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The Fall of the Greatest Monetary 'Tower of Babel'

"Pop, everybody's getting rich but you. You know, you work so hard and you're never going to make a nickel. All you do is you keep delivering these newspapers and that's about it. The guy, who's shining shoes, is in the stock market, the grocery clerk is in the stock market, the school teacher is in the stock market, the teller at the bank is in the stock market. Everybody's in the stock market! You're the only one that's not in the stock market."

My father, a newspaper delivery boy used to sit and laugh and say,

"You'll see! You'll see! You'll see!" (i)

What a time to be alive, it was the Roaring Twenties, a time of peace and great prosperity. As President Hoover wrote in his memoirs about the American dream – "With increasing optimism, they gave birth to an idea called the 'New Economic Era'. This notion spread all over the country. We were assured that we were in a new era where old laws of economics no longer applied" – this time it was different.

Reuben Cain was a new stock salesman in 1929, who did not understand why the stock market kept going up, but stock reporters like Charlie Mitchell and the J.P. Morgan people said that it could only get better, even the founder of General Motors kept saying "Confidence! Not halfway confidence, but 100% confidence. This is the real basis of our prosperity!"
Reuben thought to himself "Well, they really are like God. They know it all and it must be the way it's going because they say so". (i)

Insider trading took on a whole new look in the late 1920s as "painting the tape" became a national sport. Groups of wealthy investors and insiders would acquire shares in a company and would then pay off reporters with blood money to write something exciting about the company. Unsuspecting investors, who knew nothing about the companies in which they were investing, were buying and pushing the price ever higher, while the savvy traders were getting out.

Shares soared to record highs and the prices no longer had anything to do with company profits or the economy - it was a spectacular speculative boom. Mass illusion and total euphoria had gripped the nation. It was the nature of the beast. It was the Roaring Twenties.

Irvin Bush, president of the Bush Terminal Company, said in November of 1928 "We are at the beginning of a period that will go down in history as the golden age".

The 1920s will also be remembered as a period of new technologies such as the automobile, the radio and the increasing use of air travel. The United States was the fastest growing economy and manufacturing leader of the world. There was a powerful economic boom and money was easy to come by, so, the American people heavily mortgaged their homes and invested all their savings into the stock market. Banks invested their customers' deposits into the stock market - everyone was in the market - spin the wheel of fortune!!

Most economists encouraged the people to invest in the market, as it was very safe. Many ordinary citizens and others not so ordinary increased their risk exposure by purchasing shares on margin. Stock brokers were routinely lending their investors up to 2/3 of the cost of the shares. Some were geared up as much as $9 debt to $1 cash. Debt rose to over $8.5 billion, greater than the money in circulation. Fortunes were being made, which fuelled the market with more investment and higher share prices.

In September 1929, Irvin Fisher, one of America's greatest economists said "Stocks are now at what looks like a permanently high plateau. In a few months I expect to see the stock market much higher than today".
From 1921 to 1925 the housing market had also taken off like a rocket. Some properties increased by up to 500% in less than one year. By mid 1925 prices were, however, beginning to decline. The property bubble was ready to burst.

Around the globe the "new world economic order" was taking shape, as the same market exuberance and prosperity occurred simultaneously in the biggest economic boom in history. International debt was at levels never seen before.

From 1921 to 1929 the Dow Jones index rocketed from 60 to a peak of 452.

Oh, if only they had listened to George Washington, back in 1789 - "No generation has a right to contract debts greater than can be paid off during the course of its own existence".

Thursday October 24 1929 - Black Thursday - The Genie is let out of the bottle - The Dow looses 9%

Monday October 28 1929 - Black Monday - The Dow loses 13%

Tuesday October 29 1929 – Black Tuesday - The Dow loses 17%. In only one week the stock exchange had lost $30 billion – ten times more than the government budget and more than the United States had spent fighting World War 1.

Millionaire margin investors became bankrupt overnight. Bankrupt speculators' and even aristocracy, committed suicide by jumping out of buildings.

Wednesday October 30 1929 - R.W. Mc Neel, a market analyst with the New York Herald Tribune says - "This is the time to buy stocks. This is the time to recall the words of the late J.P. Morgan - that any man that is bearish on America will go broke!"

By the end of November 1929 the stock market had fallen by 70%. The market continued to fall to a low of 45 by June of 1932, a 90% drop. By 1942 the U.S. stock market prices were still 75% below the 1929 peak.

