Second Great Depression? Looking for effects at super-correlated industries...

Economics Economics Questions
1

I don’ know if extreme Fed/ECB/etc interventions will ultimately prop up these ailing markets and economies and postpone the inevitable catastrophe. I’m really thinking that as this spins out of control and the Fed really steps in as a lendor of last resort, confidence in it, the US economy and the US dollar will continue to dwindle, even with G7 efforts to prop up the greenback. With China’s inflation already creeping up, I don’t exepct them to escape this unscathed either.

Questions about the soundness of the whole Financial System will ultimately be raised, especially after it is painfully proven that Bernanke’s arsenal to combatting catastrophe (inflation) is really the cause of the catastrophe itself. Once and for all, the answer to what caused the First Great Depression will given unequivacally by the actions of those who failed to avert and ultimately brought about the Second.

Will we see these developments as a result of the current crisis? I don’t know. As much as it is painful though, I think it will be the only way to give proper capitalism a chance; a chance that may well never arive though as knee-jerk reactions point to the other end of the market-government spectrum.

I won’t go into the risk of a protectionist, socialist, authoritative backlash, but I think it is very real. And with it, just as we saw with the 20s, 30s and WWII, the risk of major wars rises proportionately.

I was interested to hear your opinions about what the coming years will mean for super-correlated industries. Correlated with both overall economic activity, but mostly correlated with the state of the world’s high-income population (luxury industry, bizjet manufacturers, yacht manufacturers).

During the boom years of 2003-2007 business aviation grew by leaps and bounds as so much wealth was created. BA manufacturers continue to enjoy strong sales as emerging markets start showing demand for the benefits of corporate aircraft. Backlogs are tremendous, with many orders now coming from commercial operators and air-taxi companies. Similarly, luxury companies like LVMH, parent of Luis Vuitton have enjoyed spectacular growth as more and more people clamour for luxury goods. The yachting industry has been rejuvenated by the ever-increasing demand for yachts and super-yahts, and as of yet, there appears to be no sign of stopping all these high-end focused industries.

But will this segment ride out the coming storm? Or will it be precisely the mass-affluent that suffer the greatest decline during the coming contraction/recession/depression?

2

It is a simplistic analysis, but methinks the ones who will lose the most are those with the most to lose. Even worse, when people are hungry, ostentatious wealth is the approximation of wearing a glowing neon “loot me” sign. Of course, most of those who have the most deserve to lose it. There is hardly a rich man today who did not make his money via unjust means (government/corporate partnerships, exploitation of foreign labor which is semi-voluntary at best, regulation-backed monopolization, hereditary wealth, etc.).

3

The scenario is meant to be simplistic. The more detail you try to predict, the more wrong you’re likely to be. Although there are many examples of profit opportunities created by dislocations caused by govt involvement, I think your argument, especially through the use of the word, “unjust”, strikes me as a little bitter and somewhat socialist.

4

Whilst I disagree on inheritance, all the instances of wealth-acquisition he mentioned are, in fact, unjust.

5

I was actually referring to my response as simplistic. If I sound bitter, why oughtn’t I be? I will face soon $5 gas and $10 bread because oligarchies of private/government partnerships have, in anti-market fashion, conspired to preserve the status quo. Existing companies have been propped up at the expense of rising competition. On the other hand, I can hardly claim innocence myself. I work in an industry where I am paid through second-hand thievery (we’re gov’mint contractors, see). But I do it to survive. One of the reasons I have to do it to survive is that immense, unwieldy corporations propped up by government welfare and competition-strangling regulation, dominate almost every market available.

An example: homeowners, particularly those facing foreclosure. Each and every one deserves to lose their homes. Their buying into the easy credit system is part of what caused home prices to skyrocket. By saving any of them, the government keeps housing prices artificially inflated, and further out of the reach of those of us who are hesitant to go irresponsibly into debt. On the other hand, the banks, which largely earn money by lending out money they don’t have in a fraudulent scheme to reduce us all to debt-slavery, have done everything possible to encourage this. Offering easy credit increases the amount people can pay for houses. House prices then go up, forcing larger loans to buy in. The cycle develops to the point that, like today, people are borrowing far too much to afford to pay back with even the slightest interest rate increase. With the first foreclosures, sales must be made on the cheap, forcing down prices overall. This reduces the value of… you can see the story elsewhere.

