Understanding The Great Depression And The Failures Of Modern Economic Policy
Practically everyone who comes into Steve’s office these days seems worried about the markets, the economy or, in the worst case, a massive economic collapse that could take us back to the days of the Great Depression of the 1930s. To assuage those fears and get some perspective, Steve speaks with Dan Blatt, author of Understanding the Great Depression and Failures of Modern Economic Policy.
Are Markets At Risk For A 1930s-Style Great Depression?
They say that those who ignore the past are doomed to repeat it. It is also said that history doesn’t repeat itself, but it often rhymes. So, Steve wonders if the U.S. might be in for another deep 1930s-style depression. Dan’s take is an unequivocal “no” because we live in an era of greater global trade that is far more resilient than the weak international markets of the 1920s that couldn’t survive the imposition of higher tariffs. While we could have other problems such as the financial collapse of 2008, we really aren’t at risk for a severe recession, opines Dan.
Tariffs Triggered The Great Depression Of The 1930s, Not The Market Crash
In his book, Understanding the Great Depression and Failures of Modern Economic Policy, Dan explains what led to the market’s collapse. In the 1920s, England and France were major financial powers, not the U.S. Back then, the U.S. was a major market for European goods, and Europeans sought items such as American-made automobiles. To protect American interests, America misguidedly introduced the Fordney-McCumber Tariff of 1922 that imposed heavy duties on imports into the U.S. and kicked off a trade war with Europe. Shortly thereafter, the Europeans imposed their own tariffs on American imports, and the internecine tariff wars were on.
In parallel, Wall Street banks were delighted to lend millions of dollars to British and French companies that were global trade powers at that time. European companies borrowed heavily from U.S. banks and used some of that money to service their dollar debts and some to buy U.S. exports. As a result, the U.S. went from being a debtor nation to a major creditor nation, while tariffs, in parallel, made it difficult for Europeans to sell their goods to the U.S. The net results were that trade began to collapse because of high tariffs on both sides, and European borrowers started to default on their massive debts to Wall Street.
Then, on Black Tuesday, October 29, 1929, Wall Street crashed, and set off the Great Depression. While most believe the stock market crash of 1929 led to the Great Depression, it was really a flare-up in response to a decade of tariff wars coming to a head with defaults on large debts. Psychologically, the market crash was when average Americans realized that all was not well with U.S. businesses and banks. As Dan puts it, it was the moment when optimism changed to caution, when greed changed to fear, and people started to really worry about their economic wellbeing.
As an economic factor, the crash was almost a non-event because, by April 1930, the market had rebounded strongly and was only down about 12% from its pre-crash highs; but the market’s strong bounce back did nothing to pull the nation out of the throes of economic depression, underscoring the disconnect between the crash and America’s broader economy.
The market was also very speculative back then, notes Steve, with investors buying heavily on margin with only 10% down and losing their fortunes when the crash happened. Fortunately, though, only a very small percentage of Americans were actually invested in the stock market, so while the margins story made for great television, its real impact was rather overstated.
Can Donald Trump’s America First Policies Disrupt Our Economy?
Switching to current events, Steve asks Dan if there are similarities between 1920s tariffs and Trump’s America First talk of imposing higher tariffs and trade barriers against our trading partners.
Dan sees some parallels but believes Trump’s policies are more narrowly focused on specific problem areas where our major trading partners are taking advantage of us, such as China’s overproduction and dumping of steel, which must be stopped. So far, there are no generalized tariffs or protections that could deeply hurt global trade flows, in Dan’s view.
Keep Your Eye On The Fed
Next, Steve switches focus to the Federal Reserve, which was a young, inexperienced institution back in the 1920s when America wasn’t a major player on the world stage. Today, the U.S. is an economic super power and the Federal Reserve plays a central role in our economy. So how does today’s Fed compare with what we had back in the 1920s?
Dan believes there are disturbing similarities. In the 1920s, the Federal Reserve held interest rates below market and kept its gold reserve in Europe so it would not impact the dollar. There are similar policies playing out today, with the Fed holding interest rates really low and hoarding $2.6 trillion of $3.8 trillion in new dollars by increasing reserve requirements in a bid to ward off inflation. As a result, asset prices have inflated but without consumer price inflation.
