Fundmastery Blog

Kurt Brouwer March 17th, 2009

In this post — the second in this series about the Great Depression — I thought it would be useful to look at employment. Before we go ahead, it is important to note that the mere fact we are even discussing the Depression right now should indicate how serious this recession is.

By the way, I believe the Great Depression itself should have been just a recession, but that government actions including higher income taxes (Presidents Hoover & Roosevelt), trade restrictions (Smoot Hawley Tariff Act of 1930) and a significant contraction in the money supply (Federal Reserve) all combined to drag the economy down much more than otherwise would have happened (see How to Squelch an Economic Recovery for much more detail on this issue).

Today, there are many levels of support that did not exist back then (unemployment insurance, bank depositor protection, brokerage firm protections, Social Security) that act to mitigate the downturn. Also, the Federal Reserve is acting aggressively to increase the money supply so these factors are good.

On the other hand, there are serious concerns such as Federal plans to raise income taxes and corporate taxes and, at the state level, sales taxes and vehicle taxes. In my opinion, raising taxes during an economic contraction is a serious policy mistake (see Stimulus: Is it timely, targeted and temporary?).

We also have an incipient movement towards trade protectionism, which is an enormous policy mistake. There is a ‘buy American’ provision in the American Reinvestment & Recovery Act of 2009 and that has already stirred complaints from our trading partners. Also, Mexico announced that it is putting up tariffs on American goods over another dispute. Though these are relatively minor events, protectionism is hard to stop once it gets going.

Is This a Recession or Great Depression II?

In my opinion, we are in a deep recession that will probably be akin to that of the 1980-82 time period. That is, I believe we will muddle through this mess and that it will not turn out to be Great Depression II.

In order to effectively discuss the Great Depression, we need to assess what it was like. In the post, we will look at changes in employment during the Depression versus the current downturn.

There is no question that unemployment is up — currently 8.1% — and there is little doubt it will keep going up for a while because unemployment is a lagging indicator that generally does not peak until after a recession ends.

Every day, we see headlines about the millions of jobs that have been lost and that sounds scary. Though we all need to be concerned about job losses, we also need to put losses in perspective.

At 154,214,000, our civilian labor force is much bigger today than it was in 1931. In fact, the labor force today is bigger today than the entire population of the country was in the Great Depression. If you include Alaska and Hawaii, the 1930 Census Report put the entire population at 123,202,660.

So, when we see headlines about the number of job losses or unemployment claims, the numbers should be adjusted to reflect the enormous increase in the size of work force.

This chart indicates just how much our labor force has grown over the past 60 years. The data at the St. Louis Fed only go back to 1948, but you get the point — there has been a steady increase in the number of people working.

Source: St. Louis Federal Reserve Bank

Looking at Employment in the Great Depression

At his Curious Capitalist blog, Justin Fox posted several very nice charts that display reductions in nonfarm employment in the Great Depression versus this recession. These charts utilize statistical information on those that are employed now versus those that were employed in the Depression.

One important point is that more people worked on farms back then, so that is one difference that could impact these results as they were not included in the employment rolls in either case.

One school of thought thinks that the larger farm workforce made things a bit better as people could at least grow their own food. On the other hand, many farms were foreclosed back then so people lost not only their job, but also their home. The loss of the family farm and the effect of the drought in the 1930s led to a significant migration — the Okies — that was very serious, as any older California or Oklahoma resident can attest.

One other more minor point is that the Depression-era numbers are not seasonally-adjusted to take into account Christmas season employment or teachers going on summer break and so on. This primarily means the line is not as smooth as current seasonally-adjusted employment statistics.

This charts the decline in employment for the Depression versus six recessions since World War II. The number of working Americans always goes down in a recession, but in the 1930s the numbers went down for a very long time — 42 months — before starting to turn up. On this chart, the pink line shows the decline in the 1930s and the light blue line is the current recession.

Source: Curious Capitalist Blog

As you can see, the six post-World War II recessions, including this one, do not bear an obvious connection to the enormous decline in employment during the 1930s.

