Life and Times During the Great Depression
The economy of the United States was destroyed almost overnight.
More than 5,000 banks collapsed, and there were 12 million people out of work in America as factories, banks, and other shops closed.
Many reasons have been supplied by the different economic camps for the cause of the Great Depression, which we reviewed in the first part of this series.
Regardless of the causes, the combination of deflationary pressures and a collapsing economy created one of the most desperate and miserable eras of American history. The resulting aftermath was so bad, that almost every future Central Bank policy would be designed primarily to combat such deflation.
The Deflationary Spiral
After the stock crash, money and consumer confidence was hard to find. Instead of spending money on new things, people hoarded their cash.
Fewer dollars spent meant more drops in demand and prices, which led to defaults, bankruptcies, and layoffs.
As a result of this spiral, the prices for many food items in the U.S. fell by nearly 50% from their pre-WW1 levels.
The price of butter went from pre-crisis levels of $0.21 to $0.13 per pound in 1932. Wool had a drop from $0.24 to $0.10 per pound, and most other goods followed the same price trajectory.
Here’s how “real value” is affected in a deflationary environment:
Real value increases: cash is king and gains in real value.
Assets (stocks, real estate)
Real value decreases as prices fall.
Debtors owe more in real terms
Real interest rates (nominal rates minus inflation) can rise as inflation is negative, causing unwanted tightening.
From Bad to Worse
The Great Depression lasted from 1929 to 1939, which was unprecedented in length for modern history.
To this day, economists disagree on why the Depression lasted so long. Here’s some of their explanations:
The New Deal was not enough
Looking back on The Great Depression, John Maynard Keynes believed that monetary policy could only go so far.
The Central Bank could not ultimately push banks to lend, and therefore demand had to be created through fiscal policy. Keynes advocated massive deficit spending to offset markets’ failure to recover.
Keynesians such as Paul Krugman believe that Franklin D. Roosevelt’s economic policies through The New Deal were too cautious.
“You can’t push on a string.” – Keynes
The New Deal made things worse
Some economists believe the New Deal had a negative net effect on the recovery.
The National Recovery Administration (NRA) is a primary subject of this criticism. Established in 1933, the goal of the NRA was to lift wages. To do this, it got industry leaders to meet and establish minimum prices and wages for workers.
Cole and Ohanian claim that this essentially created cartels that destroyed economic competition. They calculate that this, along with the aftermath of these policies, accounted for 60% of the weak recovery.
Lastly, one other charge leveled at Roosevelt by his critics is that the sprawling policies from the New Deal ultimately created uncertainty for business leaders, leading to less investment. This lengthened the recovery.
“[The] abandonment of [Roosevelt’s] policies coincided with the strong economic recovery of the 1940s.” – Cole and Ohanian
The Federal Reserve didn’t do enough
Milton Friedman claimed that the Federal Reserve made the wrong policy decision, which extended the length of the Depression.
Between 1929 and 1933, the monetary supply dipped 27%, which decreased aggregate demand and then prices. The Fed’s failure was in not realizing what was happening and not taking corrective action.
“The contraction is…a tragic testimonial to the importance of monetary forces…[D]ifferent and feasible actions by the monetary authorities could have prevented the decline in the stock of money… [This] would have reduced the contraction’s severity and almost as certainly its duration.” – Milton Friedman (and co-author Anna Schwartz)
The Federal Reserve shouldn’t have done anything
Austrian economists believe that the Fed and government both made policy choices that slowed the recovery.
For starters, most agree with Friedman that the Fed’s policy choices at the start of the Depression led to deflation.
They also point to the premature tightening that occurred in 1936 and 1937 as a policy failure. During those two years, the Fed not only hiked interest rates, but it also doubled bank-reserve requirements. These policies coincided with Roosevelt’s tax hikes, and a recession occurred within the Depression from 1937 to 1938.
Critics of these policies say that this delayed the recovery by years.
