Why It's So Much Better Than the Great Depression

Two years ago, a student at the University of Michigan asked Berkshire Hathaway (NYSE: BRK-B  ) Vice Chairman Charlie Munger to compare the 2008 financial crisis to the Great Depression. Munger, as usual, didn't mince words:

It's nowhere near as bad as it was in the '30s. This is hog heaven compared to the '30s. That was unbelievable. I lived in the 1930s. We didn't have this social safety net. You know what people did in the '30s? They moved into one another's houses. That's what families were for. It was just pain and trouble.

It's been obvious for a while that the past few years weren't as bad as the 1930s, but it struck home when the Treasury published this picture last week, comparing current job losses to the Great Depression and several other severe financial crises:

Source: U.S. Treasury.

The Treasury, as you might imagine, chalks up the comparative difference to the government's response -- namely the TARP bank bailout program, the 2009 stimulus package, and the Federal Reserve's unprecedented amounts of quantitative easing (money printing). All of those policies were either ignored, or not done as vigorously, during previous crises. At the late economist Milton Friedman's 2002 birthday party, Fed Chairman Ben Bernanke quipped: "I would like to say to Milton: Regarding the Great Depression. You're right, we [the Fed] did it. We're very sorry. But thanks to you, we won't do it again." As far as many are concerned, Bernanke and the Fed didn't do it again. And it shows in this chart.

Billionaire hedge fund manager Ray Dalio -- an underappreciated mind who has been right more than almost anyone else over the last five years -- has a more detailed explanation.

In Dalio's eyes, the financial crisis and its aftermath is all about deleveraging, or the process of getting rid of unsustainable amounts of debt built up during the bubble years. He explained it last year with a simple example. Imagine someone who makes $100,000 a year and has a net worth of $100,000 with no debt. That person can safely borrow about $10,000 a year for several years, meaning they can spend $110,000 a year even though they only make $100,000. The flip side to all that spending is that someone else is earning $110,000 a year. "For an economy as a whole," Dalio writes, "this increased spending leads to higher earnings, that supports stock valuations and other asset values, giving people higher incomes and more collateral to borrow more against, and so on." That describes our economy from 2000 to 2007.

But it can only last so long. Eventually, debt service payments take up too much of income, and everything breaks apart. "The person spending $110,000 per year and earning $100,000 per year has to cut his spending to $90,000 for as many years as he spent $110,000," to pay down the borrowing spree, says Dalio. That means some one else can now only earn $90,000. And it means the economy grinds to a halt, as it has since 2007.

Deleveraging explains why our economy is so slow. But it also explains why our jobs situation has fared so much better than other financial crises.

According to Dalio, America's recovery over the last three years "would win our award of the most beautiful deleveraging on record."

Since 2009, private debt in American has declined (mainly through default) faster than government debt has risen as a percentage of GDP. So the economy's total debt-to-GDP ratio has dropped -- that's the deleveraging. It's not an easy feat: America is one of the only developed nations in the world to actually achieve a deleveraging in recent years; Japan, the U.K., Germany, Canada, and others have all seen debt-to-GDP ratios rise over the last three years.

What's made our recent deleveraging beautiful? "Since everyone eventually gets through the deleveraging process, the only question is how much pain they endure in the process," Dalio recently wrote. "The differences between how deleveragings are resolved depend on the amounts and paces of 1) debt reduction, 2) austerity, 3) transferring wealth from the haves to the have-nots and 4) debt monetization [printing money] ... beautiful ones balance these well and ugly ones don't."

Deleveraging by its nature is deflationary -- it causes prices to fall -- which leads to falling incomes, which makes deleveraging even more painful, and so on. It turns into a vicious cycle. Dalio calls that an "ugly deflationary deleveraging." That's what happened in the Great Depression. In contrast, when too much money is printed, you get an "ugly inflationary deleveraging." That's what happened in Latin America in the 1980s, and Germany in the 1920s, when prices increased a trillion-fold in five years.

The trick to a beautiful deleveraging, Dalio explains, is for the central bank to print enough money to counteract deflation while not overdoing it and setting off runaway inflation. It's the Goldilocks "just-right" level. The economy as a whole is able to shed debt, but the Fed provides just enough support to keep nominal wages from falling and growth from declining, which lets you keep deleveraging at a sustainable rate. Striking that balance that has eluded policymakers in nearly every other financial crisis. Getting it right for the most part -- so far -- this time around helps explain the performance in the chart above.  

"The key going forward will be for policy makers to maintain balance so that the debt/income ratio keeps declining in an orderly way," Dalio wrote.

Understatement of the year. If there is one lesson from the history of deleveragings, it's that sometime, somewhere, policymakers will push things out of balance. With the economy still fragile, even a small mistake could cause things to get ugly, fast. Pain and trouble, as Munger might say.           

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (55) | Recommend This Article (74)

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  • Report this Comment On April 24, 2012, at 6:45 PM, CaptainWidget wrote:

    No disrespect to Mr. Dalio, but his statements sound more like a sculptor or a painter than a scientist. Beauty vs ugly economics? Makes it really easy to prove your case. Anything you agree with ideologically: beautiful (like wealth transferrance). Anything you don't (like de-funding the state): ugly. Who knew Science was so easy??

    Good luck finding that perfect balance. The federal government has an awesome track record of perfectly balancing compromises and finding the exact right solution for everyone *end sarcasm*

  • Report this Comment On April 24, 2012, at 6:57 PM, TMFMorgan wrote:

    Economics isn't a science -- that's been clear for a while. And Dalio's personal net worth is $10 billion. He's doing a little more than sculpting words.

