On The Reality Of Depressions; Bernanke's Folly


The common claim, often repeated, is that Ben Bernanke knows what caused The Great Depression and he (has avoided / can avoid / will avoid) one here – because he’s studied it in depth.

Has anyone questioned the primary thesis behind why there was a Depression?

I don’t think so.

But I think we should.

In 1929 the stock market crashed.  But stock market crashes were not new things then.  Indeed, monstrous, violent moves in the market were the norm from 1900 when we first have Dow Jones data – onward to the start of the “Roaring 20s” – roughly in 1924.

As the below chart shows, there were serious and extremely violent market crashes in 1901-03, 1906-08, 1917 and of course 1920 – the one nobody talks about.

1920 is where I would like to focus my attention.  It came on the heels of World War I.  A huge number of returning troops came into the workforce, overwhelming labor supplies.  There were serious changes in fiscal and monetary policy on top of it.  There is much attention paid to a claim that The Fed basically caused the Depression by raising rates from 4.75% to 7%.  This is implausible as the triggering cause, although it certainly slowed bank lending.  More importantly, there was a large inflation in both asset and general price levels, with the DOW rising from 80 – 120 – a 50% increase in less than a year.

President Harding was urged by Herbert Hoover (then Commerce Secretary)  to protect private businesses, including banks, from the consequences of their bad decisions.  He refused.  The contraction was extremely sharp, with deflation of, according to some estimates of approximately 18% at retail and more than 30% at wholesale.  GDP fell by 7%. 

Unemployment also rose rapidly, reaching over 11%.

But the recovery was equally swift.  Having been purged of inefficient businesses and excessive debt, the economy came roaring back.  By 1923 full employment had once again been reached and industrial production registered an astounding 60% increase.  The stock market came roaring back at the same time, with the DOW going from 65 to 105 in about a year.

What was different after the crash of 1929?

Several things.

First, there was a concerted attempt to prevent asset price deflation – and the bankruptcy of firms that were underwater. Hoover did not in fact “leave it alone”; indeed, he rejected Treasury Secretary Mellon’s advice to do exactly that, and instead called business leaders to Washington to urge them not to lay off workers and cut wages (sound familiar?)  He did refuse to run welfare programs, but in fact did try to bail out the banks by putting together the National Credit Corporation, designed to “jawbone” loans to weaker institutions.  It failed.  Hoover also put together the Federal Home Loan Banks Act to reduce foreclosures (familiar again?) which also failed to turn the tide of construction – foreclosures dropped, but construction did not in fact rebound.

FDR did worse.  He devalued the currency – directly, since he was able.  He also directly interfered with commodity prices, literally buying up and destroying farmer’s crops and livestock.  But all that happened, in the end, was that margins got trashed, as the income of those who he took from collapsed along with everyone else, and the devaluation of the currency made anything imported more expensive.

None of the “New Deal” actually cured the Depression.  In fact, there was a Depression within the Depression, from 37-38.  In point of fact the Stock Market lost half it’s value from 37-38 and did not recover its 1937 levels until the end of 1945 – when WWII ended.

What if all the claims are wrong?

What if Depression is a manifestation of margin collapse?

That is, what if so long as housing prices remain elevated at artificially high levels, being propped up while wages remain depressed, it is impossible to find buyers for a product that is too expensive relative to the prevailing wage?

What if the cost-push price increases we’re seeing now are going to do the same thing to everything made from basic materials (which is, basically, everything.) 

What if – just what if – charts like this are the root cause of Depressions?

What if the bottom line is that margin collapse that is forced through currency devaluation, along with the destruction of purchasing power of those who are older and have either saved much through their lives and/or are retired makes margin compression inevitable – and that so long as that continues, you cannot exit the malaise?

Improbable?  I don’t think so.  Without margins business does not hire.  You don’t pay people out of the gross – you pay them from net profit.  Without net profit you don’t hire anyone. 

False profits – that is, claims of profit which are due to balance sheet games – eventually nail you.  Thy nail you because ultimately the cash flow statement always wins.  Not sometimes – always.

Propping up failed businesses – those which cannot operate competitively in the current environment – no matter what they are, whether they be auto companies, banks or others – simply exacerbates the problem.  The more government tries to provide “help” the higher the tax burden or the more devaluation of the currency must take place.  But both have the same result – devaluation of the currency causes input prices to ramp, which in turn is passed through, which again compresses margins and destroys hiring!

