2008: 1929 or 1873?

As the stock exchanges around the world took yet another bloody beating today, the commentary in the MSM is more and more referring to the crash of 1929 and the Great Depression.

However, according to Scott Reynolds Nelson, this comparison is not particularly apt. According to most historians and economists, that depression had more to do with overly large factory inventories, a stock-market crash, and Germany's inability to pay back war debts, which then led to continuing strain on British gold reserves. None of those factors is really an issue now.

The big issue right now is a complete breakdown of the flow of money, as credit is drying up. If we want an historical parallel, Nelson argues we should look at the Panic of 1873 and the Long Depression that followed it.
The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.

But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export trainloads of wheat to abroad. Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871. By 1872 kerosene and manufactured food were rocketing out of America's heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region's assumptions about continual economic growth were too optimistic. Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life.
So far so whatever. But here is the point where the similarities start: Banks unwilling to issue credits.
As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates. This banking crisis hit the United States in the fall of 1873. Railroad companies tumbled first.
And the reason they did may sound awfully familiar, if you've been following the Fannie Mae/Freddy Mac saga:
They had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing). The bonds had sold well at first, but they had tumbled after 1871 as investors began to doubt their value, prices weakened, and many railroads took on short-term bank loans to continue laying track. Then, as short-term lending rates skyrocketed across the Atlantic in 1873, the railroads were in trouble.
Then we get to the Lehman Brothers parallel:
When the railroad financier Jay Cooke proved unable to pay off his debts, the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe.
And the really worrying bit: The Long Depression that followed lasted until 1896. Twenty-three years it took to recover from a situation so very similar to our current predicament. Read the entire piece. This is not going to be pretty. Or a lot of fun...

Related: A provisional history of the 2008 crash in the NYT . h/t De Zwijger(NL).


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