— aleatory

Which Way Now?

Tagline from 1984 Amsoft epic, Sultan’s Maze.

The first trading day of 2009, the year after the crash. Or was it? 1929’s fall of didn’t mark the bottom; those who bought then would be in the red for the next three years. 1907 on the other hand was the bottom. And stocks ran out 47% winners the next year.

I consulted Wikipedia (I know, I know) to decide which market our current predicament shares its traits with. The inability of many commentators to shed much light on such comparisons – in light of strikingly similar numbers – only gives me greater confidence that there is something in it. The sure sign of analyst capitulation being silence?


Milton Friedman’s monumental A Monetary History of the United States, co-written with Anna Schwartz, makes the now standard interpretation of what made the “great contraction” so severe. It was not the downturn in the business cycle, trade protectionism or the 1929 stock market crash that plunged the country into deep depression. It was the collapse of the banking system during three waves of panics over the 1930-33 period.

This view requires us to look beyond ’29 for the reasons, since 1931 was actually the worst year in terms of market performance. But no matter, we’re familiar with it. Starting with Geoff Cramer and last heard coming from a Fed Reserve meeting room. So the thought is what perpetuated the problem in ’29 is what the Fed didn’t do in 2008? I.e. No bank support. Except that we also have the counter-theory:

Another explanation comes from the Austrian School of economics. Theorists of the “Austrian School” who wrote about the Depression include Austrian economist Friedrich Hayek and American economist Murray Rothbard, who wrote America’s Great Depression (1963). In their view, the key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom. In their view, the Federal Reserve, which was created in 1913, shoulders much of the blame.

The thought occurs: If it’s money supply that got us into this mess, is it really money supply that gets us out? More on that later.


The panic of 1907 occurred during a lengthy economic contraction—measured by the National Bureau of Economic Research as occurring between May 1907 and June 1908. The interrelated contraction, bank panic and falling stock market resulted in significant economic disruption. Robert Bruner and Sean Carr cite a number of statistics quantifying the damage in The Panic of 1907: Lessons Learned from the Market’s Perfect Storm. Industrial production dropped further than after any bank run before then, while 1907 saw the second-highest volume of bankruptcies to that date. Production fell by 11 percent, imports by 26 percent, while unemployment rose to 8 percent from under 3 percent. Immigration dropped to 750,000 people in 1909, from 1.2 million two years earlier.

So no federal reserve, no long build up of debt and instead a pretty dodgy attempt at cornering the market in copper. Nothing really to hit on there at first glance. But lets look at it in the general sense. A maverick attempt at market manipulation causes a 38% plunge in stock values. A very sudden jolt to the system, allowing for a similar bounce back to form the next year. Nothing like the debt mountain and optimism boom we had built up to in 2008. So those looking for an immediate return to form in 2009 will surely be disappointed?

Now regarding fighting money supply with money supply – you have to shrug and admit now we’re in this mess what else is there to do? Like a druggie hooked on crack, weaning society (public, the banks, funds…) off credit is a slow process. But the danger is things do not unwind far enough – and economies like the States are arguably reaching their capacity as it is – the fact the fed etc are trying to stimulate growth by lending to consumers who have no savings is a sign in my opinion that things are hitting a roof on that side of the Atlantic. No, the long term hope for markets (assuming growth is what makes share prices move up) comes not in giving an economy electrical shocks to bring it back to life, but in developing markets elsewhere. Markets that will still experience superior rising demand for years to come. This view offers hope in that globalised companies can grow even if domestic markets can not. So provided the home-based consumer behaves well enough to allow banks to release the funds required by global corporations, what goes on in consumersville only matters if it happens to be Indian or Chinese or…

  • The retail numbers in the US will probably be horrible for a large part of 2009. What matters is how much bloodletting (i.e. closings) goes on and for how long – services are the economy, and these things have circular references.
  • What also matters is that lending rates from bank to bank go down. Currently 3-month dollar Libor stands at 117 pts above the Fed’s target rate upper limit.  Roughly 3 times what it was last January.
  • To aid a 2nd half 2009 recovery story, China must remain a growth story in the short term.

The unprecendented actions of the Fed have probably staved off major bank failures in the year ahead. Credit markets should continue some sort of reversion to the mean. But 1929 is still the general scenario we are dealing with – with the effects of the retail sector still largely to be felt. The government is preoccupied with throwing money at the carmakers. If we measure things in purely banking health terms, 2008 may have been the bottom. But let’s wait and see how the rest of the economy survives first.

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