“I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.” – Friedrich Hayek
Personal Stories from The Great Depression
“One evening when we went down to check on the bank, there were hundreds of people out front yelling and crying and fighting and beating on the locked doors and windows. They had fires built in the street to keep warm and there were people milling around all over the downtown.” – Vane Scott, Ohio
“A friend I worked with said in the Depression he rode the rails and stopped to eat vegetables out of a garden. The owner said he would shoot him if he didn’t stop. My friend said ‘go ahead,’ as he was that hungry. ” – James Randolph, Ohio
“When neighbors couldn’t get a loan from the bank, they’d come to Dad. He sold farm machinery. He never put his money in a bank. He stored it in a strongbox in the fruit cellar, under the apples. He’d loan the neighbors what they needed and they paid him back when they could. If there was a month—especially the winter months—when they couldn’t pay, they’d slaughter a cow or a pig and give him a portion. In the summer it was vegetables: corn, peas, whatever they had growing.” – Gladys Hoffman, New York
“I thought the Depression was going to go on forever. For six or seven years, it didn’t look as though things were getting better. The people in Washington DC said they were, but ask the man on the road? He was hungry and his clothes were ragged and he didn’t have a job. He didn’t think things were picking up.” – Arvel “Sunshine” Pearson, Arkansas
After the 1937-38 Recession, the United States economy began to recover.
The focus of the American public would eventually shift away from the Great Depression, as events in Europe unfolded after Germany’s invasion of Poland in 1939.
About the Money Project
The Money Project aims to use intuitive visualizations to explore ideas around the very concept of money itself. Founded in 2015 by Visual Capitalist and Texas Precious Metals, the Money Project will look at the evolving nature of money, and will try to answer the difficult questions that prevent us from truly understanding the role that money plays in finance, investments, and accumulating wealth.
Do You Know Where the British Pound is Heading?
This infographic uses the recent Brexit-related volatility of the British pound to illustrate how currency risk can impact an investor’s portfolio.
In developed economies around the world, it’s generally expected that currencies will retain their purchasing power over time.
While this is most often the case, sometimes there are situations in which currency markets begin acting in ways that are less predictable.
Growing amounts of political or economic uncertainty, for example, can cause a currency to experience amplified levels of volatility — an environment in which it may see bigger ups and downs than most market participants are used to.
Brexit, Currency Risk, and the Pound
Today’s infographic comes to us from BlackRock, and it focuses in on the recent volatility of the British pound to illustrate how currency risk can impact a UK investor’s portfolio, and how this risk can be mitigated through currency hedging techniques.
Currency risk is present in any unhedged portfolio that holds investments denominated in international currencies.
When currencies experience increased levels of volatility — such as the British pound over the last five years — it can make this risk even more evident, ultimately impacting investor returns.
Brexit in Focus
In the lead-up to the EU Referendum in June 2016, and certainly afterwards, it’s been clear that the sterling has decoupled from its typical trading patterns.
Sterling volatility, as you would know, is at emerging market levels and has decoupled from other advanced economy pairs.
– Mark Carney, Bank of England (September 2019)
Every twist and turn in the Brexit saga has helped stoke fluctuations in the value of the pound, especially in usually stable pairs such as EUR/GBP or USD/GBP. It is possible that these swings could continue throughout 2020, and even beyond.
What impact can these fluctuations have on investment portfolios, and what can investors do to avoid them?
Currency Risk 101
The challenge of currency risk is that it can affect returns, either positively or negatively.
In other words, in addition to the risk you are exposed to by owning a particular investment, you are also at the mercy of foreign exchange rates. This means the performance of your investment could be canceled out by currency fluctuations, or returns could be amplified if exchange rate movements are to your advantage.
For example, in a typical UK portfolio that holds 60% global equities and 40% global bonds, currency risk actually has the highest projected risk contribution:
Projected Risk Contribution (60/40 Global Portfolio)
- Foreign Exchange Risk: 4.55%
- Equity Risk: 3.36%
- Interest Rate Risk: 0.44%
- Spread Risk: 0.06%
- Total: 8.40%
When there is added volatility in currency markets, like in recent times, even a home-biased portfolio can be adversely affected. Given this, how can investors be sure they are getting a return from the underlying assets in a portfolio, instead of from unpredictable currency swings?
To Hedge, or Not to Hedge
There is a range of strategies that allow investors to hedge currency risk, but one simpler option may be to simply buy a fund (such as an ETF) that is hedged.
