I'm an engineer and physicist, not an economist, but in my casual studies of economics I've learned that there are many parallels. Most important among them: exponential growth is not sustainable. CNN reported with some jubilation on Friday that the Dow Jones Industrial Average has risen for 23 of the past 26 weeks, nearly matching the 24/27 record from 80 years ago. This should have given the CNN writers pause: what shortly followed this record rise 80 years ago? Ah yes, the Great Depression.
True, the economy is not quite that transparent. There are endless variables present today that were not even on the horizon in the 1920s, but there are quite a few disturbing parallels. Consider the following excerpt from http://en.wikipedia.org/wiki/Great_Depression>Wikipedia:
In the 1920s, in the U.S. the widespread use of purchases of businesses and factories on credit and the use of home mortgages and credit purchases of automobiles, furniture and even some stocks boosted spending but created consumer and commercial debt. People and businesses who were deeply in debt when a price deflation occurred or demand for their product decreased were often in serious trouble—even if they kept their jobs, they risked default. Many drastically cut current spending to keep up time payments, thus lowering demand for new products. Businesses began to fail as construction work and factory orders plunged.
For a bit of eerie comparison, take a look at this article from March:
The government reported earlier this month the U.S. savings rate is the lowest in 74 years. Worse, in 2006 the savings rate was negative. This means instead of adding to our savings we are dipping into our nest eggs or running up credit-card debt to buy stuff we can't afford.
The differences between now and the Depression era, however, are marked. For instance, as opposed to the Great Depression, we are experiencing a real estate crash in advance of a stock market crash. (This may not be true -- it's possible that the dot com crash of 2000 was prevented from reaching full “collapse” status by the actions of the Federal Reserve, which pumped up the real estate market by drastically lowering interest rates and pursuing other actions. An alternative look is that the dot com crash never finished when accounting for true inflation.) Another difference is that the dollar is now the world’s reserve currency -- and it’s falling, leading to inflation for the U.S. Of course, the most significant difference is the presence of energy in our economy and society -- and it is this fact that throws any prediction for the future way off track.
The Great Depression was marked by rapid and sustained deflation of money. Prices on all things -- from food to houses to cars to whiskey -- collapsed, decimating the economy. Higher energy costs due to Peak Oil and Gas, or even geo-political threats, threaten to power massive inflation. The winner between the competing forces of economic stagnation and energy inflation is shrouded in shadows. The outcome will largely depend on the exact timing of the various factors involved; that is, the completion of the real estate collapse, currency collapse, stock market collapse, global war, global warming, Peak Oil, and the multitudes of other variables.
If we truly have a strong temporal correlation with the events of the late 1920’s, then based on today’s Dow news we have roughly 2 years before we see the stock market crash. Of course, economists (and certainly not me) can’t hope to predict with certainty how the economy will play out in the near future. One thing is certain, however -- we will face an economic crash at some point in the not-too-distant future and it is prudent for each of us to analyze what actions we need to take.
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