Global Economic Train Wreck

The View From The Peak
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	Global Economic Train Wreck by Mike Shedlock ~ “Mish” Illinois, U.S.A. for Whiskey & Gunpowder Bloomberg is reporting, "U.K. Third-Quarter Personal Bankruptcies Reach Record": "Personal bankruptcies in Britain climbed to a record in the third quarter as surging house prices and rising interest rates pushed consumers to take on more debt than they were able to repay. "Individual insolvencies in the three months through September totaled 27,644, up 5.7% from the previous quarter and 55% from a year earlier. It was the highest since records began in 1960, the U.K. Department of Trade and Industry said on its Web site today. "A quarter-point interest rate increase to 4.75% in August and the threat of another next week is straining the finances of Britons, who owe a record 1.3 trillion pounds ($2.5 trillion). Mortgage lenders such as Abbey National Plc have relaxed their lending criteria to meet demand for home loans as the cost of property rises. "'The increase is quite shocking,' said Louise Brittain, personal insolvency partner at accountants Baker Tilly. 'There's an expectation now that people can have what they want, when they want, on credit. At this rate, we will have personal insolvencies continuing at about 110,000 a year.' "Consumers added to credit cards, personal loans, and mortgages after cheap credit and more than decade of economic growth encouraged households to borrow and spend... "Insolvencies have created a boom in debt advice services from specialist lenders, including Debt Free Direct Group Plc, which said yesterday that first-half sales almost doubled as the number of personal financial consolidations it handled jumped. The company said that its full-year profit will 'comfortably' meet market expectations. "Consumers are also taking on more debt in relation to their income to afford homes whose costs are rising faster than their salaries. Abbey, the U.K.'s second-biggest mortgage lender, said Oct. 31 it has begun offering individuals home loans worth five times their wages, because of continuing gains in house prices." It's lovely, isn't it? Bankruptcies are soaring, but the response by the biggest lender in the U.K. is to increase loan amounts "because of continuing gains in house prices." Even as home prices in the U.S. are collapsing, lenders in the U.K. somehow think home prices can keep rising orders of magnitude faster than wages and rents. This same situation is playing out in Canada, Europe, China, and, obviously, the U.S. Credit Quality According to the S&P, "U.S. Credit Quality in 25-Year Retreat Toward Junk." Following are the highlights (from Reuters): U.S. corporate credit quality has been on a 25-year decline toward junk status Almost half of all companies now rated below investment grade Liquid financial markets, downgrades in the auto and airline sectors, a spate of takeovers, and global competition have contributed to the credit quality erosion "An aggressive financial posture is necessary for survival in a stiff globally competitive environment" "The same dynamics are unfolding in Europe, albeit at a slower pace" As of September, junk, or speculative-rated issuers, defined as those rated "BB-plus" or below, stood at a record high of 49%, up from 48% at the end of 2005 and a low of 28% in 1992 "AAA" ratings dropped to 18 from a peak of 24 in 1998 The default rate could exceed 15%, the highest since the Great Depression, if the economy goes into a recession, according to Martin Fridson, publisher of independent research service Leverage World Shareholder-friendly activity, such as share buybacks, restructurings, and leveraged buyouts, have all increased debt burdens and lowered credit quality High-risk tolerance by investors has also attracted more speculative-grade issuers to the bond market 61% of all newcomers to the bond market had ratings at the "B" level, a mid-level junk considered highly speculative "B" is now the largest rating category, making up 27% of all issuers The investment-grade universe, meanwhile, is now dominated by financial institutions, "as mergers and acquisitions have created enormous financial entities with huge funding appetites." Shareholder-Friendly Activity Some of the above is so staggering I hardly know where to begin commenting, but let's start with "shareholder-friendly activity." Buybacks at these levels are NOT shareholder friendly. Headed into an economic slowdown, corporations should be hoarding cash, not squandering it. To make matters worse, corporate insiders are bailing on their own shares by the bucket load as fast as they can. Let's now turn to a statement made by the S&P, that "an aggressive financial posture is necessary for survival in a stiff globally competitive environment." Of course, that is absurd. Unless you are a lemming, you should not have to follow the competition over the cliff. Besides, the idea of lemmings jumping off a cliff as pictured in the 1958 Disney nature documentary White Wilderness is really just a suicide myth, in stark contrast to suicidal credit lending activities by corporations, which appear to be the real deal. Foreclosures RealtyTrac is reporting, "National Foreclosures Increase 17% in Third Quarter": "RealtyTrac, the nation's leading online marketplace for foreclosure properties, today released its Q3 2006 U.S. Foreclosure Market Report showing that 318,355 properties entered some stage of foreclosure nationwide during the third quarter of 2006, a 17% increase from the previous quarter and a 43% yearly increase from the third quarter of 2005." In response to one of my blogs, a person posting under the name "KIA" reported: "There are also a lot of nonjudicial foreclosure states, like Virginia, where foreclosures occur without any 'official' court filing. Personal observation: Foreclosures are roaring through. The current record holder from my office is an April 2006, loan for about $500,000 that is currently in foreclosure. The wave is past the first edge and is swelling higher and higher now." Even as foreclosures skyrocket, corporate lemmings are doing everything they can to keep the machine greased and the wheels