To make matters worse, 9 000 banks went bankrupt, as they had invested their clients' money on the stock exchange. Many bank customers that had not invested in the stock market but left their money safely in the bank, so they thought, also lost over $140 billion due to a run on the banks and uninsured bank failures. The money was gone, it had been lent out or was sitting in the stock market. It seemed like the entire country was bankrupt.

"You'll see! You'll see! You'll see!"
How could this have happened? Did nobody see the crash coming? Where were the economists and advisers? Were they all blind?

Benjamin Anderson, Senior economist for Chase National Bank accurately summed up the problem after the crash when he said -

"Basically, our present troubles grow out of the excessively cheap money and unlimited bank credit available for capital uses and speculation from early 1922 until 1928. There is no intoxicant more dangerous than cheap money and excessive credit".

The Harvard Economic society, as well as other leading economic forecasting institutions, never saw the collapse coming or the Great Depression that swept across America and the rest of the world from 1929 through to the second World War. The Harvard Economic society told subscribers in November of 1929 that "a severe depression such as 1920 – 1921 is outside the range of probability. We are not facing a protracted liquidation". It continued to issue optimistic forecasts and in August of 1930 it said "the present depression has about spent its force", in 1932 it was liquidated.

John Maynard Keynes, the father of macroeconomics lost £1 million in the crash. He was reportedly warned about a possible crash but said "There will be no more crashes in our lifetime".

Irvin Fisher, the great American economist, who had said that Wall Street will not experience anything in the nature of a crash, lost $140 million on the stock market.

In June of 1930, U.S. President Herbert Hoover declared "The depression is over".

There were, however, two notable exceptions that went against the grain of crystal ball predictions and the fortune tellers' road to riches, Ludwig von Mises and Friedrich von Hayek.

Friedrich von Hayek, Nobel Laureate in 1974, predicted in February of 1929 that a crisis and a downturn were imminent, "The boom will collapse within a few months". Ludwig von Mises, also an Austrian economist, turned down a high position with the largest bank in Europe – Kredit Anstalt, in the Summer of 1929, "A great crash is coming and I do not want my name in any way connected with it".

The Great Depression October
1929 - 1940

"A quart of wheat for a day's wages and three quarts of barley for a day's wages, and do not damage the oil and the wine." (ii)

The great depression was a worldwide time of economic contraction. It started in America and spread throughout the world with devastating effects to the industrialised countries. International trade declined sharply, construction was virtually halted, farming suffered as crop prices fell by 40% to 60%. During this decade a large number of people lived in poverty, many workers lost their jobs and were forced to live in shanty towns. Former millionaire businessmen were reduced to selling apples and pencils on street corners.

A major cause of global instability was the debt that many European countries had accumulated to pay for their involvement in World War 1. Britain suffered enormously, as her trading position in world markets was eroded, especially in textiles, steel and coal mining.

South Africa also fared badly. Demand for agricultural and mineral exports fell drastically. Wool prices fell by 75% between 1925 and 1933. The gold price however, rose rapidly and the export of gold increased substantially. France was hit during 1931 as the great depression hit the local economy which initiated the riots of 1933.

Germany was probably the worst hit, as the loans that it was receiving from America to help rebuild the country after World War 1 were stopped. Unemployment soared as the political system veered towards extremism and Hitler's Nazi Party came to power in 1933. Dictators such as Hitler, Stalin and Mussolini made huge political gains, which helped set the stage for World War II.

Newspaper headlines in America during the depression -

"Chicago teachers feed 11 000 hungry children"
"Kentucky coal miners found living on dandelions"
"New York cops to carry list of charities to direct the helpless"
 "110 children in New York city die from malnutrition"

Mary Owlsey recalls life in Oklahoma City –

"I knew of one family there in Oklahoma City, a man and woman and seven children lived in a hole in the ground. You'd be surprised how nice it was, how nice they kept it. They had chairs and tables and beds back in that hole. And they had the dirt all braced upon there, just like a cave…".

Pauline Kael, a student at the University of California -

"When I attended Berkeley in 1936, so many of the kids had actually lost their fathers. They had wandered off in disgrace because they couldn't support their families. Other fathers had killed themselves so the family could have the insurance. Families had totally broken down. Each father took it as his personal failure. Those middle class men apparently had no social sense of what was going on, so they killed themselves."