In terms of trajectory, I believe the red line (July 1981 employment peak) fits the current recession best. That is, the contraction in employment will be similar to that recession.

This next chart just compares the current downturn in employment for the 14 months of this recession versus the first 14 months of the Great Depression.

Source: Curious Capitalist Blog

Again, the trajectory of declines in employment during this recession bear no visual comparison to losses in the Great Depression. By writing this, I am not trying to diminish the severity of this downturn, but rather to point out that how different our experience is this time.

As I wrote above, I do not believe we are entering a Depression II. For that to happen, our government and other governments around the world would have to make dreadful policy blunders and, while that is possible, I consider it unlikely.

See also Part I, Are We Talking Great Depression?

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Kurt Brouwer March 16th, 2009

I doubt if any of our readers are shedding tears for billionaires who have lost a literal fortune. Nonetheless, a billion here and a billion there does add up to real money.

One example, of course, is an investment hero of mine — Warren Buffett. As a result of the serious hit taken by his company, Berkshire Hathaway, Buffett lost approximately 40% of his net worth. Fortunately, Buffett’s salary was so low that it has not been affected by the downturn [emphasis added below]:

Warren Buffett’s salary stays at $100,000 in 2008 (Associated Press / MSN Central, March 13, 2009)

The world’s second-richest man, Warren Buffett, wasn’t even the highest paid employee at Berkshire Hathaway’s 19-person headquarters last year.

…Buffett’s base salary remained at $100,000, the same level it’s been for more than 25 years. He picked up an additional $75,000 for director’s fees from some outside companies in which Berkshire has significant investments. That pay did not change from 2007 either.

Buffett, one of the most successful investors of all time, has been an outspoken critic of lavish executive compensation packages at other companies. In keeping with that philosophy, his own company doesn’t award large pay packages or give out perks or stock options.

…While Buffett’s pay remained unchanged, his net worth tumbled along with the worsening economy and stock market. Buffett fell from his perch as the world’s richest person, according to Forbes magazine’s annual list of billionaires, which was published earlier this week.

Forbes valued Buffett’s net worth at $37 billion, $25 billion less than just a year earlier when the magazine estimated he was worth $62 billion.

Along with Buffett’s declining net worth, Berkshire Hathaway’s profit slid in 2008. For the full year, Berkshire’s net income fell to $4.99 billion, from $13.21 billion in 2007.

…Berkshire owns a diverse mix of more than 60 companies, including insurance, furniture, carpet, jewelry, restaurants and utility businesses. It has major investments in such companies as Wells Fargo & Co. and Coca-Cola Co.

In addition to Warren Buffett, billionaires all over the globe took heavy hits last year. This article from Forbes tells the sad tale, though I doubt if too many of us will be shedding tears for these downsized billionaires [emphasis added]:

Who are the world’s richest now? (Forbes, March 11, 2009)

The world has become a wealth wasteland.

Like the rest of us, the richest people in the world have endured a financial disaster over the past year.

…Microsoft’s Bill Gates lost $18 billion but regained his title as the world’s richest person. Warren Buffett, last year’s No. 1, saw his fortune decline $25 billion as shares of Berkshire Hathaway fell 40% in 12 months, but he still managed to slip just one spot, to No. 2. Mexican telecom titan Carlos Slim Helú, No. 2 a year ago, also lost $25 billion and dropped to No. 3.

It was hard to avoid the carnage — in stocks, in commodities, in real estate, in technology and elsewhere. Even people running profitable businesses were hammered by frozen credit markets, weak consumer spending or declining currencies.

The biggest loser in the world this year, by dollars, was last year’s biggest gainer. India’s Anil Ambani lost $32 billion — 76% of his fortune — as shares of his Reliance Communications, Reliance Power and Reliance Capital all collapsed.