spinning. I guess the theory must be that as long as the wheels keep spinning faster and faster, they will not fly off the axle. That theory is about to be tested. The Role of Government Some responses to my blogs were blaming the "gold standard" for the Great Depression, while others were arguing that the expansion of credit by GSEs proves we need more government regulation, not less. One person concluded a very long rant with, "What is pretty clear now is that Mish is asking what will make things worse and what everybody will be asking pretty soon, pro cycle policies, stuff that will amplify the crisis." Those arguing for more government controls are, in effect, arguing in favor of Russian-style communist government central planning that is now thoroughly discredited everywhere. The free market is the answer, not more ridiculous central planning. Government setting interest rates is a problem, not a solution. The Fed even admitted it. See "Confessions by the Fed." Government-mandated programs of all kinds at every level are a huge problem, not a solution. Growth in government employment is a problem, not a solution. The invasion of Iraq wasted a half trillion dollars, and that is a problem, not a solution. The role of government should be limited to areas of safety, environmental standards, routine police work, and genuine national defense concerns, as opposed to attempting to be the world's policeman. The government has no business setting prices for orange juice or mortgages. Nor should government be in the business of promoting housing. Some 300 government programs designed to make housing affordable did exactly the opposite. We do not have a free market here, not with 300 government programs promoting housing. The free market did not cause this housing bubble; stupid government policies did. There should not be a Fannie Mae or a Freddie Mac for lending institutions to dump mortgages on. There should not be a HUD guaranteeing below-cost mortgages. There should not be programs as there are in Illinois guaranteeing low-cost loans to illegal aliens. Illinois Gov. Rod Blagojevich simply had to be out of his mind when he passed an Opportunity I-Loan program guaranteeing low-cost government-sponsored mortgage loans for illegal aliens. Those blaming the "free market" for problems should really be blaming "central planning." It is ironic to find people arguing for MORE communist central planning, because the current communist central planning (CCCP) is not working. What we really need is a free market, because the markets we have now are anything BUT free markets. The Gold Standard As far as the gold standard being the cause of the Great Depression, people simply do not know what they are talking about. Those who think like Bernanke does (the Fed did not cut rates fast enough or soon enough) do not know what they are talking about, either. For starters, we did not really have a "gold standard," but rather, much of the world had a "gold exchange standard," which is something far different. Secondly, we had massive government manipulations of all kinds throughout that period, and that manipulation did nothing but make matters worse. It continues through to today with policies designed to blow ever bigger and bigger bubbles. To dispute the myth that the gold standard is at the root of the problem, let me refer everyone to Murray N. Rothbard, the leading authority on the "A History of Money and Banking in the United States." It is a very long read, but those wishing to understand the gold exchange standard, as well as the results of government intervention of all sorts throughout U.S. history, would be advised to read the document. Following are some highlights from the above link, for the period between the mid-'20s and the start of the Great Depression: "The Gold-Exchange Standard in the Interwar Years... "After generating the burst of inflation in 1927 [by lowering the Fed discount rate], the New York Fed continued, over the next two years, to do its best: buying heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold into the U.S. The New York Fed also bought large amounts of sterling bills in 1927 and 1929. It frankly described its policy as follows: We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe, but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe's power to buy our exports. "The stock market had already been booming by the time of the fatal injection of credit expansion in the latter half of 1927... Dow Jones industrials had doubled from 95.1 in November 1922 to 195.4 in November 1927. But now, the massive Fed credit expansion in late 1927 ignited the stock market fire. In particular, throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the 'call rate,' that is, the interest rate on bank call loans to the stock market, artificially low. Before the establishment of the Federal Reserve System, the call rate frequently had risen far above 100%, when a stock market boom became severe; yet in the historic and virtually runaway stock market boom of 1928-29, the call rate never went above 10%. The call rates were controlled at these low levels by the New York Fed, in close collaboration with, and at the advice of, the Money Committee of the New York Stock Exchange... "Credit expansion always concentrates its booms in titles to capital, in particular stocks and real estate, and in the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. These included excessive mortgage loans and construction from farms to Manhattan office buildings. "The Federal Reserve authorities, now concerned about the stock market boom, tried feebly to tighten the money supply during 1928, but they failed badly. The Fed's sales of government securities were offset by two factors: (a) the banks shifting their depositors from demand deposits to 'time' deposits, which required a much lower rate of reserves, and which were really savings deposits redeemable de facto on demand, rather than genuine time loans, and (b) more important, the fruit of the disastrous Fed policy of virtually creating a market in bankers' acceptances, a market which had existed in Europe, but not in the United States... "A few days before leaving office, in March 1929, Coolidge