Betting on a real depression?
05/March/2009 11:06 Filed in: Oikos
Thoughts | Web News
What are the odds of a real depression?
Yesterday an article in the Wall Street Journal put that probability at about 20%. Is that good news or bad news, I assume that is truly an individual determination?
What Are the Odds of a Depression? by Robert J. Barrow, examines just that possibility. The report is based upon looking at 251 stock-market crashes from around the world dating back to 1870. When you factor out those associated with major wars, the current Iraq and Afghanistan conflicts do not apply, you are left with 209 crashes and 59 depressions. Defining a minor depression as at least a 10% decrease in GDP, and a major depression of a 25% decrease in GDP, crunching the numbers, resulted in the 20% number and the 2% probability respectively. The details are well spelled out in the article, as well as the title of the working paper source document.
This somewhat intertwines with thoughts in yesterday’s article which generally ties true wealth directly to stock market Dow Jones Industrial Averages. The reference point to which most recently relates, in both our article and the Barrow depression data, is to the recession of 1982 when GDP fell 3%.
In our faux pas article was also a remark about 1971, when President Nixon unilaterally took the United States out of the Bretton Woods Agreement that served us well in the post WWII redevelopment of world economies.
In that light I became inquisitive of just what were those Dow numbers from 1982 and 1971 and how they might compare with where we are now and that Dow high from 2007. That all time high came in October 2007 @ 14280. Therefore if we use this as a richness zenith, it has been downhill since that point, approximately 55%. Dow numbers for the 1971 year averaged pretty steady around 900. The numbers for 1982 were quite similar to those in 1971, except for a rally near year end that took the Dow to about 1100.
Now these numbers do not include inflation which was considerable especially surrounding the 1982 recession, or the period of stagflation. However it could be argued that inflation numbers are built into the Dow average itself, so backing out a composite inflation number, while it does make one feel somewhat better, really is not a meaningful exercise. So if you are averaging the weight of apples, it doesn’t make much sense to throw in an orange weighing exercise, unless you are not dealing with apples and oranges, but generalized fruit weights.
The biggest change however, and probably the most significant force in driving up the Dow was a rapidly increasing number of small individual investors from the 1970s and onward. The concept of investing in common stock equity as a means to grow your retirement, walked in lock step with buying your own home as your major source of wealth. If you could couple some sense of real estate speculation with a somewhat risky growth stock play, you could retire early with little true risk?
The question then surfaces does this increase from around 1100 to an excess of 14,000 mean a true increase in wealth or just a dilution of the underlying wealth according to market supply and demand characteristics relating to increasingly cheap money and debt leverage? Lacking any sort of meaningful analysis by some truly independent source, the question will probably be somewhat answered by another question. “Just how low will it go?”
So we are learning that the past and the present does not always indicate the future. We believed the words would make the numbers work. Now we are all learning that our words and numbers do not create or even forecast reality. Some will find that an impossible lesson to learn.
We have also provided a link to the Depression Odds article under our Resources tab.
Yesterday an article in the Wall Street Journal put that probability at about 20%. Is that good news or bad news, I assume that is truly an individual determination?
What Are the Odds of a Depression? by Robert J. Barrow, examines just that possibility. The report is based upon looking at 251 stock-market crashes from around the world dating back to 1870. When you factor out those associated with major wars, the current Iraq and Afghanistan conflicts do not apply, you are left with 209 crashes and 59 depressions. Defining a minor depression as at least a 10% decrease in GDP, and a major depression of a 25% decrease in GDP, crunching the numbers, resulted in the 20% number and the 2% probability respectively. The details are well spelled out in the article, as well as the title of the working paper source document.
This somewhat intertwines with thoughts in yesterday’s article which generally ties true wealth directly to stock market Dow Jones Industrial Averages. The reference point to which most recently relates, in both our article and the Barrow depression data, is to the recession of 1982 when GDP fell 3%.
In our faux pas article was also a remark about 1971, when President Nixon unilaterally took the United States out of the Bretton Woods Agreement that served us well in the post WWII redevelopment of world economies.
In that light I became inquisitive of just what were those Dow numbers from 1982 and 1971 and how they might compare with where we are now and that Dow high from 2007. That all time high came in October 2007 @ 14280. Therefore if we use this as a richness zenith, it has been downhill since that point, approximately 55%. Dow numbers for the 1971 year averaged pretty steady around 900. The numbers for 1982 were quite similar to those in 1971, except for a rally near year end that took the Dow to about 1100.
Now these numbers do not include inflation which was considerable especially surrounding the 1982 recession, or the period of stagflation. However it could be argued that inflation numbers are built into the Dow average itself, so backing out a composite inflation number, while it does make one feel somewhat better, really is not a meaningful exercise. So if you are averaging the weight of apples, it doesn’t make much sense to throw in an orange weighing exercise, unless you are not dealing with apples and oranges, but generalized fruit weights.
The biggest change however, and probably the most significant force in driving up the Dow was a rapidly increasing number of small individual investors from the 1970s and onward. The concept of investing in common stock equity as a means to grow your retirement, walked in lock step with buying your own home as your major source of wealth. If you could couple some sense of real estate speculation with a somewhat risky growth stock play, you could retire early with little true risk?
The question then surfaces does this increase from around 1100 to an excess of 14,000 mean a true increase in wealth or just a dilution of the underlying wealth according to market supply and demand characteristics relating to increasingly cheap money and debt leverage? Lacking any sort of meaningful analysis by some truly independent source, the question will probably be somewhat answered by another question. “Just how low will it go?”
So we are learning that the past and the present does not always indicate the future. We believed the words would make the numbers work. Now we are all learning that our words and numbers do not create or even forecast reality. Some will find that an impossible lesson to learn.
We have also provided a link to the Depression Odds article under our Resources tab.