I am not a socialist. However, I do believe that basically all wealth extant has been gained, directly or indirectly via corruption and injustice. I’m not sure what to do about that, but this terrible collapse, which will cause so much suffering, could be, at last, a chance, if everyone has lost almost everything, to start over, moving forward with a truly libertarian, free-market, just society and economic system. I will admit, and if it is bitterness than so be it, that part of me will be laughing as it all burns.

6

That sounds almost like Marxism… however given your caveat that you’re not a socialist I’ll presume either it just came out the wrong way or you’re genuinely confused about how wealth gets created. Our current societies are a blend of socialist ideals and free markets precisely because the socialists require the fundamental strengths of the free market (semi natural prices at least) in order to produce anything worth looting at all. As such I think it’s somewhat disingenious to state that all wealth extant has been gained via corruption.

If people like the guys at Google are rich then you have to admit that at least a fraction of their wealth is as a result of their entrepreneurial excellence, even if you’re inclined to believe that large chunks of their nominal wealth come from investments sources that are largely beneficiaries of a monetary system based on inflationary confiscation. Just about everything of value that Google offers (quite regardless of the arbitrary monetary figure that gets assigned to this as a result of disfunctional credit markets) was created by free market forces… if it wasn’t created by free market forces then it was created by accident - but I don’t think wealth often gets created by accident and neither do socialists, which again is why they need prices and at least semi free markets - without these tools of the Free Market they’d be hopelessly lost and they’d have nothing to confiscate.

The following quote from Economics for Real People seems particularly relevant here:

Lew Rockwell told a wonderful story about Gorbachev’s press secretary. When asked about his dream for mankind, the secretary replied that he hoped to see all of the world embrace socialism, except for New Zealand. “But why not New Zealand?” a reporter wondered. “Well,” the secretary responded, “we will need someone to get the prices from.”

7

I will acknowledge that in many industries, particularly early comers to the relatively new internet services industry, innovation and drive were just and considerable contributors to their success. Nonetheless, once, as has happened to some degree in that industry, industries are well-established, the major players tend to stay the major players, and, given that such things as government-defined corporate personhood and other government/business partnerships have been established, it becomes quite likely that their continued wealth and prominence are at the expense of more worthy products that simply cannot reach the market through the entrenched interests. Only in the earliest stages of an industry does the free market work in this country (discounting the VERY early effects and props of incorporation). Once major players have been established, laws, regulations, and government/business partnerships immediately start shutting down true new competition. I’m sure you could cite some counterexample, but by and large that is how the modern corporatist business environment works.

8

Jimmy, you are aware that the Austrians have a class theory of their own and, on a moral level, would consider much of what government and many corporations do as unjust, right? Just because Marxists have monopolized speaking in such terms over the past century or so, does not mean they are the only ones to see injustice in the current system.

9

I haven’t read about the austrian class theories yet no (and I’d be interested to do so as soon as I’ve finished reading the 20 or so books outstanding in my reading list on Austrian economic theory).

However, I should make it clear that I’m not saying the current system is just. What I’m saying is that the wealth (anything of value in our system) has arisen as a result of free market forces. Once it’s been created, yeah sure then people start threatening one another and confiscating/redistributing it and it doesn’t always end up in the hands of people that might “deserve” it according to one moral framework or another. My argument wasn’t that the second part of all this in our current system is fair or unfair. My argument was that there are ways to get rich, in our current system without stealing… indeed if there weren’t such ways to get rich then there would be very little in the way of riches at all. My argument is that not all wealth is held by people who stole it - which is a fairly moderate position I think.

10

Well, my argument is not that all wealth is stolen. That is too strongly stated. Rather, it is that almost no wealth is pure, that is, gained and maintained through purely free market, non-compulsory means. To the degree that the wealth is impure, it is unjust, and one has no just claim to that which was gained through injustice.