called American prosperity 'absolutely sound' and assured everyone that stocks were 'cheap at current prices.' "DEPRESSION AND THE END OF THE GOLD-STERLING-EXCHANGE STANDARD: 1929-1931 "The depression, or what nowadays would be called the "recession," that struck the world economy in 1929 could have been met in the same way the U.S., Britain, and other countries had faced the previous severe contraction of 1920-21, and the way in which all countries met recessions under the classical gold standard. In short: They could have recognized the folly of the preceding inflationary boom and accepted the recession mechanism needed to return to an efficient free-market economy. "In other words, they could have accepted the liquidation of unsound investments and the liquidation of egregiously unsound banks, and have accepted the contractionary deflation of money, credit, and prices. If they had done so, they would, as in the previous cases, have encountered a recession-adjustment period that would have been sharp, severe, but mercifully short. Recessions unhampered by government almost invariably work themselves into recovery within a year or 18 months. But the United States, Britain, and the rest of the world had been permanently seduced by the siren song of cheap money. If inflationary bank credit expansion had gotten the world into this mess, then more, more of the same would be the only way out. Pursuit of this inflationist, 'proto-Keynesian' folly, along with other massive government interventions to prevent price deflation, managed to convert what would have been a short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment that only ended with World War II." Key Points Throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the "call rate" -- that is, the interest rate on bank call loans to the stock market -- artificially low In the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe, but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe's power to buy our exports The United States, Britain, and the rest of the world had been permanently seduced by the siren song of cheap money A few days before leaving office, in March 1929, Coolidge called American prosperity "absolutely sound" and assured everyone that stocks were "cheap at current prices" "Proto-Keynesian" folly, along with other massive government interventions to prevent price deflation, managed to convert what would have been a short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment that only ended with World War II. Does any of that sound familiar? It should. It parallels nearly exactly what is happening today. In fact, it is downright eerie. This is not a rerun of That 70's Show, but rather a rerun of the roaring '20s. Roaring '20s Comparison Florida is once again ground zero on housing bubble bursting The Fed admits it kept interest rates too low too long. See Confessions by the Fed Credit derivatives are soaring According to the International Swaps and Derivatives Association's (ISDA) Mid-Year 2006 Market Survey, the notional value of credit derivatives outstanding grew 52% during the first six months of 2006, to $26 trillion. (See "Economic Conditions and Emerging Risks in Banking") FDIC-insured institutions also reported a 13% increase in credit derivatives holdings to $6.5 trillion during the first half of 2006. (See "Economic Conditions and Emerging Risks in Banking") Margin rules were relaxed U.S. credit quality is in a 25-year retreat toward junk The U.S., Great Britain, Japan, and China continue to be seduced by cheap money Japan, China, and other countries have interventionist monetary policies designed solely to help their exports and keep the U.S. consumer borrowing binge going Greenspan and the Fed simply refused to let the dot-com bubble play out. Instead, we saw "Keynesian folly" that did nothing but create an even bigger bubble in housing, putting off the inevitable one last time The administration is telling everyone how great things are even as we slide into recession. Thomas Jefferson on Banks: "I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." --Letter to the Secretary of the Treasury Albert Gallatin (1802) Keynesian folly by the Fed and this administration in cooperation with foreign central banks everywhere have put the global economy on the brink of disaster. There is no way out. All that remains to be seen is the tipping point that sends this global train on a "23 Skidoo" over the cliff. Regards, Mike Shedlock ~ "Mish" Michael Shedlock (Mish) worked in the financial services industry for 20 years at some of the top institutions in the country including Harris Bank, the Bank of Montreal, Bank One, First National Bank of Chicago, and First Data Corp. Mish is currently doing economic and investment research for a number of clients. In addition, Mish runs one of the more popular stock boards on the Motley Fool, Investment Analysis Clubs / Mishedlo and one of the more popular boards on Silicon Investor as well, Mish's Global Economic Trend Analysis. You can see more of Mish's writing on his blog also entitled Mish's Global Economic Trend Analysis. While he is not writing about stocks or the economy Mish spends a great deal of time on photography, one of his other passions. Mish has over 80 magazine and book cover credits, for magazines such as Country Magazine, Wisconsin Trails, the Chicago Tribune Sunday Supplement, Browntrout Calendars, and numerous other publications. Some of his Wisconsin and gardening images can be seen at www.michaelshedlock.com.	Peak Oil Glance at World's oil Simmons Presentations Hirsch Report (pdf) US Army report (pdf) 4 Biggest Fields Declining Kuwait's Burgan Peaks Cantarell is Dying North Sea in Decline Trouble in Ghawar Ghawar is dying Daqing Peaked Russian Peak I Russian Peak II Iran is The next Target Dick Cheney (pdf) Shell cuts reserves 5th time Rainwater Prophecy Abiotic Oil I Abiotic Oil II Petrodollar Warfare (pdf) This Week in Petroleum Petroleum Monthly Mega Projects 2004 (pdf) Price Quotes/Charts Oil Chart Crude Real Time Quotes CNN Commodities Energy Price Quote Live Gold/Silver Quotes Alternatives or Fantasy? 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The View From The Peak

