Ghost Of 1929 Re-Appears – Pay Attention To The Signals

By | December 8, 2013

They say those who forget the lessons of history are doomed to repeat them.

As a student of market history, I’ve seen that maxim made true time and again. The cycle swings fear back to greed. The overcautious become the overzealous. And at the top, the story is always the same: Too much credit, too much speculation, the suspension of disbelief, and the spread of the idea that this time is different.

It doesn’t matter whether it was the expansion of railroads heading into the crash of 1893 or the excitement over the consolidation of the steel industry in 1901 or the mixing of speculation and banking heading into 1907. Or whether it involves an epic expansion of mortgage credit, IPO activity, or central-bank stimulus. What can’t continue forever ultimately won’t.

The weaknesses of the human heart and mind means the swings will always exist. Our rudimentary understanding of the forces of economics, which in turn, reflect ultimately reflect the fallacies of people making investing, purchasing, and saving decisions, means policymakers will never defeat the vagaries of the business cycle.

So no, this time isn’t different. The specifics may have changed, but the themes remain the same.

In fact, the stock market is right now tracing out a pattern eerily similar to the lead up to the infamous 1929 market crash. The pattern, illustrated by Tom McClellan of the McClellan Market Report, and brought to his attention by well-known chart diviner Tom Demark, is shown below.

 

Excuse me for throwing some cold water on the fever dream Wall Street has descended into over the last few months, an apparent climax that has bullish sentiment at record highs, margin debt at record highs, bears capitulating left and right, and a market that is increasingly dependent on brokerage credit, Federal Reserve stimulus, and a fantasy that corporate profitability will never again come under pressure.

On a pure price-analogue basis, it’s time to start worrying.

Fundamentally, it’s time to start worrying too. With GDP growth petering out (Macroeconomic Advisors is projecting fourth-quarter growth of just 1.2%), Americans abandoning the labor force at a frightening pace, businesses still withholding capital spending, and personal-consumption expenditures growing at levels associated with recent recessions, we’ve past the point of diminishing marginal returns to the Fed’s cheap-money morphine.

All we’re doing now is pushing on the proverbial string. Trillions in unused bank reserves are piling up. The housing market has stalled after the “taper tantrum” earlier this year caused mortgage rates to shoot from 3.4% to 4.6% between May and August. The Treasury market is getting distorted as the Fed effectively monetizes a growing share of the national debt. Emerging-market economies are increasingly vulnerable to a currency crisis once the taper finally starts.

The Fed knows it. But they’re trapped between these risks and giving the market — the one bright spot in the post-2009 recovery — serious liquidity withdrawals.

But the specifics of the run up to the 1929 crash provide true bone-chilling context for what’s happening now.

The Bernanke-led Fed’s enthusiasm for avoiding the mistakes that worsened the Great Depression—- a mistimed tightening of monetary conditions — has led him to repeat the mistakes that caused it in the first place: Namely, continuing to lower interest rates via Treasury bond purchases well into an economic expansion and bull market justified by low-to-no inflation.

(Side note here: As economist Murray Rothbard of the Austrian School wrote in America’s Great Depression, prices dropped then, as now, because of gains in productivity and efficiency.)

Here’s the kicker: The Fed (mainly the New York Fed under Benjamin Strong) was knee deep in quantitative easing in the late 1920s, expanding the money supply and lowering interest rates via direct bond purchases. Wall Street then, as now, was euphoric.

It ended badly.

Fed policymakers felt like heroes as they violated that central tenant of central banking as outlined in 1873 by Economist editor Walter Bagehot in his famous Lombard Street: That they should lend freely to solvent banks, at a punitive interest rate in exchange for good quality collateral. Central-bank stimulus should only be a stopgap measure used to stem panics, a lender of last resort; not act as a vehicle of economic deliverance via the printing press.

It’s being violated again now as the mistakes of history are repeated once more. Bernanke will be around to see the results of his mistakes and his misguided justification that quantitative easing is working because stock prices are higher, ignoring evidence that the “wealth effect” isn’t working.

Strong died in 1928, missing the hangover his obsession with low interest rates and credit expansion caused after bragging, in 1927, that his policies would give “a little coup de whisky to the stock market.”

5 thoughts on “Ghost Of 1929 Re-Appears – Pay Attention To The Signals

  1. Harinder

    But Somali lets just take the puzzle one by one. Who does this tapering go to? Is it for all the banks as a whole or only the ones who bargained for it?
    The biggest banks like citibank and goldman sachs got the lions amount in this tapering and they were the ones who started sub prime in the first place and they also hedged their position in the market knowing very well that the loan scenario would collapse one day or the other.
    Now these very banks are buying commodities , gold , stocks etc. further fueling a bubble.
    Why would someone pay billions of dollars in fine and still be complacent in its working as a responsible bank?
    The problem with tapering is that the few hands who control the market would sell bringing the market down and cause panic like situation, then the weaker hands would sell, after that those very institutions would buy again because its only taper and its not like the end of the bond buying program.
    But amongst all this taper news, does anyone know who buys these 85 billion bonds? who does this money go to? what is the interest the FED pays or gets for these bonds?
    The basel norms were formed exactly for this , that the banks should be stronger than before and some central bank reports were given to all the central banks for what is coming?
    Because if it wasnt so then why would our banks stop giving loans to car buyers who didnt have 6 lakh in income tax returns (SBI).
    Everybody knows its coming , nothing is going to change just useless panic and that is the time to buy by selling your kitchen sink.
    Thats what Warren Buffet would do and also Rakesh Junjunwala.

  2. Somali Chakrabar

    Though investors having got used to excess liquidity do not like the idea of quantitative easing coming to an end but economic recovery does present the case for reducing the quantitative easing. Excess liquidity due to quantitative easing finding its way into the capital markets can create potential asset bubbles. Moreover due to low interest rates more people start putting their money into riskier assets. Once the QE taper begins, the markets may begin to perform more in line with economic fundamentals. However it seems that QE once started is very difficult to withdraw as markets react sharply and the policy makers have a tough time getting buy in from different quarters and arriving at consensus in a manner that creates the least disruption in the markets and economy.

  3. Harinder

    You are right sir, this is going to end badly. Just because of cheap money moving around the globe, inflation reached a peak this may – july and has stabilised since because of the rhetoric of taper. It will come or the US dollar is going to face a crisis sooner or later. The only thing that they can do right now is to scale down little by little.
    But the question arises how much is enough? They already are buying 85billion / month since so many years. What is the size of the hole? Why didn’t they let the banks collapse then? It would have been easier now.

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