Dan warns us to be careful in the coming years as the Federal Reserve raises its Fed Funds rate back up above 3% because higher rates could have unintended consequences for businesses and consumers that have built up alarming levels of debt over the past nine years of low interest rate borrowings. He believes it’s imperative that the economy stay strong in the coming years so businesses can service their debts and absorb higher rates without falling apart.
He also warns of unintended consequences from Trump’s desire to sharply reduce regulations on businesses, such as the lowering environmental standards, and urges Steve to quiz his business contacts and broad listener base for clues on the impact of these deregulatory efforts.
Impact Of Fed Plan To Sell Its Vast Bond Holdings
Recently, the Federal Reserve announced plans to gradually unwind its massive bond portfolio in a phased manner that it doesn’t rock the bond market. In parallel, the Fed plans to gradually nudge up interest rates. Dan doesn’t see these bond sales as a concern as long as the Fed Funds rate stays below 3%. He wouldn’t be surprised, however, if the canary in the coal mine might be abroad, especially in emerging market economies that have gorged on low-interest dollar denominated debt and could be at risk for a default-related collapse.
To What Extent Does Our Government Control The Economy?
Finally, Steve and Dan briefly talk about the unprecedented extent to which the U.S. economy has been controlled by government policies such as the Affordable Housing Act, the Troubled Asset Relief Program, and the Fed’s control over interest rates over the past two decades. For example, Steve cites pressure on banks to lower lending standards to make the housing dream come true for more Americans, even though many were not financially fit enough to take on mortgages.
In wrapping up, Dan wants investors to keep an eye out for how the Federal Reserve’s interest rate hikes influence businesses and the economy, especially as the Fed Funds rate crosses the 3% mark, and to look for early signs of trouble abroad as harbingers of economic weakness hitting our own shores.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: Practically everyone who comes into my office these days seems worried. They’re worried about the rise in the stock market, ironically; they’re worried about the economy; they’re worried about their future. And it seems that in the back of everyone’s head, there’s a voice whispering, is the world going to collapse once again and will we go back to the days of the depression era of the 1930’s?
Big worries those, so let’s get some perspective. Dan Blatt is the author of a recently published book, Understanding the Great Depression and Failures of Modern Economic Policy, and he joins me today to discuss the book. Welcome, Dan.
Dan Blatt: Thank you, Steve. Thank you for having me on your program.
Steve Pomeranz: My pleasure. So, it’s said that those who ignore the past are doomed to repeat it, and it’s also said that history never repeats itself, it just rhymes. So which aphorism should we choose for today’s discussion?
Dan Blatt: Well, there are rhymes, there are rhymes, but as long as we are living in a globalized economy, you can’t have another great depression.
One of the major factors that led to the Great Depression was the trade world of the time, tariffs destroying international markets. And as you know, if the market is destroyed it can’t recover. Today, at least, we have a globalized market. We can have other kinds of problems, but you really can’t have a Great Depression.
Steve Pomeranz: Well, you wrote in your book that after post-World War I, with the punishing Treaty of Versailles and then the fact that the United States basically closed their borders to foreign trade, that Europe didn’t have the money to pay back those loans and it created quite a problem.
I don’t know whether I stated that correctly, but you had mentioned tariffs as being an issue. Was that how it worked out?
Dan Blatt: Well, the Fordney-McCumber Tariff of 1922 kicked off the trade war. It developed through the 1920s. The results were put off because the European debtors borrowed more money. Wall Street was delighted to lend money to England and France. England, the British Empire ruled the seas and dominated the world, and every bit and piece that the Brits hadn’t picked up, the French had grabbed. They were the world powers of the time, and Wall Street just funneled enough money to them, so that they could service their dollar debts and keep buying our exports.
Steve Pomeranz: Why did the United States increase the tariff and create such an impossible situation for their trading partners? What was the psychology back then?
Dan Blatt: Well, it was a little bit deceptive because the Fordney-McCumber Tariff was not that much worse than the tariffs before World War I. But before World War I, we were a debtor nation, and it was England and France and Germany that ruled the financial world.
What we were doing was practically irrelevant. After the war, though, we increased those tariffs and everybody owed us money. We were the major creditor nation, and Europe had to sell goods into our market to get the dollars with which to service their debts. And we said no, that won’t happen and, of course, all of central Europe, including Germany, had been financially undermined by the Treaty of Versailles for provisions.
And, so, during the 20s while we were prospering, Europe was progressively falling into the abyss.