Home Multimedia Forum Books Articles^New! News/Updates^New!

How prepared are we for the permanent energy crisis ?

Global Economic Train Wreck

by Mike Shedlock ~ “Mish”
Illinois, U.S.A.
for Whiskey & Gunpowder

Bloomberg is reporting, "U.K. Third-Quarter Personal Bankruptcies Reach Record":

"Personal bankruptcies in Britain climbed to a record in the third quarter as surging house prices and rising interest rates pushed consumers to take on more debt than they were able to repay.

"Individual insolvencies in the three months through September totaled 27,644, up 5.7% from the previous quarter and 55% from a year earlier. It was the highest since records began in 1960, the U.K. Department of Trade and Industry said on its Web site today.

"A quarter-point interest rate increase to 4.75% in August and the threat of another next week is straining the finances of Britons, who owe a record 1.3 trillion pounds ($2.5 trillion). Mortgage lenders such as Abbey National Plc have relaxed their lending criteria to meet demand for home loans as the cost of property rises.

"'The increase is quite shocking,' said Louise Brittain, personal insolvency partner at accountants Baker Tilly. 'There's an expectation now that people can have what they want, when they want, on credit. At this rate, we will have personal insolvencies continuing at about 110,000 a year.'

"Consumers added to credit cards, personal loans, and mortgages after cheap credit and more than decade of economic growth encouraged households to borrow and spend...

"Insolvencies have created a boom in debt advice services from specialist lenders, including Debt Free Direct Group Plc, which said yesterday that first-half sales almost doubled as the number of personal financial consolidations it handled jumped. The company said that its full-year profit will 'comfortably' meet market expectations.

"Consumers are also taking on more debt in relation to their income to afford homes whose costs are rising faster than their salaries. Abbey, the U.K.'s second-biggest mortgage lender, said Oct. 31 it has begun offering individuals home loans worth five times their wages, because of continuing gains in house prices."

