More Questions on the World Economy

The last time I raised apprehensions about the World Economy and asked questions about the economy (late April), the consequences were quite disastrous. A few months down the line, I am no more knowledgeable about the world economy. On the contrary I am outright more skeptical about the economy and the ability of our policy makers. At various points i had very clearly stated that the only long-term solution was in a massive debt write off. Ultimately, I am quite sure that the world will witness such a write off, the only question is who will be the loser and what percentage will be written off. I would believe that the quantum of write offs will vary but it could be in the range of about 40-50% of the present debts. Only such a large write off would create conditions conducive for a recovery of the world economy.

In the interregnum, I believe that the world economy is at the cusp of a turning point (more like wilting point). We are likely to have policy level interventions yet again, which would be temporary in nature. Unlike the past (2008) we are likely to have policy makers intervene before things get out of hand. In all likelihood we may witness a scenario where the world would simply drift downwards - a la Japan. Our yesterday's thinking is their tomorrow's idea. There could be innumerable triggers since for the past two months we have been living on a scenario where "no bad news is good news".

I would need satisfactory answers for me to be convinced otherwise. By the way convincing answers have to have a combination of statistics, logic and historical precedent, otherwise I would continue to be a doubting character.

Questions:

1. Despite the historically large interventions by the ECB, why are the Greek Spread over the German Bond spreads at a record (today they crossed the May 2010 level). To place things in perspective, in May it was widely believed that Greece would have to be bailed out and there were also doubts about the survival of the Euro.

2. Why are equity markets so complacent while the bond markets (which traditionally have forecast each and every crisis) are yields that have not even been seen during the Great Depression. The Japanese and Swiss 10 year bonds are quoting at yields of about 1% or less.

3. Do the Governments have any more meaningful (effective) tools that would enable them go beyond the ineffective Quantitative Easing. QE now it comes in Parts: QE 1 was over (and hype and ended with a whimper), they are getting ready for QE2. So we can actually have many many episodes - just like the Soap episodes on the vernacular Indian idiot box - they run into hundreds.

4. Do the policy makers know that they are going to start pumping money at the wrong end (giving it to the banks, who will not lend it) rather than thinking about steps to the consumer in a non-debt format.

5. While the Equity markets are so hopeful about 3% US GDP growth, what do the commodity markets (especially the Journal of Commodities smoothed index) and other Indicators like ECRI leading indicators know about the economy that the equity markets don't know?

More questions later, but incase you have any answers please do enlighten me.

Brother, Can you spare me a Dime: Some Great Depression Statistics

The events of the past few weeks evoke mixed reactions. They vary from ironic relief at being closer than the run-in-the-mill consensus that talked about a recovery for about year and are now ‘shocked’ that the US economy may be on the verge of tipping over, to a reaction of sadness that my prognosis of a deflationary spiral may be too close to comfort-even for an ardent bear. This is because as I noted, it is always easy to earn money in bull market as there will always be a greater fool to buy what we want to get rid of. So in order to help place the Great Depression in a better perspective, I have decided to go back to my favourite discipline (History) to equip myself with the information that would hopefully enable me to overcome the despair that awaits us. For the record, I continue to believe that there is a very high probability that the US will face a double dip recession as will most parts of Europe over the next 1-2 years.

Much has been written about the Great Depression and its comparison with the present problems with the world. The eerie similarities only make it imperative that we have greater awareness of the impact of the Great Depression on different sectors. The reason for this is because I personally believe that if we understand the impact of the Great Depression, we would be able to take advantage of events that may unfold over the next five years. First we are bound to witness a deflationary spiral and then to be followed by an inflationary spiral. Since, I believe that my diagnosis of the problem is mostly right; it would now best to concentrate on the cure in order not to save the patient (which is beyond our ability) but to at least save our self.