Ben Isaacs was a salesman in Chicago -

"…I sold my little car for $15 in order to buy some food for the family. I had three little children...
…Finally, people started to talk me into going into the relief…. I didn't want to go on relief. Believe me, when I was forced to go to the office of the relief, the tears were running out of my eyes. I couldn't bear myself to take money from anybody for nothing. If it wasn't for those kids… I tell you the truth… many a time it came to my mind to go commit suicide than to ask for relief. But somebody had to take care of those kids."

What caused the Great Depression?

In 1913 the Federal Reserve Act was passed in America establishing the creation of a Reserve Bank system. The system was intended to stabilise economic trade between an individual or a company, a commercial bank and the Reserve Bank via the use of trade bills, which should at all times be backed by gold. The act made it illegal for the Reserve Bank to create money out of nothing and thereby counterfeiting the currency.

The Act was nevertheless violated by the Reserve Bank as it printed at will and debased the national currency so as to finance the government's voracious appetite to spend beyond what it raises in direct tax.

This excessive money floods the market, which leads to financial bubbles. Eventually the paper money is refused by individuals and companies as a means of payment for products and services and we get a monetary collapse.

Government is the source of all inflation, which can be defined as "an increase in the quantity of money and credit relative to available goods resulting in a substantial and continuing rise in the general price level, an increase in the quantity of money caused by government".

This inflation, once created, becomes the speculators elixir as they invest it wherever the greatest profits are to be made. At first, it does not find itself onto the commodity market (consumer price index) where it would immediately be recognised and measured, but instead it inflicts its mischief into the property market and stock market causing speculative bubbles.

Prior to the establishment of the Federal Reserve Bank there had been a one hundred year period of stable prices. However, from 1914 to 1920, the economy, under the Federal Reserve guidance saw wholesale prices increase by 240%, the currency in circulation increased by 243%, checking deposits went up by 196% and time deposits by 240%. The Reserve Bank also started to replace gold certificates, which were 100% backed by gold, with paper notes that were only 40% backed by gold. Debasement was at hand. From 1920 to 1929 the money supply increased by a further 62%.

Back in the 1920s, the British pound was the dominant world currency. Britain was the world superpower, it was militarily overextended, was running foreign trade and budget deficits (twin deficits – very much like America today), and its empire was on the decline. Its economy was propped up by an America that was using counterfeit – printed money as an investment to enable Britain to purchase goods from America.

The British pound was at the time overvalued and was used by many smaller nations as a reserve currency - note: Today the American dollar is similarly used as a global reserve currency. At the same time, Britain was losing gold to America, as due to political pressures the Bank of England refused to allow interest rates to rise.

America, on the other hand, was a rising industrial giant exporting its manufactured goods and new technologies to the world; and running trade surpluses. America also subsidised foreign loans to help American exports, maintain high employment and increase exports. In other words, world trade was not based on reciprocal exchange of production but on America subsidising its trade partners so that they could buy American goods with American money.

Events that lead to the 1929 collapse and the Great Depression that followed -

From 1922 to 1928 the Fed chairman, Benjamin Strong, in contravention of the 1913 Federal Reserve Act, counterfeited the American currency by issuing huge amounts of federal dollars, created out of nothing, which was lent to the American government via the issue of treasury bonds. This had the effect of increasing the money supply, i.e. inflation, which in turn allowed the commercial banks to enter into credit expansion via corporate and private loans.

Like the liquor prohibition at the time, there was nothing tastier than forbidden fruit, and so the Federal Reserve continued to pump paper into the economy. The excess liquidity first resulted in the bond price collapse. This was followed by the housing market collapse and finally the stock exchange collapse. The problem with monetary excesses is that they will flow towards the nearest dark hole, and are hidden for a very long time before they are noticed in the increase in consumer inflation, by which time the damage has already been done.

The increase in American money supply also had the effect of lowering interest rates, which assisted Britain, as it had the effect of making its interest rates comparatively higher, thus encouraging money to flow into Britain and stop the loss of gold. But alas, market inbalances had been created, trade was on the decline and the speculators would have the last say on the stock market - a spectacular crash in America followed by the rest of the world - the wheel of fortune had come off its hinges.