It's lovely, isn't it? Bankruptcies are soaring, but the response by the biggest lender in the U.K. is to increase loan amounts "because of continuing gains in house prices." Even as home prices in the U.S. are collapsing, lenders in the U.K. somehow think home prices can keep rising orders of magnitude faster than wages and rents. This same situation is playing out in Canada, Europe, China, and, obviously, the U.S.

Credit Quality

According to the S&P, "U.S. Credit Quality in 25-Year Retreat Toward Junk." Following are the highlights (from Reuters):

U.S. corporate credit quality has been on a 25-year decline toward junk status
Almost half of all companies now rated below investment grade
Liquid financial markets, downgrades in the auto and airline sectors, a spate of takeovers, and global competition have contributed to the credit quality erosion
"An aggressive financial posture is necessary for survival in a stiff globally competitive environment"
"The same dynamics are unfolding in Europe, albeit at a slower pace"
As of September, junk, or speculative-rated issuers, defined as those rated "BB-plus" or below, stood at a record high of 49%, up from 48% at the end of 2005 and a low of 28% in 1992
"AAA" ratings dropped to 18 from a peak of 24 in 1998
The default rate could exceed 15%, the highest since the Great Depression, if the economy goes into a recession, according to Martin Fridson, publisher of independent research service Leverage World
Shareholder-friendly activity, such as share buybacks, restructurings, and leveraged buyouts, have all increased debt burdens and lowered credit quality
High-risk tolerance by investors has also attracted more speculative-grade issuers to the bond market
61% of all newcomers to the bond market had ratings at the "B" level, a mid-level junk considered highly speculative
"B" is now the largest rating category, making up 27% of all issuers
The investment-grade universe, meanwhile, is now dominated by financial institutions, "as mergers and acquisitions have created enormous financial entities with huge funding appetites."

Shareholder-Friendly Activity

Some of the above is so staggering I hardly know where to begin commenting, but let's start with "shareholder-friendly activity." Buybacks at these levels are NOT shareholder friendly. Headed into an economic slowdown, corporations should be hoarding cash, not squandering it. To make matters worse, corporate insiders are bailing on their own shares by the bucket load as fast as they can.

Let's now turn to a statement made by the S&P, that "an aggressive financial posture is necessary for survival in a stiff globally competitive environment." Of course, that is absurd. Unless you are a lemming, you should not have to follow the competition over the cliff. Besides, the idea of lemmings jumping off a cliff as pictured in the 1958 Disney nature documentary White Wilderness is really just a suicide myth, in stark contrast to suicidal credit lending activities by corporations, which appear to be the real deal.

Foreclosures

RealtyTrac is reporting, "National Foreclosures Increase 17% in Third Quarter":

"RealtyTrac, the nation's leading online marketplace for foreclosure properties, today released its Q3 2006 U.S. Foreclosure Market Report showing that 318,355 properties entered some stage of foreclosure nationwide during the third quarter of 2006, a 17% increase from the previous quarter and a 43% yearly increase from the third quarter of 2005."

In response to one of my blogs, a person posting under the name "KIA" reported:

"There are also a lot of nonjudicial foreclosure states, like Virginia, where foreclosures occur without any 'official' court filing. Personal observation: Foreclosures are roaring through. The current record holder from my office is an April 2006, loan for about $500,000 that is currently in foreclosure. The wave is past the first edge and is swelling higher and higher now."

Even as foreclosures skyrocket, corporate lemmings are doing everything they can to keep the machine greased and the wheels spinning. I guess the theory must be that as long as the wheels keep spinning faster and faster, they will not fly off the axle. That theory is about to be tested.

The Role of Government

Some responses to my blogs were blaming the "gold standard" for the Great Depression, while others were arguing that the expansion of credit by GSEs proves we need more government regulation, not less. One person concluded a very long rant with, "What is pretty clear now is that Mish is asking what will make things worse and what everybody will be asking pretty soon, pro cycle policies, stuff that will amplify the crisis."

Those arguing for more government controls are, in effect, arguing in favor of Russian-style communist government central planning that is now thoroughly discredited everywhere.