  • Report this Comment On April 24, 2012, at 8:26 PM, maniladad wrote:

    I'm not sure who is deleveraging. I understand that individual savings is declining and individual credit card debt is increasing. US Federal Government debt is increasing and the rate of increase is increasing. This is not compared to 2009, it's about what's happening now. Am I wrong? Or if I'm right, how is this deleveraging?

  • Report this Comment On April 24, 2012, at 8:41 PM, TMFMorgan wrote:

    maniladad,

    Most private deleveraging comes from mortgages, not credit cards.

    More here:

    http://www.fool.com/investing/general/2012/02/15/believe-it-...

    Also, the rate of change in federal debt is decreasing rapidly, not increasing:

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&am...

  • Report this Comment On April 24, 2012, at 10:40 PM, devoish wrote:

    "The economy as a whole is able to shed debt, but the Fed provides just enough support to keep nominal wages from falling and growth from declining, which lets you keep deleveraging at a sustainable rate". - Morgan

    Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent. - NY Times http://www.nytimes.com/2011/10/10/us/recession-officially-ov...

    It is not the Fed that is holding up incomes. It is the safety nets and the growth of debt to support them. The Fed is feeding the top and it does not trickle down.

    Best wishes,

    Steven

  • Report this Comment On April 25, 2012, at 12:57 AM, creditrisk wrote:

    We are deleveraging fast because the government is picking up the tab. This should happen to some degree in bad times, but as times improve we need to pay down our debt so we have the financial capacity for the next rainy day.

  • Report this Comment On April 25, 2012, at 3:43 AM, morpholog wrote:

    If the GOP takes power, watch out! They are planning on plunging the economy into a deflationary depression.

  • Report this Comment On April 25, 2012, at 7:10 AM, CaptainWidget wrote:

    <<Economics isn't a science -- that's been clear for a while. And Dalio's personal net worth is $10 billion. He's doing a little more than sculpting words.>>

    Economics is a soft science, as in objective but non-verifiable. Just like psychology or anthropology. Art is subjective, just like these dumb comments...

    And Christie Walton has $10 billion dollars. Does that mean she knows more about economics than me?? sheesh.......

    Ultimately it's really easy to make a bunch of flowery verbose statement and twist them up as some sort of policy measure when you have a bunch of nobodies willing to defend your dumb words just because you have $10 billion dollars.

    In the meantime, nobodies like me have to objectively analyze and articulate their thoughts to defend their own arguments.

  • Report this Comment On April 25, 2012, at 8:45 AM, XTMFCaptain wrote:

    This is bunk. Japan saw a consumer/corporate deleveraging while the government levered up. Twenty years later, the Japanese are still in as bad of a position as they were in 1990. While Japan hasn't fallen off a cliff like the 1930s depression, they aren't anywhere near the end of their pain. Eventually, they will be rewarded with the 1930s simulation when borrowing rates rise a mere 2 or 3%. That is when the reckoning comes to Japan.

    The Fed's policy is no different than Japan. It may delay the pain, but it is only a delay.

    The other reason the depression was worse than today deals with tariffs and trade wars. Every country implemented these, and it killed the labor markets.

  • Report this Comment On April 25, 2012, at 10:47 AM, DJDynamicNC wrote:

    ^^^ There was actually an article on the Fool a few months ago about Japan and how their current "bad" economy is actually pretty stellar if you consider suchfactors as quality of life, health outcomes, culture, leisure time, and so forth.

  • Report this Comment On April 25, 2012, at 10:54 AM, TMFMorgan wrote:
  • Report this Comment On April 25, 2012, at 12:27 PM, MatiasR wrote:

    There's a difference between having and making a billion, captainwidget. And very articulate thinking you have, by calling Dalio a sculptor.

  • Report this Comment On April 25, 2012, at 3:40 PM, karakoram2000 wrote:

    The stats and the chart in this article come from data that's been massaged by the Gov't. Also, the unemployment data does not reflect poeple who are not actively searching for a job (they gave up due to no available jobs).

    Unemployment rate is much higher. Possible at or near Great Depression levels. http://www.shadowstats.com/

  • Report this Comment On April 25, 2012, at 3:51 PM, wan2bretired wrote:

    Its always best to show both sides of the coin and not that which fits ones beliefs or ideals. I agree with kk2000. Having worked with statistics in publishing scientific research, I know that people have tried to make failures look like a success by applying inappropriate data manipulation, data comparisons and statistical methodology.

  • Report this Comment On April 25, 2012, at 3:57 PM, TMFMorgan wrote:

    I will never ceased to be amazed by people who decry the manipulation of statistics, and in the next breath put their full faith in ShadowStats, whose self-stated job is to manipulate statistics. What they're upset about is not the manipulation. It's that one version of the manipulation doesn't fit their predefined view of the world (that the economy is doomed).

  • Report this Comment On April 25, 2012, at 5:58 PM, CaptainWidget wrote:

    <<There's a difference between having and making a billion, captainwidget. And very articulate thinking you have, by calling Dalio a sculptor.>>

    Do you think Sam Walton knew more about economics than me? Do you think he needed to to make a billion dollars, or do you think he spent his time chasing down margin losses in his supply chain?

    Making money is about serving customers, not about knowing an abstract field of human behavior.

    I call them like I see them, making a dumb statement about "beautiful deleveraging" with no quantifiers is dumb. Defending it because he has a lot of money is even dumber.

  • Report this Comment On April 25, 2012, at 6:16 PM, DJDynamicNC wrote:

    "Making money is about serving customers, not about knowing an abstract field of human behavior. "

    Well, yes and no.

