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May 28, 1999

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Subject: 1999 = 1929?
Author: jradoff

Articles like this crack me up:

http://www.cnnfn.com/markets/9905/26/marketwrap

In this article, a market gooroo ["retired market figure Sir John Templeton"] is quoted on how our economy and market today is similar to the market of 1929. This claim is unsubstantiated. The mass media is always looking for the Big Scary Thing to Say which will glue you to the TV so they can collect more advertising dollars. I've been hearing lots of other people talking about how our economy is now very much like the pre-Depression era. It seems like any time the economy or the market is doing well, there is a group who missed out, and thus wants to prove their Wisdom by illustrating how smart they were by staying in all those investments with a P/E of 8.

Since this article was too lazy to discuss exactly how our current economy is like 1929's, I thought I'd go through a list of the major factors which are now believed to have contributed to the Great Depression. I'll then present how I believe this differs or compares to the present.

As most people know, the crash on October 24, 1929 was only one of the more visible symptoms of the Depression. The underlying causes are many.

1) Major industries already in depression

Well before late 1929, America's key industries were already in depression. The flagship industries of the day were agriculture, mining and energy. These had already been getting slammed throughout the decade -- agriculture in particular had experienced major trouble as the result of a serious drought (the Dustbowl). In addition, the biggest "growth" industries of the day -- construction and automobiles -- were already on the decline.

Compare to present: As most people know, America's largest industries are also the strongest at the present time. Today's growth industries -- biopharmaceuticals, telecommunications, technology -- and yes, the INTERNET, are experiencing increased demand with every month, and the larger more mature companies in these sectors (even the Internet!) are experiencing healthy earnings growth.

2) Protectionist economy

In the 1920's it was believed that tariffs could be applied to protect industries from damage due to foreign competition. The Fordney McCumber Tariff (1922) increased tariffs significantly (following the crash in 1929, the USA passed the Hawley Smoot tariff in 1930 which increased some commodity tariffs as high as 100%). Most of Europe responded to US tariffs with high tariffs of their own, which decreased demand in Europe for American products.

In 1999, we've got the most open world trade system in modern history.

3) Unregulated stock markets

In 1929, stock markets were essentially unregulated. The market was rife with insider trading; wash sales which artificially inflated trading volume; margin loans up to 75% of equity with 20% interest rates; unrated, uncollateralized bond issues; inaccurate and outright fraudulent financial reporting.

Today, we have the SEC, which was created in 1934. All of the previous items are now illegal and strictly enforced, to the benefit of stockholders everywhere.

4) Overproduction

In 1929, inventories were three times the necessary levels as the result of massive overproduction. This resulted in a glut of unsellable products.

Today, the impact of excess inventory is well understood. Information technology, ERP systems, inventory control systems and just-in-time manufacturing are just a few of the techniques that keep inventories low in 1999. Just look at companies like Dell, Wal-Mart and Ford to see what we've learned about supply chain and inventory management that we didn't or couldn't understand in 1929.

5) Uneven wealth distribution

In 1929, about half the population lived at our under the poverty level. The top 0.1% had income equal to the bottom 42%. That same top 0.1% controlled 34% of all savings, while 80% of the people had no savings whatsoever [source: Brookings Institute].

You'll always have people complained that the wealthy have too big a piece of the pie. But there is no question that the standard of living, as well as the wealth, of the average person in 1999 is far superior to the distribution of wealth in 1929. In 1999, we have Roth IRA's, free checking accounts, $7.95/trade online brokers and 401(k) accounts which encourage investing and saving in ways simply unavailable in 1929.

6) High consumer debt and installment credit

In 1929, nearly all car purchases (and radio purchases!) were made on installment credit.

Perhaps this is worse today -- they didn't have credit cards in 1929. But today, the average person has more savings and more disposable income.

7) Unregulated banks

In 1929, banks invested a lot of their assets directly in the stock market. Banks didn't have depository requirements. Deposits were not insured. The Federal Reserve had little power to affect the money supply. Banks, encouraged by the government, were lending totally uncollateralized funds to former WWI Axis powers so that they could pay war repartions to other European powers. When the Axis powers couldn't pay, loans were not forgiven, bailed out or renogotiated -- and a lot of banks went under as a result.

Today, the Federal Reserve plays a very active, very independent role in guiding the economy. The FDIC actively regulates banks and insures deposits. We have an International Monetary Fund to help stabalize international currencies and help restructure loans.

8) Speculation in Radio industry

The radio industry was booming in the 1920's, creating many opportunities for radio manufacturers and radio stations. Most of these radio companies ultimately failed, taking investors money with them.

Many compare this to the current Internet boom. However, while this comparison sounds good in a 20 second soundbite, it is a superficial comparison at best. Radios are not the interactive medium that the Web is. Radio stations couldn't be set up to instantly transmit content to a worldwide audience. Radio stations had one purpose -- to sell advertising. Radios couldn't do electronic commerce, can't let you post a message on the Motley Fool, get customer service for your product, allow you to send e-mail to a friend or colleague, exchange business information, etc. In short, Radios were a network of a few key industries whereas the Internet ties together every industry. Whereas radio was simply a neat new gizmo in 1929, the advent of the Internet is a fundamental business revolution.

9) Other differences

Today, people are healthier and live longer, allowing them to spend more money. Information technology, telecommunications, fast transportation and industrial automation has revolutionized virtually every industry, increasing productivity dramatically. Women have joined the workforce. The world, while still having its share of international problems, has been free from a major shooting war between superpowers for 54 years (in 1929, WWI was still fresh in everyones mind, and the nationalism that would lead to WWII was starting to take hold of Asian and European countries).

Conclusion

Comparisons of 1999 to 1929 are superficial and unfounded. There are few if any similarities to the period leading up to the Great Depression.

I'd love to hear any contrasting views!