The free market is the answer, not more ridiculous central planning. Government setting interest rates is a problem, not a solution. The Fed even admitted it. See "Confessions by the Fed." Government-mandated programs of all kinds at every level are a huge problem, not a solution. Growth in government employment is a problem, not a solution. The invasion of Iraq wasted a half trillion dollars, and that is a problem, not a solution.

The role of government should be limited to areas of safety, environmental standards, routine police work, and genuine national defense concerns, as opposed to attempting to be the world's policeman. The government has no business setting prices for orange juice or mortgages. Nor should government be in the business of promoting housing. Some 300 government programs designed to make housing affordable did exactly the opposite.

We do not have a free market here, not with 300 government programs promoting housing. The free market did not cause this housing bubble; stupid government policies did. There should not be a Fannie Mae or a Freddie Mac for lending institutions to dump mortgages on. There should not be a HUD guaranteeing below-cost mortgages. There should not be programs as there are in Illinois guaranteeing low-cost loans to illegal aliens. Illinois Gov. Rod Blagojevich simply had to be out of his mind when he passed an Opportunity I-Loan program guaranteeing low-cost government-sponsored mortgage loans for illegal aliens.

Those blaming the "free market" for problems should really be blaming "central planning." It is ironic to find people arguing for MORE communist central planning, because the current communist central planning (CCCP) is not working.

What we really need is a free market, because the markets we have now are anything BUT free markets.

The Gold Standard

As far as the gold standard being the cause of the Great Depression, people simply do not know what they are talking about. Those who think like Bernanke does (the Fed did not cut rates fast enough or soon enough) do not know what they are talking about, either. For starters, we did not really have a "gold standard," but rather, much of the world had a "gold exchange standard," which is something far different. Secondly, we had massive government manipulations of all kinds throughout that period, and that manipulation did nothing but make matters worse. It continues through to today with policies designed to blow ever bigger and bigger bubbles.

To dispute the myth that the gold standard is at the root of the problem, let me refer everyone to Murray N. Rothbard, the leading authority on the "A History of Money and Banking in the United States."

It is a very long read, but those wishing to understand the gold exchange standard, as well as the results of government intervention of all sorts throughout U.S. history, would be advised to read the document. Following are some highlights from the above link, for the period between the mid-'20s and the start of the Great Depression:

"The Gold-Exchange Standard in the Interwar Years...

"After generating the burst of inflation in 1927 [by lowering the Fed discount rate], the New York Fed continued, over the next two years, to do its best: buying heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold into the U.S. The New York Fed also bought large amounts of sterling bills in 1927 and 1929. It frankly described its policy as follows: We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe, but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe's power to buy our exports.

"The stock market had already been booming by the time of the fatal injection of credit expansion in the latter half of 1927... Dow Jones industrials had doubled from 95.1 in November 1922 to 195.4 in November 1927. But now, the massive Fed credit expansion in late 1927 ignited the stock market fire. In particular, throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the 'call rate,' that is, the interest rate on bank call loans to the stock market, artificially low. Before the establishment of the Federal Reserve System, the call rate frequently had risen far above 100%, when a stock market boom became severe; yet in the historic and virtually runaway stock market boom of 1928-29, the call rate never went above 10%. The call rates were controlled at these low levels by the New York Fed, in close collaboration with, and at the advice of, the Money Committee of the New York Stock Exchange...

"Credit expansion always concentrates its booms in titles to capital, in particular stocks and real estate, and in the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. These included excessive mortgage loans and construction from farms to Manhattan office buildings.

"The Federal Reserve authorities, now concerned about the stock market boom, tried feebly to tighten the money supply during 1928, but they failed badly. The Fed's sales of government securities were offset by two factors: (a) the banks shifting their depositors from demand deposits to 'time' deposits, which required a much lower rate of reserves, and which were really savings deposits redeemable de facto on demand, rather than genuine time loans, and (b) more important, the fruit of the disastrous Fed policy of virtually creating a market in bankers' acceptances, a market which had existed in Europe, but not in the United States...

"A few days before leaving office, in March 1929, Coolidge called American prosperity 'absolutely sound' and assured everyone that stocks were 'cheap at current prices.'