The American Federal Reserve did start in early 1929 to put a stop to the excessive liquidity that it had created by increasing interest rates - but it was too late, the damage was terminal. After the crash of 1929, capital started to evaporate from the economy, which precipitated an economic contraction. Banks and brokerage firms collapsed, business confidence was shattered, unemployment started to increase, and spending was replaced with increased savings and hoarding of gold.

As a result, the demand for goods decreased, which led to businesses producing less and laying off workers. A healthy but very painful deflation was driving the economy, as prices dropped and business activity contracted. This cyclical recessionary bust period lasted four years from 1929 to 1933, by which time the economy was beginning to show signs of recovery.

The wise words of Thomas Jefferson will forever haunt the American people: "If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that grow up around them will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered".

The monumental blunder:

On the 8th November 1932, Franklin D. Roosevelt is elected president of the United States. The government wanted people to spend so as to stimulate the economy, but the depression was driving prices down, and so the people were saving as purchasing power increased. The government wanted inflation and as such, wanted to devalue the dollar. But America was on the gold standard, and a devaluation of the dollar would simply cause people to switch their paper holdings to gold coins, which they did.

So on that fateful day in March 1933, just as the economy was showing signs of recovery, president Roosevelt issued a proclamation confiscating all gold coins and gold certificates under the threat of heavy fines and imprisonment - "All safe deposit boxes in banks all financial institutions have been sealed and may only be opened in the presence of an agent I.R.S."
Thus he defrauded the citizens and enriched the government in the name of patriotism. Monetary inflation was reinstated as interest rates were lowered, money supply increased and massive government spending was initiated, but the contraction could not be saved.

The great depression was at hand and it lasted another seven years, as government coercion took the wealth of some to give it to others – contrary to their own constitution. Roosevelt and his economic Keynsian advisers enforced cartel price fixing, thus reducing industrial and agriculture production believing that lower production would lead to an increase in prices and the resultant inflation would increase consumption. Lower production, however, resulted in more unemployment. In fact, under the Roosevelt administration, unemployment was still excessively high in 1940.

It was only the advent of World War 2 that decreased unemployment.
Roosevelt was also responsible for tripling taxes, the introduction of anti-business regulations, which popularised and empowered unions, and thus made labour more expensive leading to greater unemployment. Strike activity was at an all time high in 1936 and 1937, and all that the government achieved was to transform America into a welfare state.

The world today – Is a global economic crash possible?

Warren Buffet once said: "It's only when the tide goes out that you learn who's been swimming naked".
Is it possible that the global tide of financial imbalances today will at some point fall like dominoes and expose governments and ordinary citizens that are financially overexposed to indeed be naked?

In this corner we have America - the undisputed world superpower

The American dollar is the global monetary standard against which all financial transactions are measured. America is also militarily overextended, finds itself on an economic decline and is funding its internal economy and external foreign trade shopping feast through foreign debt and monetary debasement as it works its printing presses around the clock. In short, the big bully is stealing from the nerds.

America's housing market has seen unprecedented growth, which has been funded through ever-increasing housing debt. The ominous signs of a bubble are beginning to show as sub-prime loans (loans made to financially stressed buyers) are starting to fail and liquidate. The dollar is hugely over-valued as foreign governments, particularly China and Japan, export their money to America to finance and stimulate American shopping for Chinese and Japanese toys, thus keeping their trade partners fully employed.

American federal debt stands at $9 trillion (it was $16 billion in 1929), and it is no longer self-sufficient in energy, and imports over 60% of its needs. It has a monstrous trade deficit and needs to borrow over $2.5 billion a day from foreign sources to balance its books. The good ship Titanic is showing signs of strain.

In the other corner, across the ocean, far, far away we have China – The undisputed consumer manufacturing champion of the world

China today is a lot like America of the 1920s. Its trade surplus is the stuff that legends are made of, and economists hail her as the 8th wonder of the world.

China has a credit boom far greater than America had just prior to the collapse of the stock exchange, built on the same principles of inflationary money creation by the central bank, which is growing at an annual rate of about 10% (probably much higher). Its money supply in 2001 was 12 trillion yuan and, by 2004, it had grown to 23 trillion yuan.

The Chinese property market has experienced a growth that is incomprehensible to western minds, as it moves millions of people into new cities. The stock exchange is on a run to the moon at a pace that makes the American stock exchange of 1929 look like a dwarf. Credit is on the increase and everyone and his dog is in the stock market.

