Previous Economic Downturns Provide Guidance

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By KATY DELAY

In his article “The Big Empty” in the Oct. 20 issue of the Business Journal, reporter Daniel Miller quoted Lew Horne of CB Richard Ellis Group as saying:

“We are in an unprecedented time right now, when you see the instability in the financial markets. It is something like nobody has seen before. There is really no pattern or trend line to look at in terms of historical trend lines or other bear markets.”

This statement is incorrect. Although every recession is unique in the details, this one and the major ones the country has experienced since the 1800s have a fundamental underlying similarity: the boom that preceded them.

Let’s compare what is happening today to what happened during the Great Depression. In the 1920s, Florida, like California today, underwent a damaging real estate boom-and-bust cycle. Florida’s experience was so violent that one contemporary economist in 1928 called it “the Florida gamble.”

“When Florida land first started its upward course there were good substantial reasons for advancing prices … (but) advancing prices drew those individuals who were speculatively inclined as molasses draws flies. … Large building projects gave an appearance of substance and worth to the whole affair. … Then the bubble broke, as they always have and always will. In the wake of the boom followed disaster, defunct banks, and depression.”

In 1925 through 1928 as the Florida gamble unwound, the concomitant U.S. stock market boom was showing foreboding signs of euphoria. The article continues:

“The (stock market) boom has not collapsed, and, from all appearances, is stronger than it has been for some time. That seeming invulnerability and capacity for unlimited progress is a market feature of all such speculative periods as they near an end. It is to be hoped that the Florida bubble will not be completely paralleled (in the stock market). Banks all over the country have entered on a new experiment in the past few years, the practice of loaning large amounts against securities (italics added).”

Does this sound familiar? Here’s more:

“A collapse in the stock market would make thousands of banks unwilling investors, very much as the Florida banks found themselves in the real estate business after 1925. Such an experience, with the inevitable blood-letting at the hands of receivers for the least fortunate, would be a blow to our progress that would force upon the country many months of painful convalescence.” (Quote from an unpublished paper, “Stock Speculation Versus Florida Memories,” E.C. Harwood, 1928)

As we now know, the Florida real estate bust of 1925 was followed by the stock market crash months after Harwood wrote this prescient article.

Analysis of the underlying trends and ultimate outcome of this and other cyclic episodes between 1800 and 2008 allows us to hypothesize the existence of a common cause of boom-bust cycles; yet economists as a class are known for their disagreement on the subject, with two notable exceptions.


Predicted before

One is the Austrian school of economists, scholars like Ludwig Von Mises and Friedrich Hayek, to whom our attention seems to turn cyclically after every recession but of whom we tend to lose sight as soon as we get another taste of easy credit. They have predicted economic difficulties due to mishandling of credit for at least a century.

A more scientific thinker, this time from among the empirical economists, is the author of the article noted above. Through extensive study of banking statistics, Harwood concluded that markets in general, and international markets in particular, work best when unhampered; but that they can only function well when the trading medium is staid. Like the Austrians, he concluded that fluctuating fiat currencies and/or poor banking standards are a catalyst for excessive credit creation, resulting in speculative boom-bust cycles.

Using his analysis, he predicted the 1929 crash as evidenced in his articles published in the Annalist of 1928, and early and mid-1929. He also predicted the devaluation and flight from the dollar of the 1970s.

Furthermore, he said that the world would continue to suffer damaging speculative peaks and crashes until voters realize that it is our incompetent monetary policymakers who create them. Legislators must acquire enough humility to admit that human agents cannot micromanage the quantity of money a failing even Milton Friedman feared and that government’s only role should be to support the natural money-creation process through the establishment and maintenance of sound banking principles and of some form of currency measuring stick.

Both Harwood and the Austrians believe that, to date, the only such device that has succeeded for any length of time is the gold standard in one form or another. The duty of our economic wizards is to find the version of it that fits today’s parameters.


Katy Delay is a freelance writer who lives in Marina del Rey.

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