Macro Economic Trends and Risks
12 September, 1857

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By FastMike
January 5, 2009

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

"...The kind of events that once took place will by reason of human nature take places again..." Thucydides

Dear 2008 Fools :


The orderly steadied himself, at the same time steadying the commander as the ship rocked. Commander William Lewis Herndon was putting on his coveted dress uniform, preparing to address his crew for the last time on his last command. He was proud of this uniform. It's medals, ribbons, sash and sword a symbol of honor : 29 years of distinguished service including taking part in the establishment of the U.S. Naval Observatory, landing and defending the expeditionary force off Vera Cruz during the Mexican-American conflict, and an epic 4400 mile journey of exploration through the Amazon Valley. 

He looked at himself in the mirror as the orderly inspected the uniform. "Perfect", he thought, "it must look perfect". The ship lurched again and the water splashed over his shoes and against the cabin wall. "Thank you, sailor, yes, that's fine. Now we need to hurry. I think that you should accompany me topside". 

Commander Herndon made his way up the ladder and pushed the cabin door open, made his way along the rail, stepping over a sailor who was grasping that rail, then up a short ladder to the quarter deck. He held himself steady by the dangling rigging from the mizzenmast. He stood tall and proud. He looked around. He saw the haggard faces of the crew, soaked to the bone and completely exhausted, strewn about the deck grasping anything they could. Shredded sail flapped and broken rigging hung from every mast, buckets rolling to and fro, passengers huddled around the mainmast, the wind, howling, unrelenting. Tired, pleading, hopeless eyes looking up at him. He looked down just as a thin wave came from aft and splashed against his heels. Without looking back he thought, "The time has come". He took a deep breath and shouted his last command : "All hands!", he paused, looked at their faces once more, and then, "Fasten your life belts! Abandon ship"! 

As all hands scrambled over the side, into the cold, dark Atlantic, 12 September, 1857, waves swamped the deck and Atlantic Ocean relieved William Lewis Herndon of command of the S.S. Central America. The ship then began the last mile and a half of her life's journey, down to the safe deposit of Davy Jones's Locker. 

In doing so, the Central America took her impeccably dressed Commander, along with over 400 exhausted crew and passengers, a stunning cargo of 30,000 pounds of California gold coin and bullion and, lastly, something that normally doesn't sink with ships : the entire economy of the United States of America.

You see, to move that California gold from the famous wild west back to the infamous financial east took 3 to 6 months by Pacific coast shipping, isthmus of Panama locomotive and then east coast shipping. 

In the meantime the miners of the gold were paid in script, banknotes in particular, and six months was plenty of time for that script to make it's way through saloons, brothels, hardware stores, farm granaries, carriages shops, blacksmith shops, hotels, horse traders, and just everywhere until it reached the hands of the pious frugal who put it in banks, those banks in turn used that script as leverage, to loan money to businesses for more western necessaries (except, perhaps, for the brothels) to grow and prosper. Thus that script became an integral part of the US economy. 

But when the Central America went down with an amount of gold equivalent to about 20% of the nation's 1857 bank gold reserves, (4% of all the surface gold ever found in California, in fact), a lot of that script was suddenly worth less than a hardy yo-ho-ho and an empty bottle of rum.

Before Commander Herdon's heroic last stand, the U.S. economy was already reeling from the effects of the collapse of the the New York branch of the Ohio Life Insurance Company�(because of some ‘fishy' accounting) which set off a series of bank failures.

But the news of the wreck of the Central America caused a bank panic that sent people stampeding to redeem their gold notes, causing more bank failures which caused a recession that saw businesses fail by the many thousands. End Sojourn.

I've read several good comparison arguments with previous business cycles, most notably "the Great Depression", . But it seems that every recession is unique, however, a few share some very common threads. 

For examples:

First is a seemingly reliable cash generator. In our case that engine was the reliability of the American homeowner. During the time of Commander Herndon's stewardship, the driver was a huge supply of gold, a good portion of it just sitting on the surface, free for the taking, i.e., money for nothing.

Second is leverage. In our case it was the innovation of pooling of reliable cash flow and creating a highly rated securities from it, and then using those securities as collateral to provide credit to further the expansion. Similarly, the California gold was pooled and securitized as "banknotes". Although this pooling of collateral was more accidental than purposeful, it was a leveraged expansion of credit nonetheless. 