Just like the America of the 1920s, China exports its trade surplus to America and other parts of the world to finance the purchase of Chinese goods and to feed the dragon of consumption. In other words, there is no reciprocal trade, and China is in effect buying from itself in the belief that it is supporting the export market and keeping employment levels high. It cannot see the possibility of financial failure from America.

The Chinese Reserve Bank further pegs its currency to the American dollar, thus artificially undervaluing its currency as it floats against the dollar. In short, the manner in which China conducts its economic affairs is a mirror image of what America was doing in the 1920s. A collapse of the American dollar will lead to a default on the repayment of its mammoth debt to China, a collapse of the Chinese economy and a global depression far worse than that of the 1930s.

A collapse of the Shanghai stock exchange will cause a financial tsunami that will lead to the collapse of stock exchanges around the world.

We further need to consider the fact that China, as a global power, carries a tremendous amount of political baggage. It has not forgotten the 19th century loss in the opium wars to foreigners, or the occupation of Hong Kong by the British until 1997. Then there was the Tian Men Square humiliation of 1989, when Chinese youth paraded a replica of the Statue of Liberty for the whole world to see. China has also formed a political alliance with Russia and Iran over future supplies of oil, which could precipitate a world war in the Middle East - surely the guns are loaded and ready.

Other global financial problems

As if trade wars and currency devaluations by all exporting countries were not enough, we also have a global crude oil supply problem, peak oil and global warming.

Now add a derivative market problem that did not exist in the 1920s. According to the Bank of International Settlement data there are $370 trillion derivatives sitting on a wall just waiting for somebody to give them a push. Today, every time a derivative trade goes bad, the losses run into billions of dollars. A recent mal-investment on a derivatives bet in South Africa cost the trader R200 million. A derivative collapse is on the cards and nobody knows the exact damage it will cause.

Japan is just one step away from the "Funny farm" as it peddles its currency across the globe at ½% interest - the yen carry trade. It has flooded financial world markets with unprecedented quantities of effectively counterfeit money that is invested in stock exchanges around the world in the form of hot money, which is giving rise to stock valuations that are unsustainable and will ultimately collapse.

Virtually every country, including South Africa, has climbed onto the bandwagon of money creation that leads to excessive liquidity, growing credit, bad investments and high levels of inflation that could one day soon lead to hyper-inflation across the globe.

Global economies today appear to be strong, in fact stronger than at any time in history. Central banks are supremely confident that they can avert any global monetary crisis – this time it really, really is different - financial systems are far more sophisticated. However, historically we have seen that, just as the praises are sung and the tower of Babel is almost complete, tragedy strikes.

Benjamin Franklin once said - "Experience runs an expensive school, but fools will learn in no other".

Ben Bernanke, chairman of the American Federal Reserve Bank, and his predecessor Alan Greenspan have often calmed the markets on any talk of a global market collapse.

In fact Mr Bernanke, please tell us in your own words why we do not have to fear any form of financial collapse:
"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of dollars in circulation, or even credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is the equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." (iii)

I see, so in other words, you can always stimulate consumers to purchase goods and thus keep the wheels of industry and trade in motion by simply giving (i.e. lending) the consumer money. And there we have it, folks, a tidy solution from a truly gifted economist.
"You'll see! You'll see! You'll see!"

Epilogue:

Our financial world today is based on counterfeit money brought about by corrupt governments so as to deceive, rob and enslave its citizens. The biblical standards of honest scales have long left our planet.

"The Lord detests differing weights, and dishonest scales do not please him." (iv)
How close are we today to a catastrophic global financial collapse as predicted in the bible where in one hour stock markets will be wiped out and trade brought to a standstill?

They will throw dust on their heads, and with
weeping and mourning cry out:
"Woe! Woe, O great city,
Where all who had ships on the sea
became rich through her wealth!
In one hour she has been brought to ruin!" (v)

Frisco Vigario BCom, CA(SA) is a former professor of Managerial Accounting and Finance from the University of Natal – Durban, and is the founder of Vigario Seminars..

References:

(i) PBS American Experience Documentary - "The Crash of 1929"
(ii) Revelation 6:6
(iii) Ben Bernanke Deflation: Making sure it Doesn't happen here
(iv) Proverbs 20:23

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