Are we headed for another Great Depression???

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History has a way of repeating itself, however is now one of those times? After all, this past week was the WORST week in the 112 year history of the US stock market (yes, worse than the week of Black Thursday that some say began the Great Depression). So is the worst over, or still yet to come with a possible drop on the Dow to 4,000?

It’s important to consider the implications of a Great Depression for 2 reasons:

1. As business-owners and Americans in general, what do we do with our money at this point?
2. Which Presidential candidate truly understands the economics of our country (or does it even matter)? (I still haven’t decided if I will review the candidates policies yet and there affects on us…)

So let’s dive right in by looking at the similarities of our current time with the Great Depression:

1. Stock market crash – as mentioned above we’ve had the worst stock market crash in history so this is undeniable.
2. Global Affect – dozens of countries were affected by the Great Depression not just the US and now, just as back then, what bodes ill for the US will have wide-reaching repercussions. Did you read about the $400 billion German Bailout for instance?
3. Huge Personal Debt – One of the primary causes for the GD was the cheap availability of money for businesses and individuals to borrow. When people couldn’t make the payments on those notes, things got ugly (to the tune of 9,000 banks closing from 1930-1933). Banks then called for people who were making payments to immediately pay off the principal in full… Those people obviously couldn’t pay off the principal in full, so the cycle of economic collapse cascaded… Don’t get me wrong, I understand that the average household is not carrying $8,000 but instead is carrying much less and most people are paying those cards off every month (about 55%). However, with the sub-prime mortgage fiasco, there are plenty of people with mortgages they can’t afford (and couldn’t afford when they took them out).
4. Presidential candidates with no understanding of economics – If we look at Obama and McCain’s policies in detail we’ll see how they’re making the same mistakes now as Herbert Hoover and then FDR did back then.

Now let’s look at what’s different between now and then:

One reason we

1. No Gold Standard – We no longer base our money and printing it on the amount of gold in the US Treasury. The requirement to base our money on Gold theoretically contributed to severe deflation that resulted in the people who managed to get some money from the banks instantly having less value then when they put the money into the bank. Studies have suggested that there was a direct relation between the quickness with which a country abandoned the gold standard and the quickness with which they recovered from the GD. Others suggest that there was no direct correlation. Believe what you will because it’s a bit more complicated than just saying the Gold Standard cause the GD which is why point 5 below is so important.
2. No Longer an Agrarian Society – Even though, with the advent of the automobile in the 10’s and 20’s, we began our transition to an industrial society, we were still primarily a society that relied on agriculture in the late 1920’s. Not until the production required for World War II did we fully transition to an industrialized country. The huge drought that brought on the Dust Bowl was a significant contributor to the length and severity of the GD. Our current knowledge-based society really has fewer “natural disasters” that can exacerbate the stock market drop by actually devaluing the businesses and products they produce.
3. Unions have artificially driven up wages – in the 1920’s and 1930’s unions were necessary to help increase wages to a reasonable level so that the workers could afford to purchase the products being produced. Now we have unions that have made it so expensive to produce things businesses can’t charge enough money for those products to make a profit and keep those same people employed. The auto industry is the best example of people in the 20’s not being able to afford the product they produced while the cost per hour of auto production in the US today is 30 times higher than that of China.  Sorry guys, that’s just not sustainable or competitive.
4. No widespread panic – Sure people are pulling out of the stock market, but how many of your friends have started withdrawing their savings from the bank and stuffing their cash under their mattresses? We still fundamentally believe that cash in the bank is safe even if we are doubting that money in the stock market is.
5. Ben Bernake is the Fed Chairman – Ok, this has less to do with one person, and more to do with the fact that we’ve had a GD to learn from and study for the last 70 years. With that knowledge we are better prepared to avoid it. Let’s face it, Mr. Bernake is the most powerful person in America and has studied the GD at length. Because of this I would argue he better understands the causes and effects than anyone did in the 20’s and 30’s. Even if he isn’t 100% correct on the causes of the GD, he still has a larger pool of knowledge to pull from then anyone did 80 years ago.

We have 4 similarities and 5 differences… So are we headed for another Great Depression???

First off we, as individuals and households, can only directly effect a few of the items above.

1. We can affect how much personal debt we take on by learning some easy math to understand what our family can afford instead of blanketly trusting a mortgage broker who is paid on commission. Common sense appears to be as lacking back then as it is now.
2. We can vote for the candidate who has a better chance of improving our economy based on sound economic policies – NOT because they’re a war hero or a charismatic speaker. Did I mention a lack of common sense back then and now?
3. We can stop supporting unreasonable unions that have made the cost per hour of labor in the US auto market over $65! (the article was on the front page of the Wall Street Journal a few years ago comparing that number to the $3/hour cost in China but I can’t find it now…)
4. We can keep our money in banks and not panic. In other words, don’t stuff cash under your mattress unless you’re a drug dealer. If you’re a drug dealer, then just keep doing what you’re doing. 🙂

One reason engineers hate economics as much as they hate poetry is because it’s all based on theories and opinions. There are no real “economic laws” like our much beloved Newton’s Laws of Motion. With that being said neither I or anyone else can predict exactly what can happen… However, every day that we get up believing we still have a job, or that we invest money in the stock market, or that we evaluate a new business for buying, building, and selling we’re attempting to predict the future, so why stop now?

That being said, over the next 12 months I plan to buy a lot of stocks! In our buy, build, and sell mentality for growing small businesses there is rarely a case where we can get better returns in the stock market (over which we have no effect) then we do with our own business. However, if we’re at the worst point in the history of the stock market, yet 1-in-10 companies have more cash stock-piled then there current market capitalization, then this is the ripest stock market for investing in history!

Let me rephrase that, nearly 10% (876 of 9,194) of the stock’s tracked by Standard and Poor’s compustat research service have more cash in the bank than the entire company is worth based on simply multiplying the stock price by the number of outstanding shares. If you ever encounter an opportunity to buy a business for $100,000 that includes $120,000 in cash in the bank and you don’t have $100,000 please let me know immediately! In essence, 10% of our stock market is in that position. As a rock-climber in West Virginia once taught me at those points of extreme jubilation, Wahootey-Hootey!

Does that mean we’ve hit bottom? Who knows? More importantly, who cares? Invest little by little over the next 12-months as the stock market continues to move and you may have the greatest investing opportunity of your life. The same could have been said for the Great Depression… Then again, I’m just a mechanical engineer who owns a few small businesses – what do I know?

To your INVESTING success, Bryan

P.S. In the next blog we’ll look at the failed economic policies that caused the Great Depression to be as long and severe as it was and which ones the candidates are still foolishly trying.