    Making money CAN be about serving customers, in consumer-facing industries.

    Making money can also be about lining up the decimal places in arcane financial transactions and escaping notice from overworked regulators, or rent-seeking, or investing wisely, or maintaining your monopoly, or a dozen other alternatives.

    Given the money that investment bankers walk away with (much of which is all too often our own money), I think that knowledge of abstract fields of human behaviour might pay pretty well, after all.

  • Report this Comment On April 25, 2012, at 7:17 PM, CaptainWidget wrote:

    <<Making money can also be about lining up the decimal places in arcane financial transactions and escaping notice from overworked regulators, or rent-seeking, or investing wisely, or maintaining your monopoly, or a dozen other alternatives.>>

    All of these things, save for monopoly, are still about serving your customers.

    Lining up decimals with complex financial derivatives that no one understands is still customer service. Fund managers customers are those with a lot of money, and their service is protecting that money.

    Rent seeking is providing a place for your customers to interact with their customers.

    Investing wisely is providing capital for a business your own (at least partially) to provide service to it's customers.

    In a world of voluntary exchanges, the ONLY way money can be created is when value is added to someone. Both parties need to feel they got the better deal, meaning both parties are the winner in a voluntary business deal. Of course we don't live in any such idealistic utopia, and money created isn't always value added, sometimes it's flat out extorted. But the extortion isn't being perpetrated by the party you think...

  • Report this Comment On April 25, 2012, at 8:08 PM, kyleleeh wrote:

    <<Making money is about serving customers, not about knowing an abstract field of human behavior.

    I call them like I see them, making a dumb statement about "beautiful deleveraging" with no quantifiers is dumb. Defending it because he has a lot of money is even dumber. >>

    Considering the number of posts these articles get and the frequency with which you read them I think that what you are calling "dumb comments" are probably serving the Fool's advertising customers very well...they certainly seem to be keeping your eyeballs on the webpage.

  • Report this Comment On April 25, 2012, at 8:19 PM, CaptainWidget wrote:

    And? Are you trying to make some mind-shattering point, is this just kind of your way of saying "if you don't like it, take your ball and go home"?

  • Report this Comment On April 25, 2012, at 9:27 PM, steltek wrote:

    "I will never ceased to be amazed by people who decry the manipulation of statistics, and in the next breath put their full faith in ShadowStats, whose self-stated job is to manipulate statistics. What they're upset about is not the manipulation. It's that one version of the manipulation doesn't fit their predefined view of the world (that the economy is doomed)." --TMFMorgan

    I will never cease to be amazed by the fact that supposed moderators and role models of this board continue to engage in ad hominem attacks against their customers. You're supposed to set the tone for discussion.

    Furthermore, your post applies as much to you as it does do someone who "puts faith" in shadow stats, since you "put faith" in government statistics. I'm not a fan of Shadow Stats, but I checked their web site. Nowhere does it say their intended mission is to "manipulate data." Their intended mission is get to the truth behind data they feel is already manipulated. You've dismissed Shadow Stats out of hand, because it does not "fit your predefined notion of what should be" in the same way you attacked the other member.

    Pot, meet kettle.

  • Report this Comment On April 25, 2012, at 9:55 PM, TMFMorgan wrote:

    Sorry if you felt it was ad hominem. I get riled up because ShadowStats is so often used as a rebuttal by people who, out of (perhaps legitimate) worry that numbers are being tweaked, chose to use numbers that are admittedly tweaked.

    <<your post applies as much to you as it does do someone who "puts faith" in shadow stats, since you "put faith" in government statistics.>>

    Yep. And if my rebuttal to people who use shadowstats data was, "BLS data says you're wrong," I'd expect to be criticized as well.

    -Morgan

  • Report this Comment On April 25, 2012, at 10:28 PM, TMFMorgan wrote:

    <<Their intended mission is get to the truth behind data they feel is already manipulated.>>

    Agree, but they do that by tweaking the numbers. I'm not saying that's wrong, but it's what they do.

    I'm in favor of being skeptical and using several sources of data. And sorry again if my comment was harsh. Thanks for the debate, everyone.

  • Report this Comment On April 25, 2012, at 10:32 PM, duuude1 wrote:

    Wow.

    Lots of emotion on all sides here.

    I think we all know that life has been tough on a LOT of people for the past few years. And going through these harsh times makes us less willing to put our own biases aside and entertain opposing ideas.

    If someone has been body checking me into the boards and holding me down, stomping on me for years - I'm not likely to view any positive comments about the thug favorably. I think many people view the government as the thug holding them down, stomping on them.

    The question is whether that perception is accurate.

    The point of TMF is to help us all invest better, to learn new information to help us become smarter better faster... and emotion certainly prevents that. I think the best investors know that emotion prevents good investing. So my hope is that we can tone down the emotion, tune up the rational radar...so we can make some freaking $$$'s!!!

    But then again, this article meshes beautifully - BEAUTIFULLY - with my biases. I thought this was a fantastic article and gave me some very novel insights and new information that I was not aware of - so thanks Morgan.

    My biases are:

    1. housing will continue to decline very considerably (and though I want a house I refuse to buy for many years)

    2. the US economy has been and will continue to do great despite the massive shock it experienced (so I threw everything into the US equities market since 2008 and will continue to do so for the forseeable future)

    So there are a couple of possible outcomes for me here based on my actions:

    1. if people like Widget are right, my family and I will be in the poor-house - or homeless - due to my stupidity in believing that the US government has threaded the needle well

    2. if people like Morgan are right, I'm going to be sitting very very pretty

    Those of you who are on Widget's side of the divide - how are you investing?

