Great Depression

Liquidity Problems Could Overwhelm Inflation’s Effects

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LIQUIDITY PROBLEMS – 1929 

In 1928 and 1929, the Fed raised interest rates for the purpose of curbing rampant speculation in stocks. At that time, investors could borrow as much as 90% of the stock price for their proposed investment. The banks were just as aggressive as investors and were happy to oblige.

Raising rates did not slow stock speculation by investors or banks, however.

What it did do was cause a slowdown in economic activity. Thus, as economic activity declined, the stock market continued its rise, unabated.

As the decline in economic activity continued, both businesses and consumers were affected negatively. The money was available for investors to buy more stocks, albeit at a higher cost; but, businesses and consumers struggled with liquidity problems.

STOCK BUBBLE BURSTS 

The crash in the stock market brought illiquidity issues to light. Layoffs in the financial industry were numerous and swift. The ranks of the unemployed ballooned.

If you were an investor who had purchased stock with 10% down, it would take only a 20% decline for you to have lost twice as much as your original investment.

Now, imagine the plight of the banks who had lent money to investors using stocks as collateral. The collateral was worth as much as 30% less after one day of trading. Bank failures became almost commonplace during the Great Depression that followed.

FED RESPONSE

As might be expected, the Fed did purchase government securities in the open market and lowered the discount rate. It also assured commercial banks that it would supply needed reserves.

Unfortunately, “too little; too late” became the common descriptive phrase used when referring to Federal Reserve response to the crisis which it had caused. That is because the economic devastation was overwhelming.

Unemployment soared to as much as 25% and prices declined (deflation) by more than one-third. The aggressive, free-spending social programs of the 1930s government could not stop the slide and contributed to the length and breadth of the depression. At the depths of the Great Depression in 1932, the stock market had declined by 90%.

The stock market crash was not the cause of the Great Depression, though. The Great Depression was caused by a Fed policy of higher interest rates. Whatever the intention or merits of the action (the higher rates were imposed for the purpose of curbing rampant stock speculation), it led to a reduction in economic activity which was well underway before stocks crashed.

INFLATION, DEFLATION, AND THE FED 

The Federal Reserve officially implemented an interest rate policy of “higher for longer” almost three years ago. Rates moved up rapidly and bond prices have lost one-third to one-half of their value since then, depending on length of maturity. (see “And So Rates Will Be Higher” – Jerome Powell)

It matters not what the intention was or whether it was correct. What matters at this point are the circumstances in which the Fed finds itself now.

Most, or all, of our serious financial and economic problems are the result of a century of intentional inflation. The effects of that inflation lead to a loss of purchasing power in the currency (U.S. dollar). When the Fed intervenes in the markets either directly (by purchasing or selling securities) or indirectly (manipulating interest rates), it creates distortions which have ripple effects and are amplified.

In addition, those effects are unknown with regards to extent, duration, and timing. Remember being surprised at the higher increases in consumer prices post-Covid and economic shutdown. Those increases are attributable to government (and central banks) actions in response to the ‘pandemic’.

The economic shutdown was forced upon society by government – rightly or wrongly. As a result, the decline in economic activity led to huge financial and economic problems for society, including supply chain issues. These problems were met with phenomenally huge financial largesse (inflation) by governments and central banks, which, in turn, led to higher consumer prices (effects of inflation).

After more than one hundred years of trial and error, it is apparent that…

  1. The Federal Reserve causes the problems and crises with which it continues to grapple.
  2. The Fed is doomed to a role of reacting to crises of varying intensity (worse) and frequency (more often).
  3. Serious deflation and economic depression would overwhelm efforts by government to reverse the effects or contain the damage.

CONCLUSION 

There is no path to financial stability from the current point that does not involve a cleansing of huge magnitude. The cleansing will be accompanied by serious financial and economic pain. The Fed is continually dancing with its own devils amid music which is horribly out of tune. The only option left is to wait until the music stops. (also see If The Markets Turn Quickly, How Bad Can Things Get? )

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Global Credit Collapse Is Deflationary

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NOTE TO READERS:  “Global Credit Collapse Is Deflationary” was originally published as an exclusive for TalkMarkets on October 29, 2024. I have not changed anything in the article, nor is there any reason to modify or alter what is written below because of U.S. election results.

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Destruction Of Money Keeps Inflation In Check

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DESTRUCTION OF MONEY 

The “biggest collapse in the money supply since the Great Depression” continues unabated at this point. (See Ryan McMaken’s article here.)

The decline in the money supply is nearly three years old and dates back to April 2021.

This decline is a destruction of money and is the opposite of what might be expected if one is looking for evidence that could support some of the more extreme expectations and projections for inflation and its effects.

That is because most, if not all, of the analysis about inflation and its effects focuses on the supply of money and its seemingly unlimited growth.

Discussion about money creation by governments and central banks almost universally excludes mention of the demand for money.

DEMAND FOR MONEY 

Money has a demand side, too. We are not talking about the demand for goods and services. We are talking about the demand for money, itself. People need money to pay taxes and transact business; to save and invest.

As long as the supply of money is relatively stable and sufficient to finance existing normal economic activity, then the result is price stability. Without price stability, the economy cannot function reasonably.

Since the inception of the Federal Reserve, excessive growth in the money supply has led to a ninety-nine percent loss of purchasing power in the U.S. dollar.

Currently, though, the money supply is not growing. It is shrinking.

A SHRINKING MONEY SUPPLY 

A shrinking money supply is directly opposite to that which has happened which has made the U.S. dollar nearly worthless compared to a century ago.

It is also not supportive to arguments that the U.S. dollar is about to collapse and that hyperinflation is on the way.

Without the continual infusions of “new” money,  the previous inflationary “highs” cannot be maintained, let alone increased.

If a shrinking money supply continues, the end result is deflation. (see An End To Inflation – Three Possibilities)

WHAT IS DEFLATION? 

Deflation is the exact opposite of inflation. The result is a stronger currency. Instead of losing purchasing power, your dollars would buy more – not less.

Deflation is not bad. However, some of the accompanying economic effects would be very difficult to endure. The U.S. dollar would go further, but there would be fewer dollars to go around.

There would be huge price reductions in real and financial asset prices, depressed economic activity and high unemployment. Conditions would rival and probably exceed those of the Great Depression of the 1930s.

Fortunately, at least for now, we are not there yet.

CONCLUSION 

An infusion of new money might temporarily reverse the shrinking money supply and its negative economic effects, but that is not necessarily a good thing.

Think of it this way. Would you recommend a new fix to a drug addict who is undergoing withdrawal symptoms resulting from curtailing their drug use and attempting a return to sobriety?

Intentional inflation by government and central banks in the form of cheap and easy credit has created artificial financial highs, bubbles in asset prices, and a false sense of economic security.

You cannot ignore fundamental financial and economic law forever. Sooner or later (more likely sooner), we will all pay the price. (also see Gold And The Shrinking Money Supply)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!

 

A Depression For The 21st Century

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A 21ST CENTURY DEPRESSION

Some are calling it the “Greater Depression” but that still makes last century’s Depression of the 1930’s the point of reference. The Great Depression of the 1930s was bad, but what we are facing now is worse.

The Depression Of The 21st Century will likely end up being the new singular event  of discussion and comparison for all financial and economic catastrophes.  Questions of how much worse and how long it will last are difficult to answer. Predictions about the type and strength of potential recovery could be premature.

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