An alarming amount of the rhetoric being used by some experts in calling for austerity parallels the 1930's disastrous balanced-budget policies that plunged us back into a recession, writes MoneyShow's Tom Aspray. Also, he explains what investors should watch after a tough week for stocks.
It was a very rough week in the stock market, as the S&P 500 cracked the widely watched support at 1,420 on Tuesday. Prices closed the week just above the next key support in the 1,395 to 1,400 area. Friday's close was mixed, as the major averages moved in and out of positive territory for much of the day.
The action last week clearly did some technical damage, and it has now been six weeks since the September 14 highs. The decline from the early April highs lasted nine weeks and took the S&P 500 9.8% down from its highs. A similar decline would last until well after the election, and the same percentage decline could take the S&P as low as 1,322, but I do not think that is likely.
With the resurgence of the Romney campaign, which is considered to be more "business friendly," why are stocks so weak? The airwaves have been flooded with gloomy forecasts from business leaders who are focused on the fiscal cliff and high debt levels.
The fiscal conservatives favor more austerity, as they conclude that our increasing debt levels have to result in much higher inflation. Many are hoping that this will be like 1980, when Reagan's election spawned a 20-year bull market.
One election year that no one mentions is 1936, when the country was coming out of the only recession that was worse than our recent one. The debate was similar back then: Kansas Governor Alfred M. Landon wanted government regulation to be removed, and states be given more control. At the time, many businessmen challenged the programs of FDR, as they felt overtaxed and overregulated.
As noted in an excellent paper by Marshall Auerback from the Roosevelt Institute, "the Roosevelt administration reduced unemployment from 25% in 1933 to 9.6%% in 1936, up to 13% in 1938 (due largely to a reversal of the fiscal activism which had characterized FDR's first term in office)."
The author also notes that, "By 1936, many economists and financial experts (notably FDR's Treasury Secretary, Henry Morgenthau) feared the country would go bankrupt if the government kept deficit-spending." (Sound familiar?)
"And after all, they argued, the government deficits had "pump-primed" the economy. The private sector could now take off on its own and get back to close to the full employment level of 1928 to early 1929."
Though I did know the basics of this from my college days as a US history major (before I turned to biochemistry), I found the similarity of the rhetoric quite surprising. Of course, the charts pointed me in this direction, as the chart of the Dow Industrials shows a nice uptrend from the 1934 lows.
There was little in the way of a correction in 1936, as FDR had a landslide victory, but the uptrend was broken in September 1937. By April 1938, the Dow had dropped over 50% from its highs. It was in 1938 that Roosevelt submitted a budget where the deficit had been eliminated...but unfortunately so had the recovery.
Though other economists argue about the conclusions of Auerback, it is interesting to note that in 1936, the path to austerity was widely accepted. Now there seems to be a similar view that inflation is inevitable. and the hope is that by cutting our spending quickly, the inflationary spike won't be that bad.
Unlike a few years ago, no one now seems to be concerned about the threat of deflation-yet most economists agree it is much harder to stop.
Therefore I found this chart of the deflationary cycle quite interesting. A careful examination of the various stages look similar in ways to our recent past. With the recent debate over our policy with China, the Protectionism & Tariffs phase especially stood out. Hopefully, a deflationary period is not ahead of us.
NEXT: How Does This Affect Us Today?