Peter Freeman's views
Just in case anyone's interested, you can visit my website at www.cfi-partners.com.
Also, here is a blog about the current economic mess. Comments welcome.
This time it’s different – Reflections on the current mess
We are living in interesting times. You may recognize that as an old Chinese curse; not a blessing. In reflecting on the current mess, I wanted to provide some perspective, giving my views of the causes of the Great Depression. This is controversial, the usual suspects include the stock market crash, monetary contraction, tariff wars, among others.
I believe it was due to massive deleveraging; a current phenomenon; which was not counterbalanced by government stimulus and central bank intervention as a lender-of-last-resort. Boom and busts have been recurring regularly in economic history, with greater frequency in recent decades and following a typical pattern. An improvement in economic conditions or fundamental stimulates increasing investments. That’s a good thing, as it should be. But it can become too much of a good thing, especially if fueled by easy access to capital and new financing methods. For example, the dot.com or internet bubble of the 90’s reflected productivity gains from new technology that greatly improved economic conditions. IPO’s were a somewhat new financing method driving the boom, which was great fun while it lasted.
Investments usual start out being attractive for their fundamentals, their productivity or earning capacity. As a boom progresses, investors increasing seek capital gains, as internet stocks were valued not for the earning power of the companies (or lack thereof) but growth potential. This is essentially seeking a greater fool, irrational exuberance. Something triggers a reversal, a shock to the system such as a failed IPO. The cycle ten reverses, with the herd mentality working in the opposite direction, on the downside. This is not irrational, it makes sense to want to sell, to get out before it’s too late, and widespread selling pressure intensifies the decline in stock prices.
Regarding the Great Depression, the 20’s were a very prosperous era, the US economy was enjoying post-WW1 stability and the benefits of many newfangled technologies, like electricity and mass-production. New methods of financing came along, such as payments on installment plans and margin loans for stock speculation. The latter drew away a lot of investment capital from other, non-speculative purposes in the “real’ economy.
Credit tightened. The first stock market crash; Black Friday; may have been more a symptom than a cause but did get people’s attention. Private business investment decreased, deleveraging on a large scale. With a significant amount of capital tied up in the stock market via margin loans that could not be fully repaid, businesses were unable to get financing, inducing more cutbacks (if this sounds familiar, it should). Government did not take countercyclical steps to stimulate the economy initially, rather reduced spending and the budget deficit, in a misguided attempt to respond. The combination resulted in massive job losses, as we all know.
This too shall pass. And it shall come again in the future, unless we learn from past experience. In my view, the lessons include a recognition that modern capitalism is prone to instability, not equilibrium. “This time it’s different” is commonly heard in connection with each boom. We are better served if capital markets are regulated, but markets invariably find ways around our best-laid plans. For example, banks recently used securitization to evade capital adequacy requirements, much to our detriment. Truly effective regulations can be devised, but usually with serious unintended consequences, doing more harm than good.
Government policy will have its own effects, and can be beneficial or damaging. Another lesson of history is that beneficial policies are in general countercyclical, to stimulate when the economy is weak and vice versa; as Keynes taught us. We are all Keynesians now, but tend to disagree on the way to apply those principles; such as increasing unemployment compensation (the Dem’s) versus supporting small businesses (Repub’s).
The problem or my concern is the willingness of the government to exercise restraint when things improve. History is not encouraging, neither party has shown an ability to rein in spending programs once they are established. As PJ O’Rourke observed, giving money and power to politicians is like giving whiskey and car keys to teen-age boys.
I’ll check back in a few years to see how things unfold, it will be interesting. In the meantime, companies should become as flexible as possible, to ride out the inevitable cycles and capture the opportunities that do and will exist. More on that next time.