    Those of you who are on Morgan's side - what are you doing?

    That information and discussion would help me tremendously - and I think may be useful for many others as well.

    Best,

    Duuude1

  • Report this Comment On April 25, 2012, at 10:33 PM, wan2bretired wrote:

    Morgan,

    In the Great Depression the work force increased each year from 1929 to 1941, while the unemployed increased to a max of 24.75 % by 1933, however today the work force is decreasing and is almost the sole reason for the decrease in unemployment. The lie in statistics is comparing information that is not compiled or reported in the same matter. Do we know that the way the work force was calculated or ascertained in the Great Depression is the same as today? Is an improvement in unemployment today encouraging when it is predominantly based on a decreased workforce? So one could speculate that TARP decreased the workforce, therefore improved the employment numbers.

    http://www.u-s-history.com/pages/h1528.html

  • Report this Comment On April 25, 2012, at 10:47 PM, CaptainWidget wrote:

    <<Those of you who are on Widget's side of the divide - how are you investing?>>

    Non-dollar denominated assets.

    I don't think the US is doomed by any means. There have been other nations which have conquered out of control government spending and led to greater economic health and prosperity.

    I think, in relative terms, the US is still doing very well. The only problem is, it could be doing a helluva lot better. Ignoring small cracks is a great way to develop a lot of big cracks.

  • Report this Comment On April 25, 2012, at 10:49 PM, TMFMorgan wrote:

    <<I think, in relative terms, the US is still doing very well. The only problem is, it could be doing a helluva lot better.>>

    Agree 100%.

  • Report this Comment On April 25, 2012, at 11:14 PM, Melaschasm wrote:

    +1 rec for pointing out that it is not as bad as the Great Depression.

    As bad as things are right now, I do not understand how people can claim that it is worse than the Great Depression. The extreme poverty and hardship of the Great Depression is so much worse than what we are suffering today, that such comparisons are misleading at best.

  • Report this Comment On April 25, 2012, at 11:16 PM, grusilag wrote:

    People keep talking about "money printing" as if there is such a thing. Our money is issued by the Federal Reserve and banks under the Federal Reserve system. Banks don't print money "out of thin air." They print it and issue it as debt. Interest bearing debt. All of that money has to eventually be returned, plus more. Hence why deleveraging leads to deflation.. when borrowing/lending slows down no new money is issued, but with current debts being paid off, money is "used up" to pay off debts.

    I don't get how we can ever have "ugly inflationary deleveraging." Inflation (expanding the money supply) only happens when banks issue new money to lend. That doesn't sound like deleveraging to me. I just might not be understanding what he's saying.. if so please someone enlighten me.

  • Report this Comment On April 26, 2012, at 6:50 AM, Stonewashed wrote:

    What is going on? Favored banks and companies have maximized their short term profits (through the erratic pump and dump trading going on, and phoney balance sheets), funneled community's capital into their private investments, and pushed their losing bets on the banks they direct that were bailed out and vendors.

  • Report this Comment On April 26, 2012, at 7:10 AM, duuude1 wrote:

    Hey Widget,

    <<Non-dollar denominated assets... I think, in relative terms, the US is still doing very well>>

    Does "non-dollar denominated assets" = gold? Not sure what that means.

    And my assumption is that you are specifically in "non-dollar" because you believe the dollar or the US economy will perform poorly - if that is incorrect can you explain why non-dollar is important?

    And the part that seems incongruous to me (given my assumption) is then whose currency or economy are you betting on - especially given your comment "in relative terms, the US is still doing very well". Compared to the rest of the world, the US economy is doing well, and the dollar is still a favored currency.

    Best,

    Duuude1

  • Report this Comment On April 26, 2012, at 9:39 AM, deckdawg wrote:

    I don't understand the chart. I thought our unemployment rate went close to 10% in the current crisis, and had hit around 25% in the Great Depression. What is the measure reflected in the chart?

  • Report this Comment On April 26, 2012, at 10:47 AM, DJDynamicNC wrote:

    "Their intended mission is get to the truth behind data they feel is already manipulated."

    That's semantics, though. They feel the data is manipulated, so they de-manipulate the data by manipulating the data their own way.

    The word "manipulate" has a negative connotation, so that comes across poorly, but that is explicitly what they are doing. I'm not saying that's a bad thing - there is value in analyzing numbers and applying your own inputs and viewpoints to that analysis, and there is absolutely value in checking other people's work rather than taking it at face value - but to say that one manipulation is a manipulation and the other is "truth" is an application of confirmation bias, nothing more. Both are manipulation; it's possible that one is more accurate than the other but it is not inherently the case.

  • Report this Comment On April 26, 2012, at 11:05 AM, DJDynamicNC wrote:

    "The extreme poverty and hardship of the Great Depression is so much worse than what we are suffering today, that such comparisons are misleading at best."

    Agreed.

    There were far fewer social safety nets back then, and the human toll was vastly greater as a result.

    It's all a matter of how you measure it. If you're measuring by GDP growth, that's one thing, but if you're measuring by the impact that is actually had on real human beings, then you're getting a much more valuable read on how the economy is doing (in my opinion).

  • Report this Comment On April 26, 2012, at 11:06 AM, warrenzevon wrote:

    The Depression beats the hell out of 'now' for being, well, depressing, but the Depression will look good in 10 yrs in terms of the country's long-term prospects. Crumbling infrastructure, massive debt, systemic government impotence, the outsourcing of our manufacturing base (which had synergy with our much vaunted innovation and research), and an out-of-wack job market and compensation system that has cut the tie between corporate performance and middle-class advancement, while incenting our best and brightest to go to Wall St. or create the next Angry Birds app...at least the ingredients were still there for the country to get itself back on its feet. I see very little potential for that now.

