(This is Part 1 in a series.)
There are a number of developments going on beneath the surface in the financial & economic world, developments which the public may be intuiting at some level but which may also seem murky and unclear. So let's look into them:
What's happening now has some similarities to the first time it ever happened...some 300 years ago in the French economy. John Law, a Scotsman, showed the French government how coins could be replaced by paper money.
And the beauty part was that—unlike coins which depended on precious metal supplies—there was no limit to how much paper money could be produced.
This paper money came in the form of shares in Law's Mississippi Company, which was granted by the French government the exclusive rights to commerce in all of North and South America, India and China!
A fierce competition arose to get these highly valuable shares which had such valuable rights. People camped out in the Rue Quincampoix and waited for hours to see if they had gotten in on the latest share subscription.
The shares were paid for with paper money, billets d'etat, issued by the French government. And the government couldn't help but notice that this paper money acted like an elixer on the public.
Everybody was happy. Commerce boomed. The economy soared. And the price of the shares in the company rose higher day by day. France became the envy of Europe. People were getting rich!
At one point there was a momentary loss of confidance—the shares seemed so high! So the French government printed more money, and then more and more, and the shares soared higher again. Higher and higher. Everything was magical.
The peak was reached in January of 1720. The share price hovered near the peak until early spring and then began a precipitous decline until the shares—and the economy, now awash with paper money—reached the bottom.
France, which only months before seemed to be the richest and most confidant state in Europe, became bankrupt—its economy and currency destroyed.
A variation on a theme occurred during the 1920s in the United States. During the "Roaring Twenties" the modern form of money—credit—increased many times over. And the value of stocks and homes soared along with it. By the fall of 1929, the ratio of Total Credit to GDP had reached 150%, an historic record at that time.
The stock market reached its peak in August of 1929 and then began a slow decline from the lofty heights it had reached. Then, in late October of that year, the market suddenly cracked as shareholders panicked and tried to unload their stocks at the same time.
Over the next 3 years stocks lost 90% of their value and houses lost 80%. Buy and hold? In the case of both stocks and real estate, values took 25 years to get back to where they were at their peaks.
Note that the crash and depression were not caused by tight money conditions but by easy money conditions. The vast increase in credit during the 1920's created soaring asset values—which then had to plummet when the Credit Bubble that was supporting them became unsustainable.
A final example is Japan's Great Bubble of the 1980's, when the ratio of Total Credit to GDP reached the unheard of figure of 250%. It was said that the Emperor's palace and grounds were worth more than all the real estate in California. Meanwhile, the Nikkei Average reached nosebleed heights of 40,000.
The resulting bust took the Nikkei down to 7,000, amid crashing real estate. The economy has yet to recover, but what saved Japan from an outright depression is that the rest of the world—and especially the United States, the world's largest importer—was still doing okay and so Japan could export to it.
Just for the sake of comparison, let's note that the ratio of Total Credit to GDP in the United States has now reached an all-time high of 300%. And therein lies a tale...
(This is the end of Part 1. Go to Part 2.)
—jim sloman, 3.26.04 for Jan 22
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