Specialist
It’s beginning to feel like Groundhog day, which each day being the same as the day before. Except people are dying. At the time of writing, there has been over 2 million reported infections and 137,666 reported deaths. Businesses all around the world have been shut. Some countries are opening up slowly but there is a lot of talk about a second wave...
When it comes to investments, comparisons are made to the Great Depression which started in 1929 and didn’t end until 1939. While the last two crashes are increasing in the levels of volatility, many commentators are saying this will not be a repeat of the Great Depression. We’ll look at why.
Federal Reserve/ Central Banks
The US Federal Reserve helped create the Great Depression. They were raising rates even when the recession started. The US used the gold standard at the time and as the value of gold increased, people started exchanging their paper money for gold. So the Fed kept increasing rates to make dollars more valuable. It also made the cost of doing business more expensive and businesses simply couldn’t pay their bills and forced them into bankruptcy.
Today, we have seen Central Banks all around the world say they will do what they can and for as long as is necessary to get through this. Interest rates have been slashed (ECB haven’t as their rate is already -0.5%) and Central Banks have embarked in a massive bond buying programme to provide cheap money.
Government Action
President Herbert Hoover tried to trade through the recession by increasing federal spending, paid for through increased taxes. He thought that it would pass by and his main priority was balancing the budget.
One of his main concerns was pay cuts for workers. So he reasoned that pay should remain high and therefore the costs of goods remained high when they should have fallen. As the depression was global, other countries stopped buying US goods as they were now too expensive.
He embarked on protectionism, banning immigration to stop foreign workers flooding the market for lower pay and introduced tariffs on cheaper goods being imported. In retaliation, other countries introduced their own tariffs which resulted in US exports declining by 66%.
Today, governments are helping companies to stay open. The US has a $2 trillion dollar bail out package, which is even bigger than the 2008 bail out package. Governments are paying a large percentage of people’s wages, with some conditional on them not being made redundant.
The businesses we have seen go bankrupt so far are mainly the ones that rely on constant cashflow to keep operating. And we will see more companies go bankrupt the longer they are closed. But governments are providing a lot more support than in 1929.
Stock Market
Stocks fell by 89% during the Great Depression. Before that, during the Roaring Twenties, was a time when the American public discovered the stock market. Margin trading was common with many investors only putting 10% down and borrowing the rest. With so many people entering the market, share prices rocketed and created a massive bubble that was going to burst at sometime. With the economy slowing down anyway, when it burst, lots of people defaulted on their margin calls and couldn’t repay their loans.
We have already been through the margin call type crash in 2008. Markets are not as reckless this time with credit not as readily available to use to trade as previously.
The MSCI World Index fell by -33.73% in just over a month. It has since rebounded 21% in 3 weeks. For it to fall by 89% in total, we need to see markets fall a further 86% from today’s prices.
Can you see the governments and Central Banks of today letting that happen?
Article supplied by Steven Barrett, Managing Director of Bluewater Financial Planning.