Welcome to Finance and Fury, the Furious Friday edition. A lot of people are talking about how this shut down having a similar or worse economic effect than the great depression. Today, we are going to look at recessions, what happened in the great depression, and compare the governmental policies being proposed to help boost the economy. We’ll look at their theory behind this and consider whether it will it help the recovery?

  1. Talk about a recession or depression similar to that of the Great Depression – think about the roaring 20s – I know nobody listening would have been alive – but it had a stigma – the music would never end – western nations were developed – times were good and nothing could cease the music – the depression kicked in – After an initial recession
    1. Recession – a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
    2. 6 months of negative – Before now – We haven’t had a recession under this definition since June 1991
  2. What happens if it keeps going? Depression – is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a recession – characterised by length and severity
    1. a decline in real GDP exceeding 10%, or a recession lasting 2 or more years – so if GDP drops by 10% – which it could – then the economy is officially in a depression

GDP – The measurement of what we are marked against

  1. GDP = “an aggregate measure of production equal to the sum of the gross values added of all resident and institutions engaged in production – Income or Expenditure approach – we will look at expenditure

Four Components of ‘Expenditure’ GDP– might be boring for those who know the theory already – but those who don’t – quick intro

  1. C (consumption)- normally the largest GDP component in the economy = private expenditures in the economy (household final consumption expenditure).
    1. categories: durable goods (cars, TVs), nondurable goods (food), and services.
    2. Equation – Value added = Price sold at – costs of inputs (labour, materials, etc)
      1. Higher profits lead to consumption increasing GDP
    3. I (investment)- business investment in new equipment/services
      1. construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory
      2. Spending by households on new houses is also included in investment.
      3. “investment” in GDP does not mean purchases of financial products
        1. classed as ‘saving’, as opposed to investment – avoids double-counting
        2. company uses the money received to buy plant, equipment, etc.
      4. G (government spending)is the sum of government expenditures on final goods and services.
        1. salaries of public servants, military and any investment expenditure by a government.
          1. does not include any transfer payments, such as social security or unemployment benefits
        2. Net Exports = X (exports) – M (Imports)
          1. Exports – represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations’ consumption, therefore exports are added.
          2. M (imports)represents gross imports. Imports are subtracted – imported goods will be included in the terms G, I, or C

To boost GDP – Both supply and demand economic theory want to boost aggregated demand – most efficient method is the increase consumption – as it makes up the lion share of GDP – same goal but different views on how to do it

  1. Demand side – boost domestic demand – expansionary monetary policy, or expansionary fiscal policy (transfer payments)
    1. This is what we are used to – and this is what we will be getting more of down the road
  2. The policies decision are focusing on boosting consumption – demand side economics – consumption represents around 60-70% of GDP in most western nations – our economy is consumption based
    1. so lets look how well this works in the long run – go back to one of the worst GDP crashes

The Great Depression was a severe worldwide economic depression during the 1930s – beginning in the United States

  1. started in 1929 and lasted until the late-1930s – some countries almost up until WW2 (1938-39)
    1. Personal income, tax revenue, profits and prices dropped – international trade plunged more than 50%
    2. Unemployment in the U.S. rose to 25% and in some countries rose as high as 33% (in Aus due to agriculture, manufacturing) – nobody to trade with and being dependent on export markets
  2. longest, deepest, and most widespread depression of the 20th century. 
  3. What triggered it? major fall in the US share market – September 4, 1929 – Then October 29, 1929 (known as Black Tuesday) –dow jones index 381 to 230 – almost 40% – Between 1929 and 1932 – low point of 45 (from 381) – Loss of 88% – took 25 years for the US market to recover – worldwide GDP fell by 15% – met both definitions for depression

What was the cause? A lot of finger pointing at the time – there were two predominate theories

  1. Keynesian(demand-driven) – consensus = large-scale loss of confidence from market crash led to a sudden reduction in consumption and investment spending
    1. panic and deflation (price reduction) set in = people hold money to avoid further losses – Further exacerbates a decline in an economy – comes from uncertainty –
    2. Keynes– lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average – at the moment – we have both a drop in confidence – due to uncertainty about government responses – but also lowering in employment so incomes as an aggregate may drop heavily – depends on the numbers
      1. called on governments during times of economic crisisto pick up the slack by increasing government spending – but this time around additional stimulus directly to businesses and individuals
      2. Theory also states that the private sector would not invest enough to keep production at the normal level and bring the economy out of recession
  • But government and business spent more in the first half of 1930 than in any 6-month period prior – why didn’t it help?
    1. Consumers – suffered severe losses in the stock market the previous year – cut expenditures by 10% – businesses can increase investment – governments can hand out stimulus – but if people aren’t spending this theory fails
    2. interest rates had dropped to low levels – but expected deflationand the continuing reluctance of people to borrow meant that consumer spending and investment were depressed. 
    3. Core issue with increasing money supply – what if nobody borrows? Due to no confidence – of if they do borrow – their cashflows go towards repayment of debt due to uncertainty – do these sound familiar at all?
  1. But This theory doesn’t point out the cause though – just why it might have gotten worse from 1930
  1. Monetarists – believe that the Great Depression started as an ordinary recession
    1. but the shrinking of the money supply exacerbated the economic situation –they argued that the Great Depression was caused by the banking crisis that caused one-third of all banks to vanish
    2. Market crash = reduction of bank shareholder wealth and more importantly monetary contractionof 35%, which they called “The Great Contraction.” This caused a price drop of 33% (deflation).
    3. during the first 10 months of 1930 – 744 U.S. banks failed (9,000 banks failed during the 1930s)
    4. Bank failures snowballed as desperate bankers called in loans which the borrowers did not have time or money to repay.
      1. future profits looking poor, capital investment and construction slowed/ceased.
      2. surviving banks became even more conservative in lending – built up capital reserves, made fewer loans
        1. vicious cycle developed and the downward spiral accelerated – sound familiar? Same thing in 2008 and now
        2. Today – banks reining in lending through increased requirements – worried if people will lose jobs – so have tougher lending requirements – regardless of cause – from bank failures to a forced shut down of the economy –
  • Criticisms – Fed not lowering interest rates soon enough (by increasing money supply) = Central Banks failed to inject liquidity into the banking system to prevent it from crumbling – and bank failures – this is what is different this time around – but the bank lending
  1. Federal Reserve passively watched the transformation of a normal recession into the Great Depression – true – but what power does a CB have to keep small businesses open or to make people spend the money that fiscal policy is giving them

