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Daily Forex Fundamentals | Written by Saxo Bank | Jun 30 11 15:21 GMT
The Great Recession in the U.S. lasted 18 months and has appropriately been called the worst recession since the 1930s and talks of a double recession are still present. If a new recession is what it takes to clean the system, would it really be that bad?
I just finished reading the book, The First Tycoon - The Epic Life of Cornelius Vanderbilt written by T.J. Stiles, and I must say it is a really well- written and -researched book about one of America's most impressive entrepreneurs, who basically created the modern corporation though John D. Rockefeller attributed with this achievement. I recommend the book for every investor who wants to read a fascinating story about one of the most competitive person who has ever lived. It is also an interesting reading on a period where America saw the most rapid growth in her 235-year history.
In one of the last chapters Stiles describes how the Panic of 1873 almost ruined Vanderbilt and how he eventually ended up saving the whole country by utilising his enormous wealth to prop up asset values and restore confidence in the financial system. The chapter made me think about our present times and how the Panic of 1873 may help us see today's issues in different light. We are told that today's economy is highly leveraged and every policy must be implemented to stop the system from deleveraging as it would plunge the world into a new recession destroying millions of jobs and wealth. Well, the Panic of 1873 offers some perspective on this view.
Below I quote a passage from the chapter on the Panic of 1873:
The Panic of 1873 started one of the longest depressions in American history - sixty-five straight months of economic contraction. In the next year, half of America's iron mills would close; by 1876 more than half of the railroads would go bankrupt. Unemployment, hunger, and homelessness blighted the nation. “In the winter of 1873-74, cities from Boston to Chicago witnessed massive demonstrations demanding that authorities ease the economic crisis,” Eric Foner writes.
First we note that the recession lasted for 56 months, more than three times the length of the last recession in the U.S. In the text you could probably substitute iron mills and railroads with banks and real estate companies as those were “iron mills” and “railroads” of this crisis due to over-investment (speculation) fuelled by cheap credit. Does history repeat itself?
Another quote from the same chapter:
The irony is that the fall was far more severe because of the rapid rise of the previous decade. The expanding, increasingly efficient railroad network had created a truly national market. The fates of farmers, workers, merchants, and industrialists across the landscape were tied together as never before. New York had cast its financial net across the country, which meant that credit flowed to remote regions far more easily than before - but also that financial panics affected the entire nation. As Vanderbilt pointed out, railroad overbuilding was an underlying economic problem, and it was exacerbated by Wall Street's craze for railway securities. When the bubble burst, the consequences were felt across the country with devastating suddenness and severity.
The above quote is very interesting as one could substitute railroad network with computers and national market with international market as the computerisation of the world (especially in financial markets) has created a truly globalised and interconnected world economy synchronising booms and busts at a larger scale than ever before. Instead of only the U.S., New York casted its financial net over the globe which meant that credit flowed to every part of the global economy connected to the financial system. Vanderbilt pointed out that railroad overbuilding was the underlying economic problem and was exacerbated by Wall Street's craze for railway securities. Try substituting that with real estate; sounds familiar? Once again over-investment in the economy combined with high leverage on Wall Street fuelled a speculative bubble, which was bound to burst sooner or later. There is no difference between 1873 and 2008 in terms of the underlying cause of the problem - cheap credit leading to over-investment. The only difference is the role of the government.
Back in 1873 the central government of the U.S. was much weaker than today, though its powers had increased significantly following the American Civil War. Also there was no central bank propping up the financial system. This created a deep recession as credit contracted on a massive scale busting the overbuilding of physical assets such as railroads. The recession was severe plunging millions into joblessness, but the cleanout of excesses paved the way for what would be the golden era of the U.S. with rapid growth until the country saw a new panic in 1907.
If today's economy enters a new recession it will undoubtedly be painful for millions of people, but if we allow a deleveraging of the system it would eventually provide a better long-term foundation for higher future growth. So far nothing has been done and we run the risk of a decade with low economic growth with governments and central banks continually propping up the system in order to prolong status quo.
The purpose of this essay is to provide some perspective on the current crisis by looking at history. A new recession in the coming years is highly possible and rather than combat it with 'extend and pretend'-style solutions, we should allow the system to cleanse itself of excessive debt and hence pave the way for future growth.
Saxobank
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