How to Create a Depression

I watch the automobile giants lurch towards bankruptcy, slowed -- but only slowed -- by government hand-outs. I see the economy continuing its slide into depression. And I can't help asking this question:

If my wife and I had had enough of the bull market in 2003 and sense to get out accordingly, how come the seven-figure prognosticators in New York and Toronto didn't know?

I'm not trying to toot my own horn in times of such pain for so many people. I simply ask why the signs we saw weren't seen by those who make markets go? (While I'm not tooting my own horn, I'm bound to tell you that when people say how lucky we were, I emphatically reply that luck had nothing to do with it.)

When we started to get scared, we knew no more than anyone else, indeed much less than the "experts." We'd had the savings and loan scandal, bailed out by the U.S. Congress and the Enron stench.

We could see that the U.S. was $750 billion in its trade deficit, mostly to China, which held most of the outstanding U.S. dollars.

We knew that unlike Japan in former times, China wasn't a benign creditor and it would use its leverage to best advantage.

Danger signs abounded

To us, the U.S. economy looked like a big glass ball with a jillion little cracks in it. You knew that a relatively slight blow would smash it.

We knew that the U.S. was running about a three quarters of a billion dollar annual deficit and was nearly eight trillion dollars in debt. That's as if Canada's national debt was 800 billion dollars, which, sad to say, it is. The U.S debt is now more than 10 and a half trillion dollars and climbing.

The U.S. debt and deficit had, since Reagan's time, for the most part financed a false prosperity.

This was no secret. Anyone who looked could see that far from reducing the debt and deficit, the American economy was adding to it with ever more cheaper and cheaper money being loaned out while the politicians and the man in charge of money, Alan Greenspan, acted as if everything was peachy.

The housing market was red hot and you had to know that it was riding for a fall. I would look at all those real estate ads and ask: How many people are there around with credit ratings of a million dollars or even several million dollars?

We were to learn that there were not nearly as many as the market thought there were, with foreseeable consequences.

Greed feeds on optimism

What happened?

It probably started when "junk bonds" passed muster in the money-raising business. Then we had derivatives and hedge funds and a host of other "investments" that weren't really investments at all but wagers. It was gambling with all the certainty and speed of a floating crap game.

In 2003, it was obvious that the war in Iraq was a hugely expensive and ongoing mistake. In short, in 2003 when Wendy and I made our move out of the market, all signs pointed to very bad economic news ahead.

The answer as to what happened has I think, two levels.

First off, the monetary system around the world is a nest of optimism. Every banker and financier must loan money or he's not in the game. When money is not "tight," that is, the prime lending rate is low, financiers have more money available. Because times seem to be so good, optimistic lenders find optimistic borrowers and the race is on to see who can loan the most money at the lowest rate. If the people and businesses see nothing but big profits ahead, the sky's the limit and it's not long before a sturdy economy becomes a house of cards.

The crash of 1929 ought to have taught us that if moneylenders on the stock exchange allow too much margin or leverage, which is to say they require "investors" to put up less and less money, sooner or later it all hits the fan.

Stockbrokers never tell any but the most sophisticated of their clients to "sell short." Selling short means selling what you don't have and buying the shares later when they have dropped in price. This transaction acts as a brake on the market. One has to wonder why a broker will advise you to bet on stocks going up even when the better bet is that they'll go down?

Secondly, because everything seemed to be so perfect, RRSP portfolios swelling, and the price of homes going up 30 per cent a year, what was there to worry about?

Why, nothing much happened to these good things when the U.S. government bailed out the savings and loans corporations, did it?

The Enron scandal didn't seem to hurt the economy much, did it?

Why worry? The "dotcom" collapse only really hit the high rollers, didn't it?

If the markets and the players all said that they could police themselves and that if the government poked its nose in it that would ruin everything, why not believe them?

What could go wrong with companies like Merrill Lynch and Lehman Bros. looking after things under the watchful eye of Alan Greenspan. He was a financial genius, wasn't he?

1929's unlearned lessons

Lastly, we were convinced and let ourselves be convinced that things were much different than in 1929. There were safeguards in place -- though no one seemed to know what these were.

In fact, 2008 isn't much different than 1929. Over optimism bred careless credit controls and in due course the bubble burst. The more things change, the more they stay the same.

It's all governed, of course, by Mair's Axiom I, which is, in case you've forgotten: "You make a very serious mistake thinking that people in charge know what the hell they're doing."

We will have a depression. We've felt the earthquake but the tsunami has yet to arrive. In the agony, we'll tighten our rules so it will never happen again.

And, as sure as God made little green apples, it will happen again. It always has and it always will.

Related Tyee stories:

• Big Idea for 2009: Biophysical Economics
  In the future, economists will return to earth.
• The Meltdown, Seen from Below
  What union leaders, labour experts and anti-poverty activists say needs to be done.
• Risk Written on Their Faces
  Harvard researchers: Blame stock market meltdown on too much testosterone.