No repeat of the Great Depression

There have been a number of analysts like Bob Prechter and Doug Short who believe that the pattern shown by the US stock indices look like a repeat of the 1930s and the Great Depression.

It is difficult for me to make the case that the current conditions make a repeat of the Great Depression inevitable, or even likely. James Hamilton of Econbrowser commented on Short’s analysis this way:

Among the factors that turned the hoped-for recovery of 1930 into the debacle of the Great Depression were a sharp hike in interest rates in October 1931 and a decline in the overall price level of 10% per year in 1931 and 1932. Whatever else happens, I don't expect those particular mistakes to be repeated by the Bernanke Fed.

In addition to Hamilton’s assertions about the Bernanke Fed, I would add a couple of other points that should be encouraging for the bulls.


Protectionist hounds are in the kennel
Countries raising their protectionist drawbridges was one factor that exacerbated the effects of the downturn in the 1930s. This time, it doesn’t seem to be happening. Recently, the Economist reported that global trade seems to have flattened out. Floyd Norris recently wrote in the New York Times that there are even hints of an upturn in global trade.

Countries all around the world seemed to have learned to open markets and free trade lesson this time around. Consider these headlines in the last few months:

• South Korea and EU reach free trade deal
• GCC, EU may sign FTA in Bahrain next month
• China backed free-trade area in Asia to launch in 2010
• Canadian PM Harper in Panama to sign free trade deal

What’s interesting about some of these headlines is that free trade is being embraced around the world, which is highly encouraging for the long-term macroeconomic backdrop. The fact that the EU, which has a history of bickering and isn’t known for being friendly to open markets, is negotiating free trade deals around the world is a bit of a surprise to me.


What if peace breaks out?
There are also geopolitical wildcards. What if the US and Iran made peace?

Bruce Bueno de Mesquita, a specialist in game theory at NYU, forecasts precisely such an outcome:

Last year, Bueno de Mesquita decided to forecast whether Iran would build a nuclear bomb. With the help of his undergraduate class at N.Y.U., he researched the primary power brokers inside and outside the country — anyone with a stake in Iran’s nuclear future. Once he had the information he needed, he fed it into his computer model and had an answer in a few minutes…

...Iran won’t make a nuclear bomb. By early 2010, according to the forecast, Iran will be at the brink of developing one, but then it will stop and go no further. If this computer model is right, all the dire portents we’ve seen in recent months — the brutal crackdown on protesters, the dubious confessions, Khamenei’s accusations of American subterfuge — are masking a tectonic shift. The moderates are winning, even if we cannot see that yet.

Should these events come to pass, which are not on any market analyst’s radar screen, oil prices would like fall because of a reduction in the geopolitical premium and equities would rally.


No Armageddon
In conclusion, it is highly unlikely that the world is going to repeat the mistakes of the 1930s. I am concerned, however, that it would make new mistakes.

In the short term, I continue to believe that the market is extremely vulnerable to setbacks. China seems to be the bellwether. The trajectory of the Shanghai Composite seems to indicate that China’s stimulus mini-bubble is bursting and the world is in danger of getting dragged into a double-dip slowdown as China appeared to be the last engine of growth.

If a double dip does occur, investors should keep in mind that it is only a bear market, not Armageddon.