11

While I welcome any discussion on whether or not current wealth is “pure”, the subject question has received little to no attention.

So what do you guys think? Will high net-worth individuals weather the current storm? Will industries dependent on them suffer, or continue apace?

12

It really depends on public policy more than it depends on economics I think. If central banks like the Fed and the BoE start doing stupid things like printing cash willy nilly and we end up with hyperinflation then you could hardly expect anyone (aircraft manufacturers included) to escape unscathed.

The aircraft industry itself is a pretty particular beast. I can think of few industries which are so tightly regulated and subject to such a great extent to the whims of government (both the rules about who can fly where and compete with who and the interests involved in the contracts to purchase aircraft are, like no other industry, completely twisted and contorted by government regulation and expenditure). Looking purely at demand, however, these is a massive amount of new demand coming online in Asia at the moment. A good friend of mine is a pilot down in Hong Kong, flying primarily to destinations in China, and he paints a fairly rosey medium to long term picture for the aviation industry in Asia.

I think it’s hard for those of us who live in the west to fathom the impact of countries like China. This is a country which is building one power station per week! It’s also a country that is obsessed with reputation - companies like Rolex do just great there since brands are accorded a very high importance by those Chinese that can afford them (which is more and more these days). So as long as China weather’s the storm, I’d be inclined to guess that the luxury goods sector will be fine. But what are the chances that China would not be impacted by something as serious as hyperinflation in the US, if this eventually came to pass?

13

Jimmy, your analysis touches on two important points.

First though, do you think the greater risk right now is that of hyperinflation? What I always keep in mind is that things get really bad in one direction, the government will always cheat its way out of it. So the deflationary pressures cause the Fed to print like crazy and go for negative real rates, but at the same time, they’re already talking about international concerted action to prop up the dollar. It has worked in the past so it might just as well work now. What I’m concerned about is a meltdown in financials that can’t be stopped by Fed bailouts, rapidly sinking consumer confidence, possible bank runs and a general mess in the real economy.

Supposedly much of all this depends on who is elected President too - but just when I’m about to run for cover at the first sound of “Obamanomics”, the guy announces Volcker is his chief econ advisor.

What I can’t ascertain is how much of the recent wealth boom was based on globalization, (new markets, lower costs, capital mobility etc) and how much on monetary stimulation and piggybacking on low tax rates, low interest rates, and ample credit.

I’d love to believe that BRICK economies, most of which will most likely keep on growing, are what is producing this unprecedented wealth boom.

Are they though?

I’d love to hear your thoughts on that.

14

Deflation, or inflation? I think even Mises might have difficulty answering that… Here’s a good article looking at the possible deflationary pressures:
http://mises.org/daily/2926

Certainly all indications at present are that the Fed WANTS to inflate it’s way out of the mess. However, the old analogy about the central bank pushing on a piece of string seems particularly relevant here - despite their best efforts to increase monetary supply by dropping interest rates over the past 6 months, monetary supply has actually been contracting becuase the banks are no longer solvent even according to the Fed’s fairly loose regulations that require they have 10% of what they pretended they did on hand… indeed many of the banks might actually have negative reserves at present (so no matter how low you push the interest rates for those guys, you’re not going to solve the problem).

My personal bet (and I am a very long way from an expert in this field - you’d do much better to listen to the professors that contribute articles to this site) is for inflation - at the very least in as much as concerns consumer goods. Clearly inflation won’t be present in all sectors of the economy (quite the reverse if you look at housing, for example). However for basic goods like your bread and eggs, I see inflation.

One reason I’m betting on inflation is because of the foreign exchange situation - which isn’t taken into account in Reisman’s article. The Fed lowering interest rates (which Bernake seems hell bent on doing) and bad news piled upon bad news for the US economy in general, will significantly erode the incentive for foreigners to hold onto US dollars. None of the central banks around the world seems to be talking any time soon about reinforcing their holdings of US dollars and a great number of them are talking about “diversifying” their holdings. As they do so, they push the US dollar down further and send those US dollars that have had such long holidays abroad back home, where they contribute to domestic inflation both by way of increasing the quantity of US dollars in the United States and by pushing the price of the US dollar down (and thus the cost of imports up - and the US is a net importer).