  • Report this Comment On April 26, 2012, at 11:11 AM, DJDynamicNC wrote:

    "Those of you who are on Morgan's side - what are you doing?"

    Long-term value investing in primarily dividend bearing stocks.

    I'm not averse to holding gold, though I hold none myself at this time. I'm saving for retirement, and I don't want to count solely on capital appreciation for the next 40+ years and then wind up finding gold in a slump for whatever reason when I need to retire. So it's not so much an anti-gold attitude as a pro-dividend attitude.

  • Report this Comment On April 26, 2012, at 12:03 PM, DJDynamicNC wrote:

    "at least the ingredients were still there for the country to get itself back on its feet. I see very little potential for that now."

    If only somebody had proposed the sort of infrastructure building and job creation programs that occurred during the Depression.

    We could have called it "economic stimulus" or something, and paid for it with loans made at historically low interests rates which could then be paid off when the economy returned to a surplus state, as it was during the Clinton administration before the Bush tax cuts.

    Too bad nobody wanted to do that.

  • Report this Comment On April 26, 2012, at 12:20 PM, awallejr wrote:

    The sad part is we threw away some lessons learned from the Great Depression and in effect created an "almost" new one (by the repeal of Glass-Steagall).

    I was one of the few on this site defending Bernanke. Prior to Lehman collapasing almost everyone didn't want the Fed or Treasury to intervene. Nearly all just wanted Lehman to collapse. That is the one criticism I had of Bernanke and Paulsen, namely their letting Lehamn collapse.

    And what followed was the near collapse of our entire financial system. The Schiffs of the world were shouting let it all collapse. Do nothing. Fortunately Berananke ignored that advice and after he basically said he would not let the banks fail (I then bought C at $1 after hearing that) the market turned on a dime.

    There is still a lot of hurt out there but it would have been even uglier but for Paulsen's and Bernanke's actions following Lehman.

    I said it would be a long slow grind back to recovery because a lot of lost jobs needed to be replaced and there was no catalist to create them quickly (although the energy explosion in the shale areas looks interesting).

    I suppose if you are one of the many that are now living on the streets begging for food this is no different than the Great Depression. A matter of one's perspective in the end.

  • Report this Comment On April 26, 2012, at 2:41 PM, hbofbyu wrote:

    The title of this article is kind of funny.

    How about this one:

    "Why Chernobyl was so much better than the 2011 Tohoku earthquake and tsunami."

  • Report this Comment On April 26, 2012, at 3:13 PM, Darwood11 wrote:

    Morgan;

    Nice article, as usual.

    The chart is really interesting, particularly the dashed blue comparison, which I had not seen before.

    I've read Ray Dalio's comments elsewhere, but I cannot recall precisely where. I think they are valid. We can and do spend more than we earn over time, or make financial commitments based on future earning power. Purchasing a house, for example. Those spending habits can compound and it doesn't take too many years to get out of whack in financial terms.

    On the subject of "deleveraging" I was very concerned when, in 2009 or so, I began reading articles about college students who were making decisions to stay in school a few more years rather than enter a decidedly tepid job market.

    That was a decision to take on more debt, with an expectation that the economy would support that decision in 2-4 years. But what if it didn't, I asked? Now we read articles about disgruntled college graduates who are saddled with that debt, and unhappy with the current job prospects. Yes, as they have learned, taking on debt is risky. As my first business accountant told me when I anticipated a large capital purchase way back in 1979: "Are you willing to mortgage your future?" Of course, back then, we were expected to pay off our debts, and there were no infomercials on TV about the wonders of bankruptcy.

    Taking on debt sounds, oh, so innocuous, until it is put into real terms. Using Mr. Dalio's example, taking on $10,000 a year for a few years, let's say five years, doesn't sound all that excessive. However, if one takes realizes that after 5 yeas, that debt will require a payback of $500 a month plus interest for 100 months (8.4 years), then that's a real headwind to financial personal success.

    I suspect that many people simply don't do the real world numbers and come up with equivelants, which are in terms of what can be purchased for that $50k, what it really represents in personal living, and to what extent one must adjust their living to make up for that income shortfall. After all, paying off debt is "taking it off the top," isn't it?

    Or perhaps, we are a nation of gamblers?

    I've taken the opposite tack. I decided that first, let's assume there is absolutely no way of escaping the consequences of personal debt. If so, then these are not trivial decisions. Second, If getting into debt of $50K is a trivial exercise, then the opposite, which is generating an additional $50K in assets should also be trivial. I then ask, oh, so how would one accomplish that? Save $5K a year for 10 years? No problem, that means reducing one's disposable, after tax income by "only" $417 a month. "Trivial" for the average family with an average income of $49K per year? Of course, no problem reducing gross income by 10%! No problem at all!

    Way back, when I was a child of 8 or so, I recall an exercise about saving and becoming a millionaire. The idea was, save one cent in the first day, and then double the amount added to the kitty each year. So, after one year I would have a penny; after two years, I'd have the original penny plus two more, and so on. How long would it take to save $1 million? I was really excited and I thought "That's easy, even I can do that!" So, I sat down with a pencil and paper (this is before calculators) and I eagerly did the numbers to see how soon I could become a millionaire! In the back of my head, there was a little voice that said "This is too good to be true, because if it was this easy, then everyone would be millionaires!"

