Crowd outside N.Y. Stock Exchange in October 1929
Drawing striking comparisons between the Japanese economy in 1988 and the American economy today, a new book by an author who predicted the current crisis warns it’s going to get much worse before it gets better.
Day presents a fact-rich case, rooted in economic history and time-tested theory, in which he concludes that an economic contraction of very large proportions is developing.
But he contends that “due to a reactive wave of positive social mood, statistical obfuscation and understandable denial, it will take about a year for the consensus opinion to cycle through the various scenarios in descending order of optimism before the grim reality finally becomes apparent to even the casual observer.”
Though the message is stark, Day believes the book is a much-needed antidote to the self-interested optimism of the financial media.
Published on the 80th anniversary of the 1929 stock-market crash, the book offers a detailed analysis of recent economic and monetary policies to show why pundits on both the left and the right didn’t foresee the current calamity.
Day’s credibility is bolstered by his prediction seven years ago of the collapse of the housing market and the destruction of the financial-services industry, in addition to some remarkably precise market forecasts.
In a Sept. 23, 2002, WND column, he wrote:
There can be little doubt that the implosion of the equity markets will soon be followed by the pricking of the credit and real-estate bubbles. As great financial houses such as Citigroup and JPMorgan Chase teeter on the edge of bankruptcy, it is well within the realm of possibility that the triple whammy of the equity, credit and real-estate implosions will lead to the collapse of the entire global financial system.
Day told WND he “wrote the book in order to give people a means of understanding what created the present economic situation and why there is a severe dislocation between what they are experiencing in the daily lives and what the government and the financial media are telling them.”
“I think it is important for future generations to know what the assumptions, the theories and the policies were that led to this ongoing debacle, so that they have a better chance of not repeating the same mistakes of their fathers and great-grandfathers,” he said.
Day said the ideal reader of his book is anyone who scratches his head wondering how the Dow Jones Industrial Average could rise 50 percent in six months despite a rapid increase in unemployment, massive loan defaults and declining global production.
“I think anyone who is shocked at the way the politicians of both parties have continued to put the interests of Wall Street ahead of the interests of American homeowners, workers and small businesses is going to get a lot out of it,” he told WND. “I don’t know if those who were burned by the tech and real-estate bubbles will necessarily enjoy reading the book and learning how the odds were always stacked against them, but it should help them avoid buying into the next investment charade.”
Day writes in “The Return of the Great Depression” that “for anyone equipped with the correct theoretical models of economics, the financial crisis was entirely predictable.”
He points to “the bipartisan push for increased homeownership through low interest rates and relaxed lending standards,” which destroyed wealth rather than creating it.
“But what is less well known,” he writes, “is that, long before the subprime lending market erupted in 2004, it was already apparent to a few clear-eyed and contrarian economists that the housing market was possessed of the same irrational exuberance that had propelled the 1999 technology stock bubble to such gravity-defying extremes.”
He cautions: “Many of the same individuals who did not see the crisis coming are now loudly assuring the public that the worst is already past, whereas those who correctly anticipated it tend to be somewhat less optimistic about the future.”
The river is rising
In his detailed analysis, Day explains the U.S. economy has relied on a constant increase of the level of debt to fund its economic growth.
He points out the average annual expansion of commercial bank credit since 1973 is 8.4 percent, which has sustained an average of 3-percent yearly GDP growth.
But total loans and leases at commercial banks have fallen 6.8 percent this year and 8.3 percent since their peak in October 2008.
“This is an unprecedented decline,” he warns, “as the largest previous annual contraction was -1.0 percent in 1975. This strongly indicates the onset of the debt deleveraging process predicted by those who foresee a depression-sized event.”
The amount of failed bank deposits as a percentage of total bank deposits is more than twice as high as the rate during the first two years of the Great Depression, he points out, and the FDIC has announced its insurance fund is already in the red and does not anticipate returning to solvency until 2012 at the earliest.
Meanwhile, executives at large multinational industrial companies are privately reporting their future order books look worse for the first quarter of 2010 than they did for the first quarter of this year when the effects of the current crisis were being realized.
Day told WND he believes there is “no way of avoiding an economic contraction of massive proportions because there is no way of escaping the debt bomb that does not involve very serious economic costs.”
“The level of debt in an economy is somewhat like a river rising towards its banks,” he explained. “It doesn’t take a rocket scientist to realize that once the water reaches a certain level, it’s going to spill over the sides and flood everything.
“Unfortunately for the American people,” he continued, “the Congress and the Federal Reserve have been trying to prevent the river from rising by pouring more water into it. It’s simply not going to work.”
Friedman’s Keynesian dream
Day takes aim not only at the economic principles of John Maynard Keynes that are so influential today – based on the belief that the private sector needs the intervention of the central bank and government to maintain stability – but also at vaunted free-market champion Milton Friedman.
John Maynard Keynes
Day argues that while Friedman parted from Keynes on fiscal policy, “he reached the conclusion that monetary policy could be even more effective than Keynes had ever imagined.”
Friedman’s “solution for reducing the prospect for active intervention as well as the margin of human error was to propose the establishment of monetary rules instead of monetary authorities,” Day explains.
“Friedman’s dream,” he writes, “remained essentially a Keynesian one of defeating the business cycle and utilizing technical measures to provide a means of permanent economic growth.”
Day concludes that any economic actor in the industrialized nations today needs to understand and accept “that there is no easy, magical solution to a situation that has taken decades to come to fruition.”
“Regardless of whether one traces the roots of the problem back to the 1971 creation of the ‘full faith and credit’ debt-dollar, the 1933 abandonment of the gold standard, or the 1913 establishment of the Federal Reserve, this is not a crisis that developed overnight and it will not sort itself out quickly either,” he writes.
Noting the Great Depression brought about massive changes in American society that echo today, he believes that 80 years later, “the return of the Great Depression will surely inspire changes of similar magnitude.”
“But we must dare to hope that this time,” he concludes, “Americans and the people of other nations around the world will discover that the solution will not be found in more government control over society, but through an increase in human liberty and freedom for the individual economic actor.”
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