 

  1. What was the cause of the great depression – many theories about what happened after – but Friedrich Hayekand Murray Rothbard – wrote America’s Great Depression (1963)
    1. their view – the key cause of the Depression was the expansion of the money supplyin the 1920s, of which led to an unsustainable credit-driven boom
    2. Banks/Share traders – margin requirements were only 10% – Brokerage firms lend $9 for every $1 investor had deposited
      1. When the market fell, brokers called in these loans, which could not be paid back
      2. Whilst the debt levels on margin loans at the individual levels were lower this time around – the debt levels were still higher
        1. Personal debts on mortgages, CCs, personal loans – at the corporate level have highest levels of debts – gov levels as well – and in parts of the world economies was funded by QE policies –
      3. Back in 1920 into the 1930s – The chain of events proceeded as follows:
        1. Massive increase in money supply and speculation – driving share market and bond pricing up unsustainable
        2. Market dropped – Outstanding debts became heavier – prices/incomes fell by 20–50% but the debts remained at the same dollar amount
  • Debt liquidation and distress selling – Contraction of the money supply as bank loans are called in by the banks – created further liquidity issues –
  1. A fall in the level of asset prices compared to loans – then a greater fall in the net worth of businesses, triggering bankruptcies
  2. A fall in profits – A reduction in output, in trade and in employment
  3. Pessimism and loss of confidence – people see prices going down – so why spend $1 today if cheaper tomorrow?
    1. Opposite to inflationary pressures – ‘rather you pay me today than tomorrow’
  4. Today – we have MMT – out of all of these steps the one that QE and government payments are trying to avoid is the contraction of the money supply – trying to provide ‘liquidity’ to banks and governments –
  1. But Credit expansion cannot increase the supply of real goods – merely brings about a rearrangement
    1. diverts capital investment away from the free market/market conditions – how economic wealth is created
      1. Instead – production to pursue paths which it would not follow under normal conditions
    2. the upswing lacks a solid base – It is not a real prosperity. It is illusory prosperity –
      1. Example – the real value of goods goes nowhere – just the prices of things but your PP stays the same
    3. Growth is not an increase in economic wealth, i.e. the accumulation of savings made available for productive investment.
      1. arose because the credit expansion created the illusion of such an increase.
      2. Savings plummeted due to lower rates (no incentive to save – look at interest rates today) – but instead repayment of debts replaces savings – debts are high – savings rates are low – confidence is low = repay debt instead of spending
    4. Hans Sennholz – argued that most boom and bustsin an economy – were generated by government creating a boom through easy money and credit, which was soon followed by the inevitable bust
      1. like in 1819–201839–431857–601873–781893–97, and 1920–21,
      2. The crash of 1929 followed five years of reckless credit expansion by the Federal Reserve System again – to little effect
    5. Looking back on both Demand and Monetarist theories – see any problems? Their solutions are what contributed to the share market bubble – artificial increase in money supply + artificial push to increase demand
      1. It might try to put a bandaid over the problem – but never actually treat the wound – so you end up losing an arm down the road
    6. Similarities to today – prior to the crash – we already had a massive bubble in markets from easy money policies and the amount of credit – not equity – in markets –
      1. Today – rather than putting in protectionist policies and individual taxes increases (reducing the individuals take home pays) – they just shut down sections of the economy to the same effect – lower money which individuals can demand
      2. Fiscal stimulus – the jobkeeper payments – $1,500 a fortnight – for all workers – even if they were only earning $300 a FN prior –
        1. Pensioners – getting an additional payment and subsidies on rent or electricity –
        2. This flow of money is demand side – tried to boost the demand – but what good is it if there is no supply –
  • The only supply is large companies – further reducing the supply to the economy or shoring up the monopolistic behaviours of the market

Summary –

  1. Keynes -stimulus to boost aggregate demand is only really effective in relatively closed economies (why they tried tariffs back in 1930 – made it worse though)
    1. free capital flows and globalization pretty much most of the stimulus has been in fact relatively ineffective – if money being introduced in Aus is spent on Amazon – US does well – needs to be spent in local small business to help our economy
  2. The multiplier has been small – indeed negligible – and the stimulus have been therefor rather poor.
    1. these policies can hardly be justified – I don’t think the answer lies in yet more Keynesism, any more than it necessarily lies in printing yet more money
    2. So all considering, why should be we expect any different now – it comes down to individuals decisions – if people get money
  3. But old Economists still love this idea – But how is this money ever repaid? Not their problem – dead before bill is due
    1. But with MMT – debt isnt seen as an issue – as Govs can just print money – so get into as much debt now and then print your way out of it later
  4. Australia – Total Money supply (M3) 15 years ago was $500billion – today is $2.2 trillion – Growth of 10% p.a.
    1. M1 though has sky rocketed – in the past year – went from $360bn to $1.2 trn – more than tripled – but this happened in July last year –
  5. Despite what politicians are saying – printing money to try and boost the economy will likely fall short of what the targets are

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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