    Well, I quickly discovered that I would soon have accumulated the astronomical (to me) quantity of $10,000 and that I would have to figure out how to double that in order to hit my next annual target! If I could do that, why, within 28 years, I'd be a millionaire! I was completely discouraged. However, I also realized just how difficult it would be to achieve financial wealth and independence working 5 days a week as my father was doing.

    Ditto for working one's way out of debt, or "deleveraging." Back when I was 8, I had not yet heard that term, but I did realize that unsecured debt was not a good thing.

    Today, millions in the U.S. are learning the same lesson, and it is a long, slow and difficult one to learn!

    .

  • Report this Comment On April 26, 2012, at 4:03 PM, hbofbyu wrote:

    Darwood,

    You said, in a couple of paragraphs, what everyone in this country above the age of 18 should have drilled into their heads. Nicely done.

    By my definition (I know leverage has many meanings) I would add that not everyone who borrows is "leveraging".

    I thought leverage implies that you are using the money now to give you an advantage in the longer term more than if you hadn't borrowed to begin with. Like when I borrow $200,000 to purchase a house at 4% but then rent it out at a 10% I am leveraging.

    Unfortunately, much of our debt does not fall into this category. Going into credit card debt for cars, clothing, or entertainment is not leveraging anything that I can see..

    Debt spent on Education, Jobs programs, or infrastructure is another matter.

  • Report this Comment On April 26, 2012, at 4:23 PM, DJDynamicNC wrote:

    The thing to remember in the great deficit debate is that the debt we accumulate is not just arbitrary debt.

    If a company takes out a loan for $10,000 to buy a crane, the balance sheet comes out even, because it owes $10,000 in the liabilities column but now owns a $10,000 crane in the assets column.

    Similarly, if the US buys an aircraft carrier for 20 billion dollars, well, it owes 20 billion but owns a 20 billion dollar aircraft carrier.

    You can argue all you like about whether this is a wise expenditure, but bear in mind that the deficit is not just a bunch of debt with nothing to show for it. These are investments, and one of the only ways a nation can "save for the future" is through purchasing durable goods and infrastructure improvements. Alternatives exist - we could have a sovereign wealth fund to invest with, for example - but the bulk of our "savings" comes from purchasing assets that are durable for generations.

  • Report this Comment On April 26, 2012, at 4:29 PM, TrojanFan wrote:

    Yes Darwood.

    Your analysis implies a couple of things on its face that aren't necessarily truisms the way they are implied to be.

    First, who said you have to repay the debt out of personal income. Many (especially in real estate) view taking on debt (especially low rate debt covered by current rents as hbofbyu is alluding to) as a way of arbitraging inflation and the government's long-term and well established tendency to create inflation and debase money as a way of servicing its own debt. Doesn't it make more sense to pile into that side of the money trade?

    It's hard to envision now, but it's quite possible that 50 years from now when today's youth are approaching retirement (yes, they'll probably have to work 50 years rather then 40 due to longer life expectancies) the average incomes in the country may approach or exceed $500K per year in nominal terms. That means that most would be able to pay off their entire original mortgage in today's dollars with just one year's worth of income or less in the terminal year of the normal mortage contract which I expect to eventually also extend in line with life expectancies.

    Given that the long term REAL returns from the stock market are around 9% after inflation and 12% before, if you have a long enough time horizon and the discipline to lock the money away in the market in a diversified manner and not touch it no matter what happens, doesn't it make a heck of a lot more mathematical sense to carry as much debt as your bank is daft enough to allow you to for 30 or more years at a fixed rate (no inflation hedge for the bank because of the fiercely intense competition they face in the mortgage lending environment) at rates much lower then the long term returns on the stock market.

    If instead of paying down the principal as you suggest, wouldn't you make out a lot better in the end if you defer repayment as long as possible, paying interest only if you can for as long as you can, and plowing the difference into maxing out your 401(k) and your Roth and letting it compound for the rest of your natural life and then will the assets to your children and teach them to game inflation the same way you did? You maximize your earnings and simultaneously minimize your taxes both with the current reductions to taxable income from the savings contributions and preserving and maximizing the tax shield from the mortgage deduction for as long as possible.

    Wouldn't that generate a higher ultimate net worth in the end? Isn't that the objective? When you pay off the debt all you save is the interest.

    Current incomes aren't the only repayment source. Rising asset prices/dollar debasement are also a source of repayment especially on long term debt.

    If something goes wrong and you live in a non recourse state you can always stick the bank and ultimately the government with the problem and just walk away under principles of efficient breach.

    Low taxes, maximum leverage and exploitation of your counterparties ignorance and government subsidization.....now that is making money the Goldman Sachs way!!

    We should all be so sophisticated.

    If we all were imagine the places we could take this country.

  • Report this Comment On April 26, 2012, at 6:32 PM, TrojanFan wrote:

    By the way, S&P just downgraded Spain by two notches from A to BBB+ since were on the topic of sovereingn indebtedness. Perhaps more importantly, the short term rating was notched from A-1 to A-2 which is going to make it much more difficult and expensive for Spanish Banks to access short term funding. Here comes your next bailout everybody (and the US will be putting up some of your taxpayer dollars for this rescue, too, by the way).

    http://www.bloomberg.com/news/2012-04-26/spain-s-ratings-cut...

    This comes on the back of market chatter I've been hearing all day that the Bank of Japan is preparing another emergency intervention of about 5 trillion yen (about $62.5 billion USD equivalent) which is essentially their version of quantitative easing/money printing. That is probably going to happen today, maybe over the weekend.

    Coincidentally, that is almost identical in size to the contribution that the government of Japan announced about a week that they are going to make to the IMF.