That said, not all investors may want to hedge currency risk. For example, an investor has a specific foreign exchange view (i.e. that a currency will go up or down in value) may want to purposefully get exposure to currency risk to take advantage of this view.
While it may not always make sense to use currency-hedged funds, they can reduce the overall investment risk on international exposures.
And if you are not so sure of where the pound is heading in coming months, now could potentially be a good time to explore such a tool.
The History of Interest Rates Over 670 Years
Interest rates sit near generational lows — is this the new normal, or has it been the trend all along? We show a history of interest rates in this graphic.
The History of Interest Rates Over 670 Years
Today, we live in a low-interest-rate environment, where the cost of borrowing for governments and institutions is lower than the historical average. It is easy to see that interest rates are at generational lows, but did you know that they are also at 670-year lows?
This week’s chart outlines the interest rates attached to loans dating back to the 1350s. Take a look at the diminishing history of the cost of debt—money has never been cheaper for governments to borrow than it is today.
The Birth of an Investing Class
Trade brought many good ideas to Europe, while helping spur the Renaissance and the development of the money economy.
Key European ports and trading nations, such as the Republic of Genoa or the Netherlands during the Renaissance period, help provide a good indication of the cost of borrowing in the early history of interest rates.
The Republic of Genoa: 4-5 year Lending Rate
Genoa became a junior associate of the Spanish Empire, with Genovese bankers financing many of the Spanish crown’s foreign endeavors.
Genovese bankers provided the Spanish royal family with credit and regular income. The Spanish crown also converted unreliable shipments of New World silver into capital for further ventures through bankers in Genoa.
Dutch Perpetual Bonds
A perpetual bond is a bond with no maturity date. Investors can treat this type of bond as an equity, not as debt. Issuers pay a coupon on perpetual bonds forever, and do not have to redeem the principal—much like the dividend from a blue-chip company.
By 1640, there was so much confidence in Holland’s public debt, that it made the refinancing of outstanding debt with a much lower interest rate of 5% possible.
Dutch provincial and municipal borrowers issued three types of debt:
- Promissory notes (Obligatiën): Short-term debt, in the form of bearer bonds, that was readily negotiable
- Redeemable bonds (Losrenten): Paid an annual interest to the holder, whose name appeared in a public-debt ledger until the loan was paid off
- Life annuities (Lijfrenten): Paid interest during the life of the buyer, where death cancels the principal
Unlike other countries where private bankers issued public debt, Holland dealt directly with prospective bondholders. They issued many bonds of small coupons that attracted small savers, like craftsmen and often women.
Rule Britannia: British Consols
In 1752, the British government converted all its outstanding debt into one bond, the Consolidated 3.5% Annuities, in order to reduce the interest rate it paid. Five years later, the annual interest rate on the stock dropped to 3%, adjusting the stock as Consolidated 3% Annuities.
The coupon rate remained at 3% until 1888, when the finance minister converted the Consolidated 3% Annuities, along with Reduced 3% Annuities (1752) and New 3% Annuities (1855), into a new bond─the 2.75% Consolidated Stock. The interest rate was further reduced to 2.5% in 1903.
Interest rates briefly went back up in 1927 when Winston Churchill issued a new government stock, the 4% Consols, as a partial refinancing of WWI war bonds.
American Ascendancy: The U.S. Treasury Notes
The United States Congress passed an act in 1870 authorizing three separate consol issues with redemption privileges after 10, 15, and 30 years. This was the beginning of what became known as Treasury Bills, the modern benchmark for interest rates.
The Great Inflation of the 1970s
In the 1970s, the global stock market was a mess. Over an 18-month period, the market lost 40% of its value. For close to a decade, few people wanted to invest in public markets. Economic growth was weak, resulting in double-digit unemployment rates.
The low interest policies of the Federal Reserve in the early ‘70s encouraged full employment, but also caused high inflation. Under new leadership, the central bank would later reverse its policies, raising interest rates to 20% in an effort to reset capitalism and encourage investment.
Looking Forward: Cheap Money
Since then, interest rates set by government debt have been rapidly declining, while the global economy has rapidly expanded. Further, financial crises have driven interest rates to just above zero in order to spur spending and investment.
It is clear that the arc of lending bends towards ever-decreasing interest rates, but how low can they go?
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