Econ-Fin News Nov 29 2008 - This is Worse Than Great Depression

We are in a worse situation than The Great Depression
Barry Ritholtz linked to a video of Paul Solomon of the PBS News Hour interviewing with Dr. Nassim Nicholas Taleb, famous economist and author of The Black Swan : The Impact of the Highly Improbable” and Taleb’s mentor, French mathematician, Dr. Benoit Mandelbrot, Professor Emeritus of Mathematics at Yale University. Dr. Mandelbrot, a pioneer in the development of chaos theory, is regarded as the father of fractal geometry. Both say that the present economic situation is actually more serious than the Great Depression. In fact, they fear the U.S. is in the worst situation it has been in since the American Revolution.

The reason, Dr. Taleb explained, is that “Never in the history of the world have we faced so much complexity combined with so much incompetence in understanding its properties.”

Both men agree that the attempts thus far to resolve the crises are actually making matters worse. Dr. Taleb explained that “the ecology of the banking system” is being “over-optimized” because of an incompetent belief that it is more optimal to save one giant banking firm, rather than ten smaller ones.

Dr. Taleb said that the past two weeks, the financial crises have begun to disturb his sleep. He wakes in the middle of the night fearing what might happen next.

It’s more than a liquidity problem

Groundbreaking economist, Herman Daly, zeroes in on the root cause of our financial meltdown:

The turmoil affecting the world economy unleashed by the US sub-prime debt crisis isn’t really a crisis of “liquidity” as it is often called. A liquidity crisis would imply that the economy was in trouble because businesses could no longer obtain credit and loans to finance their investments. In fact, the crisis is the result of the overgrowth of financial assets relative to growth of real wealth— basically the opposite of too little liquidity. We need to take a step back and explore some of the fundamentals that growth-obsessed economists and commentators tend to neglect.

After winning the Nobel Prize for chemistry, Frederick Soddy decided he could do greater good for humanity by turning his talents to economics, a field he felt lacked a connection to biophysical reality. In his 1926 book Wealth, Virtual Wealth and Debt: The Solution of the Economic Paradox, (a book that presaged the market crash of 1929), Soddy pointed out the fundamental difference between real wealth – buildings, machinery, oil, pigs – and virtual wealth, in the form of money and debt.

Soddy wrote that real wealth was subject to the inescapable entropy law of thermodynamics and would rot, rust, or wear out with age, while money and debt – as accounting devices invented by humans – were subject only to the laws of mathematics.

Rather than decaying, virtual wealth, in the form of debt, compounding at the rate of interest, actually grows without bounds.

Brad DeLong says the Fed and the Treasury have lost the game

Now it is clear that the Fed and the Treasury have lost the game. If a depression is to be avoided, it will have to be the work of other arms of the government, with other tools and powers.

The failure to contain the crisis will ultimately be traced, I think, to excessive concern with the first two subsidiary objectives: reining in Wall Street princes and keeping economic decision-making private.


Because it tried to keep the private sector private, it sought to avoid partial or full nationalization of the components of the banking system deemed too big to fail. In retrospect, the Treasury should have identified all such entities and started buying common stock in them - whether they liked it or not - until the crisis passed.

I would disagree about being overly concerned about Wall Street profiting from the bailout, but you can go read DeLong’s argument for yourself. Interestingly, DeLong’s article first appeared in The Guatamala Times.

Consumer purchases collapse two quarters in a row
Chairman of Morgan Stanley Asia, economist Stephen S. Roach writes on the New York Times editorial page:

It’s game over for the American consumer. Inflation-adjusted personal consumption expenditures are on track for rare back-to-back quarterly declines in the second half of 2008 at a 3.5 percent average annual rate. There are only four other instances since 1950 when real consumer demand has fallen for two quarters in a row. This is the first occasion when declines in both quarters will have exceeded 3 percent. The current consumption plunge is without precedent in the modern era.


Worse, millions of homeowners used their residences as collateral to take out home equity loans. According to Federal Reserve calculations, net equity extractions from United States homes rose from about 3 percent of disposable personal income in 2000 to nearly 9 percent in 2006. This newfound source of purchasing power was a key prop to the American consumption binge.

As a result, household debt hit a record 133 percent of disposable personal income by the end of 2007 — an enormous leap from average debt loads of 90 percent just a decade earlier.

Paul Krugman notes reality is dealing a blow to conservatives’ fantasy about monetary policy causing the First Great Depression

Morally, Wall Street bankers are very young children

Mirabile Dictu! Rubin Takedown by the Wall Street Journal!