    So basically Japan is rumored to be about to print about 5 trillion yen, which they are undoubtedly going to use to top off their contribution to the IMF so that this money can get funneled into the EFSF and pumped into to Spain to prop up the Spanish banking system.

    If this all sounds like one big circular shell game to you that's backed by phoney electronic money that required no discipline, value creation or productivity to create, that's because it is.

    What a MESS!!!

  • Report this Comment On April 27, 2012, at 1:51 AM, MatiasR wrote:

    Not chatter anymore. Widget, JPY denominated REITs perhaps?

  • Report this Comment On April 27, 2012, at 12:02 PM, nancydog wrote:

    I also remember the Great Depression. Times change for all of us, but for some of us, this does not happen. Anyone riding through a large town or city might notice the Vietnam Vet, homeless and bedreaggled. One might also notice other men and women pushing shopping carts filled with their wordly belongings who appear to be without permanent homes. How about the millions of children who go to bed hungry every night. How about those folks living on the edge of bankruptcy, unemployed and searching for a way to continue to afford their family. To these people, regardless of cause, This is a Great Depression. I made my way through life with much help from the American taxpayers. My public school education was taxpayer paid. My expenses for 4 years of college were completely paid by the taxpayers, through the disabled vets GI Bill. My salary as a teacher from 2nd grade through University, was paid for by taxpayers. I am now very comfortably situated, and in retirement. Should I not feel some gratitude to those who came before me an sacrificed for my well being? Do I not owe a debt to the United States, which I doubt I can ever repay? If the so-called 1 percenters tax break is allowed to die, I shall gladly pay my share of the increase. It would make me feel good to know that I was helping students, the hungry, the sick, and the needy, by paying my fair share into the common weal. That is the difference between the Depression born generation and the current Greedy group. It has nothing to do with a political stance. It is to do with moral and ethical equity.

  • Report this Comment On April 27, 2012, at 12:24 PM, steltek wrote:

    @Morgan,

    Thanks for responding to the above. Fwiw, I'm generally on your side of the debate, but I consider these online discussions more important than simple conversations. TMF is one of the more respectable investor publications. Thus, there is real opportunity to influence thought leaders here. I find it discouraging when we are contributing to polarization instead. People generally only come around to new points of view then they are presented in a non-threatening manner.

    I believe neither BLS nor SS for many reasons - 1) I consider it impossible to gather 100% accurate data, 2) it's impossible to verify that each branch and node of the data tree is collected honestly, 3) it's impossible to verify the final database is not massaged. Both are educated guesses based on sampling.

    The primary reason this recession is not as bad as the great depression has mostly to do with technology, not financial reforms. Technology has enabled massive improvements in production and distribution. For the same reason we're unlikely to see a breakout of the Black Death, we're unlikely to see a repeat of yesteryear's mass poverty.

    But, the proponents of things like SS do have some very real and poignant arguments. Intentional inflationary policy really does favor the "money printers." It allows the government and its immediate social network to buy before the currency is devalued, always a step ahead of inflation. It's an implied tax on savers. It's not ethical. We have not formally consented to it, and the public is generally unaware of its existence. The same goes for bonds and even many forms of direct taxation.

    Democracy is broken when one group can vote unfavorable conditions on a smaller group with fewer votes. Democracy is also broken when a small group with political ties and resources can acquire exceptions for themselves.

    Until both sides recognize the ethical validity of the other, there will be no reform. And unless we begin to form a single, united movement, the system will remain broken. That begins with discussions, just like these.

  • Report this Comment On April 27, 2012, at 3:55 PM, ibuildthings wrote:

    "Until both sides recognize the ethical validity of the other, there will be no reform. And unless we begin to form a single, united movement, the system will remain broken. That begins with discussions, just like these."

    Well said. It used to be that election-year rhetoric stayed in election years. But politicians have re-discovered the art of slander via intentional misinterpretation of the other side's views. They have also kept alive their own paths to re-elections by promising to take from Voter Bloc A and give to Voter Bloc B.

    There is no substitute for intelligence coupled with integrity. When we re-discover that, we will make faster progress.

  • Report this Comment On April 27, 2012, at 4:14 PM, DJDynamicNC wrote:

    "It used to be that election-year rhetoric stayed in election years"

    I don't think that's true, actually. Take a look at some campaign quotes from the first 3 or 4 Presidential elections, and the fierce debates that erupted between those elections. Some nasty words got said.

    Or look back to the 1950s, that oft-glorified decade of alleged social cohesion and bipartisanship. Guess who dominated the news much of that decade? Joe McCarthy, literally hunting down fellow Americans and destroying their lives.

    I think false nostalgia is dangerous. The times are bad now, but they were much worse before this. We are doing better than ever, and making progress yet.

    There's also nothing inherently wrong with partisanship. After all, what is partisanship? A firm belief in the veracity and value of your own ethics and ideals, and an unwillingness to compromise those principles. Another word for that is "integrity." Being partisan and being right are not mutually exclusive.

  • Report this Comment On April 28, 2012, at 3:13 AM, PerryDawg wrote:

    Invest what you can in good dividend paying stocks... just a few. I put (and can only afford 50-100 dollars a month) into 3 stocks a month through Sharebuilder for the last 13 years or so and I have a good little pile for me anyway for retirement along with my Social Security in 12 more years. I can't complain. I deliver pizza and work on a golf course I am 53 and happy as can be. This article is pollyannish, kinda dumb to me. I just find economics fascinating. I read a lot of Thomas Sowell and the like. I love free markets. I never shoot for the moon and love life. We are so blessed to live in America. I have visited Communist counties when I was in the service. I can't understand the complaining. Look on the other side of the fence and you will give a sigh of relief. I love America and thank God daily I was born here.

