By Al Coryell
Host/Moderator

Question: We’re not headed into another Great Depression, are we?

Can you see the similarities between the chart patterns above? If I told you the left chart was a prelude to the greatest economic disaster in American history, what would you surmise about the chart on the right?

Economic historians still argue about what caused the great Stock Market Crash of 1929 and the subsequent economic depression. Whatever the cause, in October 1929, the stock markets began to collapse. Everyone one with a spare dime was leveraged in the stock market. Businessmen, housewives, grandmothers, flappers and rodeo clowns, they were all invested because the stock market was roaring like the rest of the 1920s. The market had increased five-fold in just six years with no end in sight. Neo-classical economist Irving Fisher famously proclaimed, “Stock prices have reached what looks like a permanently high plateau.”

But as the market began to fall that autumn, it suddenly became evident that something was seriously wrong. The Dow Jones Industrial Average lost 17 percent of it’s value the first week and nearly 35 percent before anything resembling a bottom was put in more than a month later. There was a great sigh of relief when what (at first) seemed like a bottom occurred on Nov. 13. The Dow closed at 198.60 that day, and the market began a recovery that lasted for the next several months.

The Dow rose almost 100 points over the next few months, reaching a peak of 294.07 on April 17, 1930. An uncomfortable confidence had tentatively rejuvenated the markets, but irreparable damage to the financial system had already been done. A first wave of bank runs, panics they were called then, had closed scores of banks, and the economic fallout was spreading like a cancer throughout the global financial system, not just the United States. There would be two more waves of bank runs before the Great Depression was over, closing nearly 10,000 banks and other lending institutions.

As you have probably surmised, the “Then” side of the top chart is a close-up of the wave labeled (A) in the second chart, the Dow Jones Industrial Average. In the Dow chart, the initial collapse of the market in October 1929 is labeled wave (A), the subsequent rise into April of 1930 is labeled wave (B) and three years later wave (C) denotes the bottom of the Dow’s collapse at about $41. The Dow Jones Industrials Index lost 89 percent of its value in a little more than three years.

When a stock or an index initially falls really hard and really fast it will tend to bounce back up quickly for a short period of time before resuming the downfall. In trader parlance it’s called a “dead cat bounce,” a rather ominous description but apropos. Wave (B) is the dead cat bounce of the 1929 crash.

The “Now” side of the top chart is a weekly chart of the Dow Jones Industrial Average today. The patterns are eerily similar and many technical analysts are watching the movement of the Dow with great concern for obvious reasons. Are we on a wave (B) dead cat bounce that will eventually take the Dow down 90 percent again? Or are we going to be able to recover and hold the bottom that was put in back on March 9? It’s impossible to say, of course, but the current global economic instability easily rivals the instability of the early 1930’s. In many ways it is much worse, but I will save the explanation of that statement for another blog.

Three major asset bubbles have been created and burst since 1983; the Savings and Loan housing crisis in the late 80s and early 90s, the tech or “dot com” bubble in 2000 and the sub-prime housing crisis in 2005-06. Three more asset bubbles exist and are looming ominously on the near horizon… a second wave of housing loan defaults (this time Alt-A and 5 year Arm resets from 2006), credit card defaults and commercial loan defaults. All three are fueled by rising unemployment. Some $52 trillion of outstanding debt exists for which the Federal Reserve and the Treasury Department are supplying roughly $2 trillion in financial institution guarantees in an attempt to psychologically prop up the bludgeoned financial system. It can’t be done, of course. The attempt is akin to trying to put out a forest fire with a garden hose.

I will leave you with one last chart.

This is a chart of the Dow since 1973. Note that the Dow Jones Industrial Average in 1975 was only 570 points. The Dow never rose above 1,000 until 1983 when President Ronald Reagan and the complicit Congress began to spend money on national defense that the Treasury didn’t have. The Federal Reserve was given carte blanche to inflate the money supply to make up for the deficit. With that act, the precedent was set for every subsequent administration to simply spend whatever it wanted and the Fed would make up the difference by inflating the money supply.

With no gold standard to limit the amount of monetary inflation, the Fed could print as much fiat money as it wanted to keep up with the growing deficit. By 2007 the Dow had inflated, with debt-laden dollars, to 14 times its value in 1983 and almost 25 times its value since 1975. The 1929 stock market bubble only ballooned by a factor of five during it’s period of asset mania, but it lost 89 percent of its value when the bubble burst. What goes up must come down as we are certainly witnessing today.

So the obvious question is… inflated by a factor of 25 times in just over 30 years, how far down will the stock market fall this time?