Is it too early or far fetched to ponder over this question?
It certainly does not hurt to give it a thought.
For most of us living in the 21st Century, The Great Depression of the 1930's
symbolises a Dark Period of Economic Suffering in the American History.
We all like to think of it as past history and something we never have to worry
about again.
Is denial really the best way to avoid another possible/probable Depression?
Wikipedia.org has an easy to read and understand article on The Great Depression
(Dec 20, 2005 Version), and the theories behind it's cause.
I strongly urge readers to follow the above link and read that article before
proceeding further on this page.
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"One possible theory is that the Depression was caused because there was a gap between
production and consumption in the US. After World War I, the United States was producing at
a very high rate and ambitious Americans were spending and purchasing things they hadn’t
been able to afford prior to World War I.
It finally came to a point where people slowed down purchasing but factories were still
producing at high rates. This created a gap, a gap that led to the stop of production, to
lay-offs and dismissals of thousands of employees. People were left without jobs and no
purchasing power, so companies were left without production and fear of producing more
products that would not be bought."
The Gap Between Production and Consumption. In the 1920's the US was producing a lot
more than it was consuming. This time around, the US is consuming a lot more than it is
producing.
How can an Economy consume more than it produces?
It has been made possible by the US Housing Bubble, which has been expanding for
nearly four decades. Thanks to the liquidity pumping machines of the Housing Market,
otherwise known as Fannie Mae and Freddie Mac.
An idea on the size of this Bubble can best be demonstrated by a graph of the
US Housing Valuation vs GDP Growth.
The US Consumers have been feeling wealthy, fictitiously wealthy, as the Price of their
Homes just keep rising, several times over inflation.
The US Consumer consumes, borrowing against this fictitious over valuation of his home.
This keeps not just the Domestic US economy going, but also the ones which produce and
export their products to the US.
The ever increasing US Trade Deficit means wealth keeps flowing out of the US.
For the last several years, a good portion of this outflowing money has been coming back
into the US. As Foreign Governments funnel back this money into the US economy by investing
in Fannie and Freddie. And these GSE's in turn loan this money back to the US consumer to
buy houses, driving up Home Prices and further inflating this Gigantic Housing Bubble.
It will finally come down to a point when Americans will just not buy any more homes.
Because, they neither need nor want more homes. The Speculators who are the primary driving
force behind this historic runup of home prices, put their houses for sale. Supply of homes
increases, but there are not that many buyers, prices start falling.
The Housing Market collapses, pretty much like Nasdaq in 2001.
Those directly or indirectly employed in this sector, lose their jobs.
US Consumers can no longer borrow against the value of their homes. And now they cannot
keep spending like before. A drop in Consumer Spending snowballs on to other sectors of
the Domestic Economy.
Demand of goods and services from every sector of the Economy goes down. Massive layoffs
and unemployment further erode the purchasing power of the Consumer. Creating a negative
feedback loop for the Housing Market.
A Recession turns into Depression.
Not to speak of the Economies who depend on exporting to the US.
The US Consumer will feel a lot poorer, say if even one half of this fictious wealth were
to just disappear in a couple of years.
"The Wall Street crash of 1929 is widely considered to be the foremost event which
marked the start of the world-wide financial crisis."
This time, could this read something like, "The US Housing Market Crash of 2006 marked the
start of the Biggest Financial Crisis of The Twenty First Century".
"Family farms that had been mortgaged during the Twenties to provide money to
“get through until better times” risked foreclosure when their owners failed to make
payments."
Could this be repeated, this time around with houses?
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"Easy credit fuelled the consumer driven economy of the 1920s, and following the
depression, credit availability began to tighten, both for business and consumers."
The 1920's was not much different than the last several years.
"Foreclosures on the American home – often seen as the safest investment that one
could make – rose throughout the period, and affected people in all income brackets."
Rising Interest Rates, and the resulting increase in mortgage payments will leave a
lot of home owners unable to make their monthly payments.
End Result - foreclosures will rise dramatically.
The declining home values may lead many other home owners to simply abandon their homes
and loose them to foreclosure, rather than keep throwing their money into a black hole.
"Another was that there had been no federal oversight of the stock market or other
investment markets, and with the collapse many stock and investment schemes were found to
be either insolvent or outright frauds."
Mortgage fraud has been increasing. Stories of realtors themselves telling buyers how to
falsify financial information to trick the system and qualify for gigantic loans, are also
on the rise.
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"Unfortunately, many banks had invested in these schemes. By the end of 1930, there
had been over 1300 bank failures; in 1931 nearly 2300 more banks failed. 1932 saw the
collapse of the banking system."
When the home loans go bad, the banks cannot get their money back from insolvent home
owners. Could this be repeated all over again?
"The Great Depression was caused by catastrophically poor monetary policy
pursued by the United States Federal Reserve during the years leading up to the
Great Depression."
Again sounds like the recent past years.
"The policy of contracting the money supply was an attempt to restrain inflation,
which exacerbated the actual problem in the economy, which was deflation."
That is what the Fed has signalled, it will be doing.
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