  • Report this Comment On April 29, 2012, at 1:42 PM, steltek wrote:

    "Being partisan and being right are not mutually exclusive."

    Thoughts like that are why neither congress nor voters achieve meaningful reform. What's right for one person is not right for another. That is why it is necessary to compromise and build a system that works for as wide a spectrum as possible.

    No matter how "right" you feel you are, it's not "right" to use violence or the threat of violence to force your beliefs on others. That is the most basic tenet of Democracy - to give choice to the people. Free will and consent are the basis of ethics.

  • Report this Comment On May 01, 2012, at 2:12 PM, leohaas wrote:

    Finally someone who can explain in layman terms what is going on! Kudos.

  • Report this Comment On May 02, 2012, at 1:32 PM, margaretmn wrote:

    "Balance"???? Just read the budget for this fiscal year http://www.whitehouse.gov/omb/budget/Overview/

    actually just read the summary page. You can fire every federal employee there is at DOD, EPA, everywhere and there is still not enough revenue to service the debt and pay the non-discretionary bills (SSA, Medicare). If there's a way for this house of cards not to fall, I'd like to know it. And when it does, don't the markets come with it?

  • Report this Comment On August 14, 2012, at 10:55 PM, MHedgeFundTrader wrote:

    My grandfather was an immigrant from Sicily who joined the army during WWI to attain US citizenship, lost an eye when he was mustard gassed on the Western Front, and settled down in the Bay Ridge section of Brooklyn after the war.

    He bought a three bedroom brick home on 76th street for $3,000, eventually raising four kids. Back then, there was a dairy farm across the street, and horse drawn wagons delivered ice blocks door to door. During the roaring twenties an assortment of relatives chided him for avoiding the stock boom where easy fortunes were made trading on margin. When the 1929 crash came, all of them lost their homes. Grandpa finished off the basement, creating space for two entire families to move in. He never bought a stock in his entire life.

    Because dad contracted malaria with the Marines on Guadalcanal during WWII, the old man moved the family to Los Angeles in 1947 for the dry, sunny weather. Unfortunately, the train stopped long enough in Las Vegas for a flim flam man to sell him five acres of land for $500. Ten years later my dad drove out to check out the investment. It was a tumbleweed blown, jack rabbit and rattlesnake ridden piece of land so far out of town that it was worthless. You couldn’t see downtown, even if you stood on the rusted out model “T” that occupied the land. After that, the parcel became the family joke, and grandpa was ridiculed as the world’s worst investor.

    Grandpa died of emphysema in 1977 at the age of 78. Chateau Thierry and Belleau Wood finally caught up with him. What German shrapnel and gas failed to accomplish, 60 years of smoking two packs a day of Marlboro’s did. His estate executor put the long despised plot in Sin City up for sale. Although the final price was never disclosed, it was thought to be well into eight figures. In the intervening 30 years the city of Las Vegas had marched steadily Southward towards Los Angeles, eventually encompassing it, sending its value through the roof. The deal triggered a big fight among the heirs, those claiming he was the stupidest demanding the greatest share of the proceeds, the bad blood generated continuing to this day. It turns out the world’s worst investor was really the best, we just didn’t know it.

    What was the address of this fabled piece of real estate? Why, it is 3325 Las Vegas Blvd. South, the site today of the Venetian and Palazzo Hotels, home to the Dal Toro restaurant, the venue for the Mad Hedge Fund Trader’s last Las Vegas strategy luncheon. I’m sure grandpa is laughing in his grave.

    The Mad Hedge Fund Trader

  • Report this Comment On September 18, 2012, at 1:02 PM, maninatl wrote:

    "The rich rules over the poor, And the borrower is servant to the lender."

    Proverbs 22:7

    Even though this country has many Christians, they have forgotten what is written in their Bibles. When you borrow, you are indebted to the lender as long as you have the loan. Some people think they are the winners due to this country's bankrupty protection laws. I agree that those laws are good in protecting the borrower from personal harm from the lender. Another group of people think that they are winners if they default on the loan and walk off. Everyone will have to pay for his own actions. It was not the bank's fault that you took up a mortgage thinking that house prices will continue to skyrocket. People have forgotten to live within their means.

    Borrowing money is not a winning proposition if you don't have the means to repay the money. Ben Bernanke, representing the American government, wants people to borrow more, even now! With all his great academic knowledge he doesn't understand the ruin caused by too much personal debt. Else he would not be pushing this country's banks and in turn the people to borrow more. He wants to stimulate the economy by borrowing. It will be too late before the great Ben realizes that economy will not grow better by being saddled with debt.

    The banking system (or lending system) as we know it today is going to change drastically if people think that it is not a problem to default on their mortgage and walk away from their payment obligation. Many of those people even continue to stay in their houses till the banks come to repossess the property. Basically they are getting to live for free. Banks are not putting too much effort in repossessing the defaulted houses since they have already been bailed out by the government using taxpayer money and so they now have tons of money more than they would have earned the proper way.

    In future people will not be able to get low money down loan from a bank. Banks will make sure they will get back their money. Banks know that these golden bailouts will happen only once in a lifetime. So in future if they don’t critically assess the borrower’s ability to pay, they are going to lose money.

    You still can get a 3.5% money down from Fannie Mae. Since it is the taxpayer’s money they don’t care about losing money. Government will just raise the taxes to bail them out if they lose money. Even if they are not bailed out what do they care. It is not their money in the first place.

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