…Those with ties to Wall Street were particularly hard hit. The former head of American International Group, Maurice “Hank” Greenberg, saw his $1.9 billion fortune nearly wiped out after the insurance behemoth was bailed out by the U.S. government. Today Greenberg is worth less than $100 million. Former Citigroup Chairman Sandy Weill also fell from the ranks…

Though all of these rich guys lost money, there was a qualitative difference in the likely future outcomes in the group. For example, Buffett has a stake in a single company, Berkshire Hathaway, but it is made up of stakes in many other companies. So, he is diversified and his fortune will likely recover nicely when the economy and the stock market rebounds.

However, others such as Hank Greenberg of AIG will probably not see their fortune again because AIG stock has been essentially wiped out. He was probably not very diversified and it shows. His net worth went from $1.9 billion to $100 million, a decline of over 90%.

If you are diversified, a stock market decline can be painful and full of ‘white knuckle’ moments, but eventually things will recover. However, those who had most of their net worth tied up in one company have potentially lost it all.

See also Buffett: Let’s unite to fix the economy and Buffett Got Better Deal Than U.S. Treasury.

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Kurt Brouwer March 16th, 2009

Will China dump the dollar?

We began hearing about this issue quite a bit last year when the dollar was falling sharply versus other major currencies. At that point, the dollar was falling versus the Euro so the question centered on China’s willingness to withstand currency depreciation in its dollar-denominated holdings.

Due to the falling dollar, there was also widespread questioning of the dollar as the world’s reserve currency and questions across the media spectrum on whether China would begin phasing out of the dollar and moving to the Euro as the world’s reserve currency.

Why would China have to move to the Euro or the Japanese yen, if it wanted to sell part of its dollar position? Because China’s financial reserves are big enough that the Chinese government has to have its assets denominated in a very large, liquid currency. And, there are not too many of those around other than the U.S. dollar, the Euro and the Japanese yen.

For a variety of historical and cultural reasons, I doubt if the Chinese would seriously entertain putting most of their foreign currency and foreign assets holdings in the yen, so the choice is between the dollar and the Euro.

Unfortunately, for those predicting the demise of the dollar as the world’s reserve currency, we’ve been having a rather serious financial panic and that has led to a remarkable strengthening of the U.S. dollar. In fact, since July of last year, the dollar has been gaining and the Euro slowly sinking. What’s going on?

Source: Wikipedia Commons

To start, let’s put things in perspective with two charts from the treasure trove of information at the St. Louis Federal Reserve’s web site. The first chart shows the Euro (priced in dollars) since its inception in 1999 until March2, 2009. The low point was in 2001 when it costs 84 cents to buy one Euro. The high point came last year when it cost nearly $1.60 to buy one Euro.

In this chart format, the line going up indicates a time when the Euro is strengthening. When the line heads downward, it means the Euro is weakening versus the dollar. The gray bars indicate times of a recession in the U.S.:

Source: St. Louis Federal Reserve

In the next chart, we see the same information, but over a much shorter time period from January 2007 up to March 2009:

Source: St. Louis Federal Reserve

So, the scenario for China dumping the dollar due to weakness versus the Euro (the other potential reserve currency) is over for now. However, now we are seeing reports of China being concerned, not about the weakness of the dollar, but rather about the overall solvency of the U.S. government.

So, we have the same question — will China dump the dollar? — with a different triggering event as this recent piece from Bloomberg suggests [emphasis added]:

China’s Premier Wen ‘Worried’ on Safety of Treasuries (Bloomberg, March 13, 2009, Belinda Cao & Judy Chen)

China, the U.S. government’s largest creditor, is “worried” about its holdings of Treasuries and wants assurances that the investment is safe, Premier Wen Jiabao said.

“We have lent a huge amount of money to the United States,” Wen said at a press briefing in Beijing today. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

Well, that is an interesting statement. In fact, I suspect many of us would agree with Premier Wen that we would like the U.S. government to maintain its good credit too. The massive budget deficit that is being debated right now is not exactly an austerity budget though.

White House National Economic Council Director Lawrence Summers, asked about Wen’s remarks, said overseas “confidence” in Treasuries would be hurt without the administration’s steps to end the economy’s decline. President Barack Obama is relying on China to sustain buying of Treasuries amid record amounts of debt sales to fund a $787 billion stimulus package.