Bernanke never ran a business.  I have.  So have millions of others.  Business – especially small business – is not hiring, and there’s only one reason why – sales and margin prospects make it impossible to earn a fair return on the marginal cost of that next employee.

We got out of the Depression after WWII because we had destroyed the entire industrial capacity of Western Europe.  It was literally bombed to smithereens.  We were thus the only man standing with industrial capacity, and that meant pricing power – in other words, margins.  We also killed off an awful lot of competition for jobs, which meant labor had wage power.  Between those two we had a monstrous ramp in both industrial output and general prosperity; with wide margins business could (and did) hire, and with a relatively tight labor market wages were firm.  Technology also helped – The War brought many technological advances which filtered down to the common man.

If this is correct, my friends, then what Bernanke is doing will inevitably make the situation worse.  It has to, because what is doing will further damage margins

In fact we need to force those business that are non-viable out of business by withdrawing the unnatural support under them, even if it temporarily causes people to lose jobs. 

We have to support the dollar, which means normalizing interest rates and returning the saver’s ability to earn a living income off their saved wealth. 

We are in a perilous time.  Indeed, the policies of our government – to borrow and spend, larding up the interest costs down the road and protecting those who are bankrupt, simply means that cost pressures – and margin collapse – will accelerate.  This will tighten the spiral we are now in – not make it better.


I don’t think so.  Not with what we’re seeing in the data.  A million people came off unemployment benefits over the last month.  This month’s personal income and spending shows that spending is continuing while income is collapsing.  This is margin compression at the personal level, and we have multiple companies and reports showing insane amounts of cost-push pressure on inputs, with Kimberly-Clark, among others reporting the highest increases in input cost pressures in the firm’s history.  Look at the GDP report.  Virtually all of it was inventory – 1.44% of the 2% headline. Without the inventory build we saw only 0.56% GDP growth, and the deflator – the implicit inflation gauge in the numbers – stands at 2.2% across all products and services.

Even high-flying companies like Apple are reporting margin pressures.  But don’t be fooled by firms like Apple and other semiconductor manufacturers.  High-tech toys are great, but you can’t eat them, they won’t heat your house, and you can’t get to work in one.  You have to look at the necessities and their derived products to see where we’re headed – and there, it does not look good at all.

Remember, Bernanke already QE’d $1.4 trillion.  But he didn’t help things by doing so – he in fact made things worse.  Nor did he decrease interest rates – the 10 year Treasury Rate actually rose during that time.  None of what he claimed would happen, in point of fact, did. 

Why not? 

Because his actions have damaged, and continue to damage, margins for both businesses and households.

I think Bernanke is wrong.  Dangerously, perhaps even critically wrong.  He is focused on getting lending moving, because we live in a credit-driven world and he’s focused on bank credit. 

Yet we’re in this mess due to too much credit. More of what poisoned the economy cannot provide help – it can only make it worse.  We must instead focus on input costs, which paradoxially means pulling the rug out from under the crooks that caused the mess – the banks – and forcing them to be resolved so the debt overhang they are carrying is removed.   At the same time we must encourage asset deflation and the increase, not decrease, in yields. 

Borrowing must become expensive, so that it is not undertaken for any purpose other than a high-probability productive venture – the very venture that the lender of that capital – the saver – can then earn a solid return on.

All of this is focused on increasing the operating margin not only of business, but more importantly of households.  Debt default clears household balance sheets at the same time it destroys the banks that made imprudent loans.  “Buy today and pay never” must end, to be replaced by save today and buy tomorrow, because again, not only must operating margins at business be supported, but also operating margins at the household level!

Yes, old businesses that had an artificially-propped-up margin structure will die.  But they will be replaced by new businesses without the millstone of debt and structure around them that led to the older firm’s demise.

New banks, unburdened with bad balance sheets, will rise to take the place of old ones.

There will be pain in the short term and nobody wants to admit to that fact – or the consequences. 

But that pain is not avoidable.  Our can-kicking game has led us to kick the can through successive iterations to the point that it is now a 55-gallon drum filled with cement.

Bernanke is wrong.

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