Wednesday, February 12, 2014

The Dow's Low In 1932 Almost Tested Its High In 1835! Asset Price Deflation In The 1930s Took The Dow Back To The 1860s

These charts released by @Macro_Tourist in a PDF are a must see. I saw them all at Zero Hedge a few days ago (1, 2). There are charts of interest rates and commodity prices going back to 3,000 BC, a gold chart since 1263, and there's a chart of the "western stock market" since 1509. There was a also a chart that specifically showed the U.S. stock market (Dow Jones Industrial Average) since 1789, which I focused on below. In a previous post, I showed you that the Dow's low in 1942 (92.9) was below its secular bull market high of 103 in 1906 (-9.7% over 36 years). But @Macro_Tourist's chart showed an even better flatline. The Dow's low in 1932 (41.2) almost tested its high of 36.6 in 1835 (+12.5% over 97 years). For an analogy that's similar to my previous post, the Dow's low in 1932 (41.2) crashed through its high of 48.9 in 1869 (-15.7% over 63 years). That's how insane the asset price deflation (or deflation overall) was in the 1930s. It took stock prices back almost 100 years.

What's interesting here is the Federal Reserve was already 19 years old at the time and already experienced a few booms and busts and the roaring twenties before this deflationary collapse. So they obviously didn't have their eye on the ball. Look at the chart of the Dow in the 1920s, a rebalancing was inevitable (Michael Pettis, an expert on China, called the U.S. Great Depression a "chaotic rebalancing"). The Austrian school believes it was the monetary inflation and monetary tightening by the Federal Reserve that fueled the massive boom and bust. And to this day, economists wonder if it was the lack of monetary stimulus by the Federal Reserve (money supply, QE) or lack of fiscal stimulus (deficit spending) that failed to backstop the massive deflationary collapse in the economy and asset prices. The Federal Reserve's gold reserve requirement could have been part of the reason why the Fed didn't act to expand its balance sheet until 1932, or maybe not (paper). Let's not forget that protectionist trade policies also contributed to the deflationary forces.

Today, the combination of (unprecedented?) monetary stimulus and deficit spending have so far kept asset prices from collapsing and the economy from contracting since the great recession (2007-2009). But now the question is whether asset price inflation, fueled by releveraging and the Federal Reserve's massive liquidity injections, could actually be positioning the U.S. for another round of deleveraging and deflation when the next powerful negative catalyst hits wire. Some believe this is the reason why the Fed started to reduce its asset purchases (QE) recently.

Look how insane this chart is. So when looking at history, maybe these Dow 5,000 calls, which was a level last seen in the 1990s, isn't really that crazy of a prediction after all.

Source: @Macro_Tourist via The Trader and His Shadow (blue and gray lines added)

Related post I found: Could The Stock Market Test A Trend Line From 1843? (Chart)

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