Steve Pomeranz: Everyone thinks that the stock market crash of 1929 was a big contributing factor, was it?
Dan Blatt: Well, it did do one thing. That was the moment when optimism was changed to caution, when greed was changed to fear, when people started to worry about it. So, it did have an effect. But as an economic factor, it was almost a non-event. What people forget is that by April of 1930, the market had rebounded and was only down about 12% from its September ‘29 highs.
Now, if you think that the market decline has a big impact on the economy, how can you ignore the market rebound and explain why that didn’t bring the depression to a quick end? Obviously, the market has some impact, but it was certainly not a major factor.
Steve Pomeranz: The market was very speculative back then, a lot of people were buying on margin with 10% down. So, a lot of the market participants lost their fortunes. But the market itself, as you said, rebounded back, and I guess really a very small percentage of Americans were actually invested in the stock market, so perhaps that led to it.
Dan Blatt: Even the margins story is a little bit overstated because, by September, the professionals in the market had become enough concerned so that margins were being increased to 30% and even 50%—levels that don’t look bad, even by today’s standards. Well, yeah, there were some, who were margined greatly, but even the margin story is overstated.
Steve Pomeranz: There’s a lot of talk now about America First, and raising barriers or getting a better deal with our trading partners. You wrote this book about that. You wrote this book and you studied the tariff situation a lot. Are there any similarities that you’re seeing, between the kind of talk we’re seeing today and what went on back then?
Dan Blatt: That’s a very dark road to go down, but, thank goodness, right now, it’s still directed specifically at certain problem areas.
I’m not saying there aren’t problems within the national trade that have to be dealt with, but, so far, it’s still particular areas. Like, for example, China’s overproduction of steel and in some other areas, and those things are troubling and you don’t want to go too far down that road, or you’ll get in trouble.
But I’m not saying that we should not be negotiating and trying to deal with some of the ways in which our major trading partners are taking advantage of us.
Steve Pomeranz: But you’re not seeing any kind of talk about the type of tariffs that got us into trouble way back when?
Dan Blatt: No, I don’t see any generalized tariffs on the horizon, thank goodness.
Steve Pomeranz: One of the things you wrote about, that I found quite interesting, was that the Federal Reserve back then was really quite young; they were like adolescents. They didn’t really know, even the United States was kind of like an adolescent, in the sense that you had mentioned before, we were a debtor nation.
We weren’t really that important on the world stage, but after World War I, we really became the most important country in the world, but we were very young and very inexperienced with our role as leaders. How would you compare the Federal Reserve today to the Federal Reserve back in the 1930s?
Dan Blatt: Actually, there are some disturbing similarities. In the 1920s, the Federal Reserve, toward the end of the ‘20s, was maintaining its interest rates below market rates. Nobody wanted the Federal Reserve’s interest rates to go up. But it was sterilizing its reserves, which in those days was gold. We were keeping reserves of gold in Europe, so they couldn’t come into the country. And we were doing other things to keep the inflow of gold from impacting our dollars in circulation. Today, we’re doing the same thing. We’ve tremendously increased our dollars; but $2.6 trillion of the 3.8 trillion in new dollars that were created, they’re in the Federal Reserve. They’re being sterilized.
The Federal Reserve has increased reserve requirements, and the big banks are keeping huge amounts of money in the Federal Reserve where it can’t circulate and can’t push up prices. And, so, we have the same phenomenon. We have asset price inflation gathering steam but without consumer price inflation. But asset price inflation is real inflation, and it has its own troubles.
And we have to be careful about what happens now. When the Federal Reserve starts to get its interest rates back up, say above 3%, you’ve got to start paying attention. Because after eight, nine years of interest rate suppression, you have all kinds of commercial extremes that are disoriented, and you have leverage rates that have gotten truly alarming.
So, it’s very important right now that the economy remains as strong as possible so that when interest rates don’t rise, like they did in 2005 and 2006, when interest rates started to rise, things started to fall apart.
Steve Pomeranz: Yeah.
Dan Blatt: So, we have to keep score right now; it’s 6 months into the Trump-Ryan regime. And they are deregulating like mad, but we don’t know where the beef is yet. You should be asking some of your listeners who are in business, or who have business clients in that trade association, just how the deregulatory efforts are proceeding. Are they strengthening the business environment?
Steve Pomeranz: Interesting.