"DEPRESSION AND THE END OF THE GOLD-STERLING-EXCHANGE STANDARD: 1929-1931

"The depression, or what nowadays would be called the "recession," that struck the world economy in 1929 could have been met in the same way the U.S., Britain, and other countries had faced the previous severe contraction of 1920-21, and the way in which all countries met recessions under the classical gold standard. In short: They could have recognized the folly of the preceding inflationary boom and accepted the recession mechanism needed to return to an efficient free-market economy.

"In other words, they could have accepted the liquidation of unsound investments and the liquidation of egregiously unsound banks, and have accepted the contractionary deflation of money, credit, and prices. If they had done so, they would, as in the previous cases, have encountered a recession-adjustment period that would have been sharp, severe, but mercifully short. Recessions unhampered by government almost invariably work themselves into recovery within a year or 18 months. But the United States, Britain, and the rest of the world had been permanently seduced by the siren song of cheap money. If inflationary bank credit expansion had gotten the world into this mess, then more, more of the same would be the only way out. Pursuit of this inflationist, 'proto-Keynesian' folly, along with other massive government interventions to prevent price deflation, managed to convert what would have been a short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment that only ended with World War II."

Key Points

Throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the "call rate" -- that is, the interest rate on bank call loans to the stock market -- artificially low
In the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country
We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe, but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe's power to buy our exports
The United States, Britain, and the rest of the world had been permanently seduced by the siren song of cheap money
A few days before leaving office, in March 1929, Coolidge called American prosperity "absolutely sound" and assured everyone that stocks were "cheap at current prices"
"Proto-Keynesian" folly, along with other massive government interventions to prevent price deflation, managed to convert what would have been a short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment that only ended with World War II.

Does any of that sound familiar? It should. It parallels nearly exactly what is happening today. In fact, it is downright eerie. This is not a rerun of That 70's Show, but rather a rerun of the roaring '20s.

Roaring '20s Comparison

Florida is once again ground zero on housing bubble bursting
The Fed admits it kept interest rates too low too long. See Confessions by the Fed
Credit derivatives are soaring
According to the International Swaps and Derivatives Association's (ISDA) Mid-Year 2006 Market Survey, the notional value of credit derivatives outstanding grew 52% during the first six months of 2006, to $26 trillion. (See "Economic Conditions and Emerging Risks in Banking")
FDIC-insured institutions also reported a 13% increase in credit derivatives holdings to $6.5 trillion during the first half of 2006. (See "Economic Conditions and Emerging Risks in Banking")
Margin rules were relaxed
U.S. credit quality is in a 25-year retreat toward junk
The U.S., Great Britain, Japan, and China continue to be seduced by cheap money
Japan, China, and other countries have interventionist monetary policies designed solely to help their exports and keep the U.S. consumer borrowing binge going
Greenspan and the Fed simply refused to let the dot-com bubble play out. Instead, we saw "Keynesian folly" that did nothing but create an even bigger bubble in housing, putting off the inevitable one last time
The administration is telling everyone how great things are even as we slide into recession.

Thomas Jefferson on Banks:

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."

--Letter to the Secretary of the Treasury Albert Gallatin (1802)

Keynesian folly by the Fed and this administration in cooperation with foreign central banks everywhere have put the global economy on the brink of disaster. There is no way out. All that remains to be seen is the tipping point that sends this global train on a "23 Skidoo" over the cliff.

Regards,
Mike Shedlock ~ "Mish"

Michael Shedlock (Mish) worked in the financial services industry for 20 years at some of the top institutions in the country including Harris Bank, the Bank of Montreal, Bank One, First National Bank of Chicago, and First Data Corp. Mish is currently doing economic and investment research for a number of clients. In addition, Mish runs one of the more popular stock boards on the Motley Fool, Investment Analysis Clubs / Mishedlo and one of the more popular boards on Silicon Investor as well, Mish's Global Economic Trend Analysis. You can see more of Mish's writing on his blog also entitled Mish's Global Economic Trend Analysis. While he is not writing about stocks or the economy Mish spends a great deal of time on photography, one of his other passions. Mish has over 80 magazine and book cover credits, for magazines such as Country Magazine, Wisconsin Trails, the Chicago Tribune Sunday Supplement, Browntrout Calendars, and numerous other publications. Some of his Wisconsin and gardening images can be seen at www.michaelshedlock.com.

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