Third is the rapid deleveraging. In our storm, it was the failure of credit standards and credit rating agencies that had magically turned junk paper into AAA bonds; i.e., money from�nothing. Along a similar vein, it was a combination of embezzlement and the loss of the Central America that caused a run on the banks by investors trying to redeem their gold banknotes.

But that recession was localized to the industrialized northern states. The south was dependent on cotton and European trade and was not effected as much.

As far as a global recession besides the Great Depression, one did occur in the late 19th Century. The parallel is notable.

During the most serious recessions in living memory, 73-74 and 80-81, there were really only three world economies: Japan, Western Europe (both dependent mostly on the U.S.), and the Soviet Union, a centralized economy, controlling eastern Europe and fed it's needs. But the United States dominated the world economy then. It was a case of ‘what was good for the U.S. was good for the rest of the free world'. Hence our suffering was their suffering and our prosperity their prosperity.

But today, we are sharing economic power and resources, with India, Brazil, Russia, India, China, Japan, and the EU plus England, each with it's own vision, government, culture and goals.

The Long Depression, a global depression, which lasted about a decade, marked as it's starting point, 18 September, 1873�when Jay Cooke & Company, a financing company, collapsed. (How's that for coincidence?). The similarities with today's failed bond auctions, or the inability to market CDO or swaps are striking. Jay Cooke was overextended and their $300 million intercontinental railroad bond offering failed, taking Cooke down, as well as the railroad and started a cascade of financing company and bank failures along with a stock market collapse.

At its' roots was a speculative bubble that grew out of the post war growth of railroads, Jay Cooke being one of it's biggest financiers (both war and railroad). President Grant was trying to put the country on a gold standard and the Federal Government was trying to extract the promissory 'greenback'�from the economy. The entire economic expansion became dependent on ever extended credit. 

Earlier that year, a nearly identical speculative bubble deflated in Europe. It too, was due to an over expansion in credit, railroads and other infrastructure and the end of the Franco-Prussian war, from which war reparations from France fed the bubble in Germany and Austria. When reparations were completed, the financing bubble burst, climaxing with the Vienna Stock Market Crash in May 1873 it took the newly formed Germany, and old Austria and Europe down with it. (And no, Strauss never wrote a "Bubble Waltz").

The most outstanding parallel that can be made with that credit bubble and ours, is that all the major economic powers deflated for mostly the same reason : credit extended well beyond the ability to raise the actual funds. 

The recovery lasted ten years and was slow and uneven around the globe, as each nation had different resources, different circumstances, different governments and there was little cooperation, if any at all, between global economies. 

It is interesting to note that in each of the above mentioned recessions, the Federal Government did not launch mass spending programs, job programs or any type of stimulus. The 1857 recession was overshadowed by a civil war; The 1873 recession simply in its' own good time. It's worthy to note that our Great Depression lasted nearly ten years and was ended by war spending, in spite of FDR's mass spending stimulus. 

So to sum up, history may give us clues or at best, similar results, but by no means certainty. When one looks at past history aside from the infamous Great Depression, it is clear that growth, government, speculation, bubble, some trigger and collapse is a common thread, but scale, length and recovery may be variable, indeterminate and sometimes catastrophic. 

Unlike the sinking of the S.S. Central America, we get information when it happens, not days later. Large amounts of money are moved by a wealth of instant information and common sense investing by a well informed public. The ordinary citizen is a major component of today's bond and equity markets. We have become one, out of many, indeed.

And this is without any comparison, ever. 

We know the story of the Central America because it was a disaster but we ignore the hundreds of successful journeys that brought wealth and prosperity. When, in fact, the subtle history of that economic disaster had its' making in each shipload of gold, in each nugget and flake of gold dust, used to build a paper empire only to be swept away by the same winds that sunk the Central America. 

Capitalism seems to suffer the curse of Sisyphus, who was condemned by the gods, because of his greed and hubris, to roll a large stone up a steep hill, only to have it roll back down when he neared the top.

It is apparent that the upcoming year is filled with uncertainty. We may be facing an unequal disaster, or a decline with a quick and powerful recovery. But there's simply no precedent at all.

One thing is very certain though. And that is the stone is definitely rolling down the hill.

Your deck swabbing Fool,

P.S. : I hope I haven't bored everyone too much with my ostentatious  musings on history and economics this past year. 

In any event, I'd like to thank all of you who have read my posts here. Your expressed appreciation is the finest compliment I have ever received.

Thank you, all, ever so much and all the best to you.... and a wonderful New Year