”When they forgot the nuts and bolts, everyone got screwed”
Today’s ”When they forgot the nuts and bolts, everyone got screwed” award goes to Joseph Nocera for a short New York Times profile of the only remaining independent U.S. tractor-truck maker, Navistar

The company’s chief executive, Dan C. Ustian, had just returned from Washington, where he had attended a big executive conference held by The Wall Street Journal.

No sooner had he shaken my hand than he launched into a passionate speech about the failure of the banking industry to do what it was supposed to be doing to help get us out of this crisis.

“It appears that money is being loaned by the government to the banks at a very attractive rate, and that money is not getting down to consumers or businesses,” he said. “We have had 2,500 bankruptcies in our industry in a nine-month period. You can’t believe how many of those trucking companies have been in business a long time, and they’re profitable, but they can’t get working capital. And when they can get it, they have to pay an arm and a leg. Some of the midsized customers we do business with are paying 14 and 15 percent for money, with a lot of onerous covenants. So that is what is happening to our customers.”



Then what?

Seriously, what comes after? How can I protect my children?

Personal economics in a depression

Cash, durable goods, and commodities.

Save your cash as much as you can. Reduce your purchases to needs, not wants. When the real deflation hits, keep an eye on *any* major durable appliance purchase that has a >10 year lifespan, and buy when these are cheap.

In the stock market, I'd still wait- I consider it at least 20% overvalued still. When the DOW goes up over a 5 day period *or* hits 100, that's the time to buy stocks again. Until then, avoid all financial paper markets, they're just too little cash for too much risk during a depression.

Oh, and don't forget what the survivalists teach- a 2-3 year food supply in house is vital.

Ideally, find out what your children are good at, and turn those skills into products you can sell locally.

Maximum jobs, not maximum profits.

Here in the UK it's brutal too

Yikes, pretty scary stuff, but get this - here in the UK with the oil price plummeting the price of gas at the pump here is still $8.00+ a gallon and it had gone up to as much as $12.00 a gallon last early summer.

To us on this side of the pond the whole thing looks like a desperately shakey pack of cards set to collapse the world over... unless you are in China of course. Buy gold I reckon, lots of it if you can... if you're not as debt ridden as much as everyone else that is.


Best steps?

Advice and opinions please - If we have some cash, is it better to pay off as much of our mortgage as possible or hold on to the cash? What good will cash do us if the dollar collapses? We are afraid we will both be unemployed and unable to pay our mortgage unless we get the principal as low as possible now and refi for a low monthly payment. Any advice is appreciated!


Well, these are predictions based on macro economic data and there are others who believe the dollar will remain strong, safe haven. Considering the UN just said the dollar potentially could collapse it might be wise to get a multi-currency interest savings account, where a percentage of your money is in multi-foreign currencies, a basket of currencies the stronger currencies, like the Euro, the Yen, etc.

Then on mortgages, the problem is devaluation of the price of the house to refinance so that's up to you to go refinance shopping and figure out what is your best option.

One thing I think everyone on this blog can agree with, don't sign anything until you've read all of the fine print and understand what it says.

Here's my thought

I'm in close to your position- just enough equity in the house that if I had to go bankrupt tomorrow, all creditors would be paid, the house would be sold, and I'd have about $15k left over.

Here's my thought- this deflation won't be allowed to last. The question is, how soon will we see an M1 money injection? Right now, as long as deflation is going on and all we're seeing is M3 stimulus, you're putting good money in that will be better money in a few months.

My suggestion- figure out your Worst Case Scenario budget. Don't forget unemployment insurance in that. A true collapse of the dollar will mean hyperinflation, not deflation. Refi now if you need to fit your mortgage into your worst case scenario- say, 1/2 your potential unemployment insurance (mine is there now). Pay off whatever credit cards you can, and then hunker down, save cash, and watch the PMI. When the PMI reverses and starts going back up, use whatever cash you've been able to save to buy the type of durables that will last you the next 10 years or more, because this will be the bottom of the deflation. PMI went up for 70 years until September, and has nosedived since, so it's a pretty good indicator of what CPI will be soon. You'll never see durables priced this good again in your lifetime.

After that, wait until you have a good paying job, and watch inflation. As the dollar crashes, inflation will skyrocket. Eventually your mortgage (mine's around $200k) will be worth less than a loaf of bread if the dollar really does totally crash- and that's the time to pay it off.

Maximum jobs, not maximum profits.