For most participants, post-bubble bear markets have been sudden and severe. The 1929 example ran for three years and the post 1873 example lasted for five years...
Although crashes are grisly events, they share a common response from the establishment. No matter how shocking, bloody, expensive, ruinous or just plain shattering a crash is � within a week, there is no one in the street who didn"t see it coming. As ironical as this is, there is a critical link from the stock market to the economy...
This melancholy event is being confirmed by the behaviour of politicians and policymakers. After swanning around claiming credit for the boom politicians panic and then find scapegoats. Remember the "Goldilocks" celebration of perfect management of interest rates, money supply and the economy. Well, all five great bubbles from the first in 1720 to the infamous 1929 have been accompanied by such boasting, followed by what can best be described as frenzies of recriminatory regulation. If the political path continues � protectionism � will follow.
One of the worst such examples was called, in real time, the Tariff of Abominations. But, this is enough of dismal events and it is time to turn to irony for amusement and enlightenment. The clash between the establishment and financial history is rich with irony. Beyond that, financial history, itself, should be considered as an impartial "due diligence" on every grand scheme promoted during a financial mania by the private sector as well as by policymakers. Let"s use a good old fashioned term � policymakers have been financial adventurers.
One of the richest ironies occurred with the 1873 mania and its collapse. With typical strains developing in the credit markets during a speculative summer, the leading New York newspaper editorialized:
�but while the Secretary of the Treasury plays the role of banker for the entire United States it is difficult to conceive of any condition of circumstances which he cannot control. Power has been centralized in him to an extent not enjoyed by the Governor of the Bank of England. He can issue the paper representatives of gold, and count it as much as the yellow metal itself. [He has] a greater influence than is possessed by all the banking institutions of New York.�
In so many words, because the treasury secretary was outstanding and had the benefit of unlimited issue of a fiat currency � nothing could go wrong. But it did; the initial bear market lasted for five years and the initial recession ran a year longer. The pattern of severe recessions and poor recoveries continued such that in 1884 leading economists began to call it "The Great Depression", that endured from the 1873 bubble until 1895.
An index of farm land value in England fell almost every year from 1873 to 1895. Of course, academic economists were fascinated and for a couple of decades wondered how such a dislocation could have happened, or even worse, discussed how it could have been prevented. Ironically, this debate continued until as late as 1939 when another Great Depression was belatedly discovered.
Naturally the long depression was blamed upon the old and unstable Treasury System, and at the height of the "Roaring Twenties" John Moody summed it up with:
"The Federal Reserve Law has demonstrated its thorough practicality, and thus secured the general confidence of the business interests. The breeder of financial panics, the National Banking Law, which had been a menace to American progress for two decades, has now been replaced by a modern scientific system which embodies an elastic currency and an orderly control of money markets."...
In late 2007, Gregory Mankiw, boasted that the US had a "dream team" of economists as advisors, and as with all claims at the top of six previous bubbles "Nothing could go wrong". And even if things went only a little wrong there were the "safety nets" that Krugman claimed would prevent serious deterioration. Our view on Keynesian safety nets has always been that in a bust they would be about as useless as a hardhat in a crowbar storm.
In the post-1929 bust policymakers were realistic enough to know that the boom caused the bust. The SEC was established to prevent another hazardous 1929 mania. Also, one of the promoters of the SEC boasted that the SEC would put a "Cop at the corner of Wall and Broad Streets". Without much doubt the SEC has failed to live up to its billing. The discovery of malfeasance always accompanies the discovery of malinvestment.
Of course, the other act passed to prevent another 1929 mania was Glass-Steagal, which separated commercial banking from the evils of Wall Street. This was taken off the books in 1999 as too many banks were participating in the high-tech frenzy.
Has this happened before? I"m glad I asked the question. With the financial violence of the South Sea Company in 1720, the House of Commons passed the "Anti-Bubble" Act, which was taken off the books in 1771 � just in time for the full expression of the 1772 bubble. As with the climax of the 1720 bubble the Great Depression ran for some twenty years. This was also the case for the bubbles that blew out in 1825, 1873, and 1929...
The real audacity is in the claims of charismatic economists that their personal revelations can provide one continuous throb of happy motoring. As Hayek said � Keynes, as a young scholar, was absolutely ignorant of financial or economic history. Only someone who was ineffably ignorant of financial history would claim that it can arbitrarily be altered...
On May 5, Bernanke observed that the "broad rally in equity prices" is indicating that "economic activity will pick up later in the year."
At the height of a similar rebound to April-May of 1930, Barron"s wrote:
�It is thus apparent that the public preference for stock is not only as marked as ever, but also the will to speculate is still a speculative factor not to be overlooked. The prompt return of huge speculation and the liberal manner in which current earnings are again being discounted indicate that it will be difficult to quench the fires of stock-market enthusiasm for long.�
Prompted by an animated stock rally, the Harvard Economic Society, but with more gravitas, concluded that it "augured" a recovery by late in the year. As we all know this did not last and what we should understand is that it is the dynamics of a crash that sets up the exciting rebound. Not policymakers.
Let"s look at a classic fall crash, which we expected. The pattern is interesting. The 1929 crash amounted to 48%. The decline to the low in November 2008 was 47%, and within this the hit to October 27 amounted to 42%. In 1929 the initial plunge amounted to 40% to October 29.
The rebound was to November 4, in both examples, with 2008 gaining 17% and 1929 gaining 12%. The final slump into each November was 22% and 23%. Is it important to identify it as 1929 or 2008?
Our "historical" model expected the crash and the rebound, as well as the nature of the establishment"s utterances...
Ironically, today"s excitement in the markets and convictions in policymaking circles are important steps on the path to a great depression. As disconcerting as this may be, it is worth reviewing another clich� of policymaking, which is the notion that lowering administered rates will restore the momentum of a boom. Massive declines in short rates, such as Treasury Bills have only occurred in a post-bubble crash. In 1873 the senior bank rate plunged from 9% to 2.5%, as the stock market crashed. In the 1929 example the fed discount rate plunged from 6% to 1.5%, as the stock market crashed...
There are some early terms to describe the sudden loss of liquidity that marks the end of a bubble. In the 1561 crash Gresham wrote the �Credit cannot be obtained � even on double collateral.�.
Another term goes back to the 1600s when Amsterdam was the commercial and financial center of the world. The Dutch described the good times as associated with "easy" credit and the consequence as "diseased" credit...
Misselden in the 1618 to 1622 crash earnestly believed that throwing credit at a credit contraction would make it go away. [He was wrong].
, I am not confident that the downturn will end this year.
