1929 the board members could have acted boldly by pushing the discount rate ever higher, but they were paralyzed by timidity.” Paralyzed by timidity, does that remind you of today’s Fed? The board let the market run and on September 3, 1929 the day after Labor day the market reached its peak even though no one knew it.
Many people would wonder what caused the crash, but none put it as well as Huey Long, the senator from Louisiana as told by Ellis, “The wealth of the land was being tied up in the hands of a very few men. The people were not buying because they had nothing with which to buy. The big business interests were not selling, because there was nobody they could sell to. One percent of the people could not any more than any other one percent; they could not wear much more than any other one percent; they could not live in any more houses than any other one percent. So, in 1929, when the fortune-holders of America grew powerful enough the one percent of the people owned nearly everything, and ninety-nine percent of the people owned practically nothing, not even enough to pay their debts, a collapse was at hand.”
Now where did all the money come from? Businesses were making money as America was a manufacturing engine that produced almost 40% of the world’s manufactured goods. Businesses could pay real wages and productivity through technology boomed. This country made real products and businesses sold them in bunches. Textiles, steel, cars, and vacuums, America built and sold them all and business produced cash and times were good. Behind these businesses were businessmen and behind them were bankers. They would do very well and by doing very well they created competition that wanted to do just as well, but maybe cut some corners. This would create the banking problem. Bubbles need willing buyers and buyers need credit and the bankers’ willingness to lend will be next week’s view of how the sequencing of cycles work. Today, just know that the consumer was like the college kid. They bought and they bought a lot but they used leverage. And when the leverage was taken away by the downturn, they were the first ones to go bankrupt. The nation would follow.
Sincerely Yours,
C Thomas Printer
On this date in history… 243 years ago to be exact, Los Angeles was founded by Spanish settlers.
Also born on this date ….radio broadcaster known for telling his listeners now for the rest of the story, Paul Harvey.
Thank you for listening today and you can find all of our articles and more on our website cthomasprinter.com.