A history lesson in Sandy’s wake

18:52, Nov 01 2012

Traders on the New York Stock Exchange were given an early Halloween present this week in the form of "Frankenstorm", the name locals gave super storm Sandy, which, lashing America's east coast, interrupted not just markets but schools, flights, commutes and the impending presidential election.

But beyond the terrible costs in both human and economic terms, Frankenstorm masked the 83rd anniversary of Black Tuesday, where on the same day in 1929, 16 million shares traded hands – a record that would hold for 40 years – as William Durant, the Rockefeller family and other Wall Street tycoons tried but failed to stem a share market crash that began the day before.

Following that Monday's 13 per cent fall, Black Tuesday saw stocks crash another 12 per cent. And while a short recovery would begin the next day, it was the beginning of the 1930s bear market rout, which would precede the Great Depression and plunge the world into political chaos.

Despite the almost superstitious fears with which some investors treat such anniversaries – we were only just past the anniversary of 1987's Black Monday on October 19 – there was little risk that Monday would have opened with the same ferocious drop had Frankenstorm not hit.

Yet as with the anniversaries of all momentous events, it is nonetheless worth some reflection. After all, most of the world is still in the midst of an economic downturn that has no precedent since the 1930s, and many of the causes of that era's crisis have an eerie correlation with the present.

Economic historians generally attribute the crash of 1929 to a mixture of debt, speculation, weak regulation and impending protectionism. Leading up to the crash, more than US$8.5 billion (NZ$10.2b) in loans – worth more than all US money in circulation – had been extended for buying stocks.

Around the time that economist Irving Fisher opined that stocks had reached “a permanently high plateau”, the average price-earnings ratio for S&P Composite companies had topped 32.6.

As the current US central bank chief Ben Bernanke has repeatedly observed, the Federal Reserve neither stepped in before or after the 1929 crisis, and in Washington, under the presidency of Herbert Hoover, Congress was debating whether to introduce record US tariffs on 20,000 imported goods.

It wouldn't be until June 1930 that the Smoot-Hawley Tariff Act would pass into law, but the seeds of destruction had already been sown. Despite a plea by the League of Nations in 1927 to end such tariffs, a movement led by farmers in the opposite direction brought a comfortable win the next year for Hoover in the White House and his Republican colleagues on Capitol Hill.

As Europe was recovering from the ruinous effects of war, reparations and hyperinflation, the interests of lobbies and their elected representatives were threatening to deal the world a body-blow. With debate on the tariffs raging back and forth in Congress, Wall Street was responding with wild swings on the Dow. The future of profitability had suddenly become unclear and with it the profitability of all those margin loans on issue.

Today is a very different world, of course, with the share market coming out of a crisis rather than a nine-year rally, but the nexus between markets and economics, Wall Street and Washington, is still the same. Had the NYSE been open on Monday and Tuesday it would have likely reported the same tepid range-trading that typically precedes a presidential election, but it could be forgiven for being much more bearish than that.

Republican contender Mitt Romney, after all, is threatening to label China a "currency manipulator" and with that institute a new set of tariffs in the name of protecting, like Hoover, American jobs. With a 50 per cent chance of being elected, there is therefore a 50 per cent chance of this happening, if we take the former Massachusetts governor at his word. Yet with China not only slowing, but being overtaken by Mexico in terms of competitiveness, a global trade and currency war based on counterfeit reasons is the last thing the world needs.

Further, Romney's threats to strip back government spending in lieu of tax hikes for the rich could kill whatever is left of weak jobs growth and consumer demand. Harsh austerity measures, favoured by many Republicans, is not only choking the European recovery, but threatening to kill it, just as they did in Weimar Germany under chancellor Heinrich Brüning.

In Spain, where youth unemployment exceeds 50 per cent and austerity could see public spending contract by 10 per cent of GDP over several years, the IMF's new fiscal multiplier infers that the economy could contract by up to 15 per cent over the same period as a result. Well beyond a recession, such policies look set to mire southern Europe in a veritable depression.

Indeed, there is an insidious philosophical undercurrent that links the two eras. As with Brüning and Hoover – who were both proponents of the "efficiency movement", known in Germany as rationalisation and America as Taylorism — technocrats in Europe and budget hawks in the United States alike have favoured efficiency over welfare, tightening over largesse and battening down the hatches over counter-cyclicality.

Obviously, a crisis of debt cannot be solved through more debt alone, yet a swing too far in the opposite direction could not only threaten political peace – as it did in 1930s Germany or present-day Greece – but end up being more economically harmful than the original situation.

In a cruel dose of irony, Sandy's Frankenstorm was exacerbated by abnormally warm Atlantic coast surface sea temperatures, the result of a changing climate wrought by industrialisation's over-expansion.

We have an unprecedented opportunity to remake capitalism into something more sustainable, and thereby create new jobs and businesses. But we have politicians who instead wish to punish workers for investors' mistakes while protecting vested interests against not just global competition but responsibility for a ruined environment.

Frankenstorm's revenge may have be brief, and the opening bell on Wall Street has already sounded again, but a non-gentle reminder has again been issued that the system we've created – built on excessive borrowing from the future and from nature alike – is facing its limits. Rather than seeking to make that system more efficient, or using more tools of discredited financialisation to produce ever-diminishing returns, we need to consider new solutions.

It took America several years to learn the lessons of 1929 and implement Roosevelt's New Deal. Four years after the crash of 2008, and on the eve of another presidential election, it's uncertain whether policymakers have learned the current lessons either.

Michael Feller is an Australian investment strategist at Macro Investor.


Sydney Morning Herald