In 1929 manufacturing constituted 25.2% of the US Economy, while trade consisted of 15.5%, Finance 14.7%, services 10.1% and agriculture 9.7%. While factories employed10.7 million, wholesale and retail trade employed 6.1 million, transport and public utilities employed 3.9 million, services 3.4 million, finance 1.5 million and construction 1.5 million.

Agriculture was an important component of the US economy. In 1930 rural population in USA constituted about 25% of the total population. The US had nearly 6.5 million farms and agricultural produce was an important 40% of the total US exports. About 2.4 million farms had less than 50 acres. Interestingly one million farm families had a net income of between US$100-300. Little wonder that the US agricultural sector was devastated by the impact of the Great Depression.

As the Depression gathered in intensity, the US Economy went into a downward spiral, which reached its peak intensity in 1933. By 1932, US Gross National Product had dropped by 33% and unemployment soared to nearly 25% (up from 3% in 1929). Prices of most of the goods had been cut in half. By March 1933, manufacturing output had fallen by almost half while wholesale prices fell by 38%. Nearly 3.4 million manufacturing jobs had disappeared along with 1.4 million in the whole sale and retail trade, 688,000 in the construction sector, 567,000 in the service sector, 214,000 in finance, insurance and real estate sector. To place this in perspective the US civilian (non-institutional) labour force was about 49.10 million.

An overview of the devastation shows the magnitude of problem.
•    In the manufacturing sector, the durable segment bore the brunt and it declined by 70-80% in output terms, while in terms of employment it contracted by about 55%.
•    Amongst the manufacturing sectors: shoes, tobacco, foodstuffs, textiles and non-durables fell by a relatively more modest 10-20% while employment in these sectors fell by about 30%.
•    In 1929 the USA produced about 4.5 million passenger vehicles by 1933 it had shrunk to 1.1 million. The sector now employed about 45%  less than at the outset of 1929. However, wages collapsed by 75%.
•    In 1929 the US housing starts numbered 509,000; by 1933 they had reduced to 93,000.
•    Spending on Advertisements plunged by more than 60% between 1929-33 and it did not recover to the pre-crash level until after World War II.
•    More than 9000 banks (or about 30% of those that existed in 1929) failed between 1930-33.
•    The Urban Population of the USA had risen by 27.3% in the 1920s, and it fell to 7.9% during the 1930s.
•    At one point the US Federal Government provided employment to about four million workers as part of its attempt to create jobs through infrastructure projects.

The Great Depression devastated the US agriculture sector:
•    Between 1929-32 crop and livestock prices crashed by almost 75%;
•    Farm incomes declined by 60% and in US Dollar terms they fell from US$13.8 billion to US$6.5 billion.
•    The cash proceeds from marketing farm products in 1932 were about one-third lower than they had been in 1919.
•    Farm foreclosures grew exponentially: I would equate the problem the present day home foreclosures (though it is like comparing Oranges with Apples).
•    Average farm foreclosure rate from 1913-1920 was about 3.2 per 1000 farms, which grew to 17.4 per 1000 farms in 1926 and by 1933 it had jumped to 38.8 per 1000 farms.
•    During 1933 itself more than 200,000 farms were foreclosed.
•    The farm foreclosures ebbed only with the establishment of the Farm Credit Administration in 1933 which began refinancing mortgage loans at low interest and finally after the passage of the Farm Mortgage Moratorium Act (1935) which forbade seizures for a period of 3 years.

The US budget which was in surplus till about 1929 (about US$734 million) tripped into a deficit of about US$2.7 billion in 1932, by 1936 this had increased to US$8.2 billion due to a combination of spending and reduction in revenues. World War II added to the woes of the US budget: it jumped to US$57.4 billion in 1943.

Tailpiece:
•    This is not to claim that the Great Depression was uniformly horrendous. The US illegal alcohol industry boomed: it jumped about US$2 billion since the introduction of prohibition in 1925.
•    Africa was relatively better off: while the value of world exports declined by 66% during the period 1929-34, Africa’s exports declined by 48%.