More Thoughts on The Depression

by JDH on August 8, 2009

Back on June 27 I made reference to The Great Crash of 1929 by John Kenneth Galbraith. It’s an easy, quick and informative read as he walks the reader through the events leading up to and including the Crash of 1929, and the aftermath.

He describes how, in early November, 1929, a few days after the first crash, margin calls forced investors to sell whatever they could. In most cases, rather than dumping their bad stocks, which had little value, they were forced to sell good stocks. Investors were heavily invested in investment trusts, the forerunner to what today we call mutual funds.

The great investment trust boom had ended in a unique manifestation of Gresham’s Law in which the bad stocks were driving out the good.

Sound familiar? Sounds like what happened in 2008 when our quality gold and mining and uranium stocks got hammered along with everything else. They got hammered because they were quality stocks, and that’s all investors had to sell to raise cash. Being a quality stock was a disadvantage.

Galbraith also dispels some misconceptions about the Great Depression. We have all heard the stories about brokers and investors jumping from tall buildings, but his review of the suicide statistics during that time period reveal that that was not the case. While suicides did not increase, embezzlement did.

In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months or years may elapse between the commission of the crime and its discovery.

(There is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth). At any given time there is an inventory of undiscovered embezzlement in–or more precisely not in–the country’s businesses and banks. This inventory–it should perhaps be called the bezzle– amounts at any one time to millions of dollars.

It also varies in size with the business cycle. In good times people are relaxed, trusting and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly.

In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The above paragraph was contained in a book first written in 1955, and refers to the events of 1929, and yet it could have been written today.

Think about Bernard Madoff. He was an embezzler for many years, stealing his clients money, but until he got caught all of his clients were happy; they thought they were making money.

The Crash happened on October 28, 1929.

In January, February and March of 1930 the stock market showed a substantial recovery. Then in April the recovery lost momentum, and in June there was another large drop. Thereafter, with few exceptions the market dropped week by week, month by month, and year by year through June 1932. The position when in finally halted made the worst level during the crash seem memorable by contrast. On November 13, 1929, it may be recalled, the Times industrials closed at 224. On July 8, 1932, they were at 58. This value was not much more than the net by which they dropped on the single day of October 28, 1929.

The point? Depressions don’t end quickly, and the initial crash is not usually the bottom; that comes along later.

I still believe that with the unemployment rate at 10% in major cities like Toronto, there is no way we are having a recovery. It’s just not possible. Yes, the S&P closed over the 1,000 level, so this bear market rally may have a way to run yet. For now, I’m a skeptic, and I will remain so until we talk again next week.