Another reason I see inflation is because the real reserves of many consumer products are reaching an end. Global supplies of any number of consumer goods are at all time lows and crisis have already hit various countries (Egypt, Indonesia and China are all suffering food and fuel shortages) due to these countries subsidising or price caping various goods and underinvestment supply side. You can keep the prices of things such as grain low temporarily by creating “false grain certificates”, however eventually if you do that consumption will outstrip production and when reserves hit zero the game is up - someone comes in with their certificate for 100 tonnes of grain and you don’t have any… then everyone else with grain certificates (who had no intention of cashing them in) says “hey what the heck, you’re supposed to have my 100 tonnes as well?”

To an extent, this same argument can be applied to all savings (not just savings of grain). If you create “false certificates of deposit” (i.e. fractional reserve banking) then the market is going to rather misjudge the amount of real savings that are available for investment and, whilst you can do that for a while, eventually your real savings run out and then the game’s up. At that time, real savings (and today that basically means real useful stuff, like commodities) all of a sudden start to become worth a whole lot more.

So in summary, even if the US does see monetary contraction, they’re still going to have to bid for the products they use on a global market and we’ve seen an unprecedented global boom recently (driven largely by inflation, both inside and outside the US). Globally, I think the prices of commodities are set to rise because there’s no easy way to bring extra production online promptly. This, in conjunction with a weaker dollar, would contribute to domestic inflation in the price of consumer products in the US because the US is a net importer.

Whether these inflationary factors could/will be offset by monetary contraction in the banking system remains to be seen. If it is then you can bet your right arm it’s accompanied by a lot of people feeling a lot of pain in the US - which means a lot of pressure on politicians to “do something” about it (even if sitting on their hands would actually be the very best thing they could do, aside from closing the central bank). And if there’s on thing politicians are good at it’s responding to pressure groups (particularly when those pressure groups are made up of the majority of the population in an election year).

It will be interesting to see what the ECB does as well. Their mandate is to control inflation but they also have a lot of pressure on them to yeild to the weakening US dollar (to “save” groups like EADS who were stupid enough to sign contracts in USD without long term hedges on their currency risk). I read something in The Economist recently suggesting that the ECB typically steers around 0.25% away from what logic would suggest they do (given their mandate to control inflation) for every 1.25% shift in the US… so when the US is dropping interest rates the ECB tends to as well, even if they know very well they have inflationary pressures. Certainly it will be difficult for the ECB to cut interest rates much with the Germans standing firmly against the idea and the French people, more than ever, complaining about their “pouvoir d’achat” (which translates to their ‘buying power’). Luckily for French politicians, most French people (aside from the odd economics professor at Aix en Province or Paris) are blissfully unaware of any relationship between the interest rates that the ECB sets and price inflation - so the ECB might get away with interest rate cuts even still (especially if things get worse in Spain, Greece and Italy).

If the ECB does drop interest rates however, I’d be inclined to believe that this would simply postpone the problem since fundamentally that wouldn’t change anything. The Fed would still be a sinking ship, it would just be one with the ECB attached to it’s hull. Then not only would the US be plowing through global savings reserves of consumer goods, but the ECB would be joining them… One day or another though, there’s not going to be any more grain left in the grain elevator - and when that day comes, it’s going to be a good day to have real savings (gold, silver, copper, bread, milk and eggs).

But all of that is really just my best guess as to what will happen - and my best guess probably isn’t as good as that of many many professional economists or accademics (I am but a humble computer programmer by trade).

PS: This one is a bit random - and he’s taken very selected pieces of data (completely ignores Mortgage Equity Withdrawls, for example, which have helped to prop up consumption through and since the 2001 recession) but makes for interesting reading none the less:
http://www.itulip.com/forums/showpost.php?p=30006&postcount=1

Jimmy

15

By the way, I think you’d probably want to read up on Austrian Business Cycle Theory there… Characters like Mises and Hayek devoted a great deal of their lives to these questions so would certainly have some answers for you.