“China’s purchases of American debt have been one of the few bolts keeping the wheels on the global economy,” said Phil Deans, a professor of international affairs at Temple University in Tokyo. “If China stops buying, where does Obama’s borrowing to fund his stimulus come from?”

Treasuries declined after Wen’s remarks, before recouping the losses later. Yields on benchmark 10-year notes rose as high as 2.96 percent, from 2.85 percent late yesterday, and were at 2.83 percent at 12:27 p.m. in New York…

“Of course we are concerned about the safety of our assets,” Wen said after the annual meeting of the legislature. “To be honest, I am a little bit worried.”

It’s an ironic moment in that the leader of an avowedly Communist government is urging capitalist America to be more financially sound.

As we saw earlier in this post, the Chinese government does not have many currency alternatives. Last year and this year too, China made significant investments in commodities such as energy and energy infrastructure. But, it’s economy is still heavily dependent on the U.S. economy and, therefore, on the U.S. dollar.

This piece from the Wall Street Journal makes a good — though a bit unsettling for the Chinese– point:

Rhetoric aside, it bears repeating that China will find it hard to make a meaningful shift out of Treasurys, the prime current channel for investment of its $1.95 trillion foreign exchange reserves.

Some say China could switch holdings into gold — but that market’s highly volatile, and not large enough to absorb more than a small proportion of China’s reserves. It’s not clear, meanwhile, that euro, or yen-denominated debt is any safer, more liquid, or profitable than U.S. debt — key criteria for China’s leadership.

Most pertinent of all, even if China decided to sell off some of its U.S. Treasury holdings, it would scarcely be able to dump that in large blocks. And a partial selloff would surely lead to a slump in the Treasury market, eroding the remaining value of China’s portfolio…

The Chinese have few options on where to go with its estimated $2 trillion in reserves, of which approximately 70% is believed to be in dollar-denominated assets. So, if the Chinese cannot move their assets out of the dollar, why is Chinese Premier Wen voicing concerns now? Here are three reasons:

• I believe this is just a case of China making sure that China’s need are paramount in the minds of U.S. financial leaders and, of course, President Obama.

• It is also likely that the Chinese wanted to make a point as the global economic conference — the G-20 meeting — gets underway in the United Kingdom. The G-20 is a group consisting of the top economic nations in the world and its members constitute about 90% of the world’s economic output.

• The U.S. is taking lots of steps to stimulate its economy. China is also doing so too. However, the European countries are not doing much in this regard. It may well be that China is also making this point to pressure other governments to do more to stimulate their economies and therefore to stimulate demand for consumer goods from China.

So, the question was: Will China dump the dollar? My answer is, no it won’t. But, will it keep the pressure on the U.S. to be more fiscally prudent? I sure hope so.

Update: Apparently, I’m not the only one who found it ironic that the premier of China suggested the U.S. get its financial house in order. This editorial from Investor’s Business Daily made the same point:

…With China holding a trillion dollars in U.S. government debt, what Wen is worried about is Uncle Sam’s massive spending spree devaluing the U.S. dollar and threatening “the safety of our assets.”

He sounded not like the Communist dictator he is, but like the concerned head of an institutional investment firm warning the management of some troubled insurance company or mutual fund in which he has placed confidence to shape up and start behaving like successful businessmen…

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Kurt Brouwer March 12th, 2009

We have all read or heard comparisons of this economic contraction or recession to the Great Depression in the 1930s. There is no doubt that this financial panic triggered a severe recession that could well be the longest since World War II.

Nonetheless, the comparisons to the Great Depression are a huge stretch in my view. In this case, let’s look at declines in the Gross Domestic Product (GDP) as a measure of economic contraction. Alternatively, you could look at measures of unemployment or bank failures or any number of other indicators of economic distress. For now, let’s look at the economy itself and how this contraction compares to the Great Depression.