Dan Blatt: What’s actually happening there? And, by now, to just begin to show up and, from this point on, we have to keep score, and you’re in a good position to do that, with your broad listener base.
Steve Pomeranz: Interesting. Well, the Federal Reserve is talking now about putting—de-sterilizing as you put it—getting some of those bonds that they’ve been buying droves of back into the economy, so to speak, and getting that money back into the economy.
At the same time, they are raising rates very, very slowly. But rates back in ‘05 and ‘06, as you talked about, they were over 5%. Today, they’re still at 1% and 2, and the 10-year bonds are 2.
Dan Blatt: Yeah, that’s still pretty stimulatory.
Steve Pomeranz: Yeah. No, I know.
Dan Blatt: I don’t think there’s anything to worry about. Just as a matter for us, just as a matter of caution, I would say, you start to have to pay attention to it, when it gets north of 3%. I would be very surprised if anything untoward happened because of that before it gets above 3%.
But, you know, the canaries in the coal mine may be abroad. Emerging market economies are gorging on dollar-denominated debt right now. And I would expect the first problems to arise here and there in the weaker economies abroad.
Steve Pomeranz: Interesting. My guest is Dan Black, author of the recently published book, Understanding the Great Depression and Failures of Modern Economic Policy.
And we’re talking about the Great Depression and maybe some comparisons with today. You write in your book that there are really true limits to the government’s ability to control economic policy. We’ve had an economy that really has been controlled by the government since the great recession. You still don’t think that the government has that much influence over the economy?
Dan Blatt: That’s a very good point, Steve, we don’t have a market business cycle anymore, for these two decades now; we have had a government-directed market system and a government-directed business cycle. You want to know what happens with the dot-com bust and the credit crunch bust? You start with going over the government policies that preceded it, especially the interest rates, suppression efforts of the Federal Reserve and the policies that undermine the credit standards in the housing market before the credit crunch. So, I’m not saying there weren’t malefactors in the private sector, but the government incentives were powerful during that time.
Steve Pomeranz: Yeah, well, there was a lot of pressure on the banks to write a lot of loans.
Dan Blatt: You got it.
Steve Pomeranz: Especially to make the housing dream available to many Americans, who probably were not ready or financially.
Dan Blatt: And isn’t it interesting that Fanny Mae and Freddy Mac are still in business?
Steve Pomeranz: Yeah.
Dan Blatt: And the Affordable Housing Act is still in business, although it is now at least countered by the restoration of credit standards that the banks have to pay attention to.
Steve Pomeranz: Well, I know, but Fanny Mae is reducing their standards. They’re reducing the FICA scores that you need, their loan to value equity is…
Dan Blatt: You noticed that, did you?
Steve Pomeranz: [LAUGH] Yeah, I noticed that. So, it seems like they’re back to this idea of getting as many people in homes as they possibly can.
Dan Blatt: mm-hm. That’s correct. And, of course, there’s nothing to worry about. What’s to worry about? What could go wrong? What could possibly go wrong?
Steve Pomeranz: [LAUGH]
Dan Blatt: There’s nothing to worry about—until there’s something to worry about.
Steve Pomeranz: Well, like it’s all good until it stops. [LAUGH] Like musical chairs or whatever, the merry-go-rounds.
So, what is one takeaway, as we run out of time here, that you can give to our listeners? As you mentioned interest rates, that’s something to watch out for. Anything else that you can give us, to be careful about? You know, we look for these tectonic changes in the world, in the economy, when we make adjustments to portfolios. Anything else on your mind?
Dan Blatt: Well, the main thing right now is just to keep an eye on the Federal Reserve, as it very cautiously—and rightfully so very cautiously—allows its interest rates to rise, and until they get over 3%, and keep an eye on what’s happening abroad, as that happens, because, as I say, I think the canaries in the coal mine will appear abroad.
Steve Pomeranz: Abroad…and which interest rates are you referring to when you say the 3%.
Dan Blatt: That’s the Federal Reserve’s Federal Funds.
Steve Pomeranz: Federal Fund’s Rate? Alright, okay.
Dan Blatt: Yeah.
Steve Pomeranz: Alright, we’ll take a look at that.
Dan Blatt, author of Understanding the Great Depression and Failures to the Modern Economic Policy, joins me today, good discussion, Dan. A nice perspective or deep look at your study of the Great Depression of the ‘30s and how things look today. Thank you so much for joining me.
Dan Blatt: Thank you for having me.