GDP: Great Depression vs. Current Recession

To start this comparison, here is a chart from the wonderful Calculated Risk blog that shows how far GDP has declined in this recession versus that the cataclysmic decline during the Great Depression:

Source: Calculated Risk

Calculated Risk had this to say about the chart [emphasis added]:

What is a depression? (Calculated Risk, March 10, 2009)

…The Great Depression saw real GDP decline 26.5%.

The post-WWII recession lasted 8 months and saw real GDP decline 13%. This decline in GDP was due to winding down the war effort – something that was celebrated – and is excluded when analysts call the current slump the “worst since the Great Depression”.

I still think a depression is very unlikely. More likely the economy will bottom later this year or at least the rate of economic decline will slow sharply. I also still believe that the eventual recovery will be very sluggish, and it will take some time to return to normal growth…

This point about the post-World War II recession is a good one that is often overlooked. It was sharp and severe as our war effort wound down and millions of men and women returned from the war. It was a deep recession that is largely ignored in all the media hype about this being the worst downturn since the depression.

The chart above assumes Q1 2009 will be bad and I would agree with that. Going on from there, I suspect Q2 2009 will also be rough, but after that we will see a leveling off of the decline and, eventually, positive economic growth. Positive growth could start later this year or even in Q1 2010.

Here is a good chart, also from Calculated Risk, that shows several outlooks for economic growth — or lack thereof — this year.

Source: Calculated Risk

Most economists are forecasting a very weak economy in the first half of the year. After that, they generally see some sort of upturn, however much of that optimism is based on the current economic stimulus legislation having some positive impact this year.

David Rosenberg, Merrill’s chief economist, has forecast the biggest downturn as well as the biggest recovery. Eventually, the economy will recover and begin moving up and I would agree that it is unlikely to do so until later this year.

No Comparison to Great Depression

Despite the severity of this decline, I cannot see a reasonable comparison between this recession and the Great Depression. The economy has been contracting and reasonable people can agree or disagree on the duration of the recession and its likely level of GDP downturn.

But, with a cumulative GDP decline of about 4%, we have a long way to go to even equal the post-World War II recession with its decline of 13%, much less that of the Great Depression, which was over 26%.

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Kurt Brouwer March 12th, 2009

We have not even gotten through this recession, but there are signs of inflation ahead in 2010 and beyond. Given the extraordinary amount of debt our government is incurring, plus the high levels of government spending and other factors such as increases in the money supply, I believe inflation will be the inevitable result.

Pimco Predicts Inflation, Joining Buffett, Faber (Bloomberg, March 11, 2009, Wes Goodman)

Pacific Investment Management Co. which runs the world’s biggest bond fund, joined investors Warren Buffett and Marc Faber in saying inflation will quicken, sounding a warning for Treasury investors.

U.S. government and Federal Reserve efforts to snap the recession will increase costs for goods and services as soon as 2010, Pimco said in a report today on its Web site by Chris Caltagirone and Bob Greer. Commodity producers are also delaying projects, which may limit supply and lead to higher prices when global growth resumes, according to Pimco.

“Inflation will rise,” Pimco said. Treasury securities that give investors protection against higher prices in the economy are “attractive now.”

Pimco is among a growing list of investors who are warning that programs to counter the U.S. slump will increase consumer prices as the economy starts to revive. Investor Jim Rogers, author of the books “Hot Commodities” and “Adventure Capitalist,” said this week U.S. policies will hurt conventional Treasuries, those that don’t offer inflation protection.

President Barack Obama is asking Congress to pass a budget that will result in a record $1.75 trillion deficit. He has already signed into law a $787 billion package of tax cuts and government spending.

Treasury Inflation Protected securities (TIPs) are one answer to concerns about inflation, but right now investors are more concerned about the slowing economy than they are about the potential for higher inflation in a year or two.

…TIPS fell 9.5 percent, based on Merrill’s inflation-linked index, indicating investors saw less need to protect themselves against rising prices for goods and services.

…Buffett, the billionaire investor, said March 9 on the CNBC television network that efforts to stimulate a recovery may lead to inflation rates exceeding those in the 1970s.…

This level of government intervention may be necessary to get the economy moving again, but there is a price to be paid and that will almost certainly be inflation.

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