Platt Perspective on Business and Technology

Open markets, captive markets and the assumptions of supply and demand dynamics 11

Posted in macroeconomics by Timothy Platt on April 18, 2016

This is the eleventh installment to a brief series on underlying assumptions as they arise and play out in economic systems, and in production and marketplace systems (see Macroeconomics and Business 2, postings 230 and loosely following for Parts 1-10.)

I have been discussing economic friction, as one of the core narrative threads through most of this series. And I began addressing the role of politics in that in Part 8. And to better connect this posting with the progression of thought leading up to it, I repeat here, two definitional bullet points:

• Economic friction and business systems friction are the consequential outcomes of miscommunication and communications delays, and of failures in acquiring and acting upon essential business intelligence in a sufficiently timely manner.
• And politically grounded economic friction is economic friction that arises as a result of adherence to preconceived ideologically driven vision, and even when that means acting in denial of direct empirical evidence to the contrary. Politically grounded economic friction arises and flourishes when politically driven ideological purity overwhelms empirical reality as a source of guiding principle.

In keeping with that starting point, I then briefly and very selectively sketched out how miscommunications, and resulting politically grounded economic friction, played significant roles in leading the world into a Second World War: in the Atlantic, Europe, Africa and the Middle East (see Part 9) and in Asia and the Pacific (see Part 10.)

I stated in Parts 9 and 10 that I would follow their discussion with an at least brief analysis of how the United States and then the world as a whole were drawn into the Great Depression. I will do so here, noting up-front that when I say that I will selectively address that set of issues, I mean that I do so with the goal of setting up a template of historical fact and experience for discussing our more recent Great Recession, and the still unfolding story of China and its recent and still developing challenges.

There are two basic approaches that I could pursue here in outlining the origins of the Great Depression. I could start with and focus on a carefully select set of historical detail and then briefly frame them in terms of a set of overarching principles, or I could attempt to address this essentially entirely in terms of those general principles, leaving the details to reference links inserted into the text. I was initially planning on pursuing the second of these approaches but decided to attempt the first instead. So I begin with the Roaring Twenties: a time in history when the world at large, and certainly much if not most of the Western World thought that good times were here to stay – permanently, and that wealth would grow and grow and for anyone willing to reach out to grab their opportunities.

This included investors who came to see their every gamble in whatever market as a sure bet win; this included the investment agents as individuals and the financial institutions that they worked for that packaged and sold investment instruments, and that then turned around and accepted them as collateral on loans – and even when the funds so loaned out would be used to buy more shares of those same investments. The good times were here; the good times were here to stay.

• I have cited pre-Great Depression bank holding companies in the past in this blog, but chose to raise their specter again here too as a first (non-)working example of this phenomenon. Banks organized under holding companies, with many of these business entities including and effectively controlling several or even many distinct and otherwise separate banking institutions. Many of those individual banks in turn owned and operated large systems of branch offices. These holding companies issued publically traded stock shares, which is not necessarily a problem in and of itself. But their own member banks routinely came to accept their own holding company’s stock as preferred collateral when making loans, and both to individuals and to businesses. And this created levels and types of fiduciary risk that were both significant and unexamined, as they conducted this business, and as an industry-wide practice.
• As a second (also not really) working example, I would cite real estate speculation. The best known example of this in the United States for the 1920’s, at least categorically stated, has to be that of Florida real estate scam sales. See Swampland in Florida and Florida Land Boom of the 1920s for some specific details of this. And I note in this context that Florida real estate scams are still alive and well, and actively offered to the unwary and even today as I write this. And Florida’s real estate “irregularities” only represent one fragment of a more pervasive and far reaching problem.
• As a third example, I turn to the stock market in general, and note its lack of transparency in what businesses were required to report about themselves and their finances, in order to offer stock shares for public sale. Stocks were marketed by salesmen who made their income from that on commission for the most part and who had a vested personal interest in completing sales of shares and regardless of the actual risk and reward potential faced by the buyer. This created an almost perfect conflict of interests driven marketplace. And the admonition caveat emptor (let the buyer beware) fully held sway. Purchase of stock shares was in many respects simply a form of gambling for most investors. Stock speculation levels rose dramatically through the 1920’s and both for the number of investors participating, and for the levels of participation that they entered into on average, per investor. And the percentage of this overall investment activity that was backed by loans from banks and other financial institutions skyrocketed too. For references to some of the specifics of this, see this piece on Speculation.
• And I will round out this set with the commodities markets, which I will simply note here were very largely driven by speculation, and more specifically by speculation that investors entered into while burdened by deception on the part of traders and commodities producers, and opacity in these markets and in their traded offerings. (See, for example: the Encyclopedia of Chicago: commodities markets.)

These events and circumstances: these investment traps and minefields and these heavily rigged games were all, in effect products of political decision making as governed by lobbyists and as justified by political dogma and personal political agendas.

Now, let’s consider the above offered four (non-)working examples and that bald assertion concerning them, in terms of some underlying principles that both enabled those bad practices and others like them, and that led to the Great Depression as a whole.

1. All four of them, and in fact the workings of the economy as a whole, were driven by essentially entirely laissez-faire political ideology, and a politically motivated doctrine according to which essentially any and all governmental regulation is and must be bad. Adam Smith and his The Wealth of Nations were selectively invoked and interpreted as if religious icons, and Smith’s vaunted invisible hand, governing and stabilizing the marketplace and economy was simply assumed as unquestionable truth and a validation of the political claim that outside governmental regulation of the marketplace is unnecessary and that it is avoidably repressive. So businesses and financial and trading institutions and the people who ran and operated them could do so, essentially entirely without regulatory oversight that would limit or control recklessness or even overtly predatory behavior on their part.
2. This also meant consumers and buyers, and of finished products and services, and of investment instruments and options did so without any assurances and without being able to make informed due diligence decisions, at least as might be supported and sustained by law. Caveat emptor, as noted above, held sway in all marketplaces and for all participants in them.
3. Now let’s focus specifically on investments and investment instruments. I just noted the opacity that went into them and that masked what was in them and certainly for actual risk and opportunity faced. At least as importantly, investment options became more and more convoluted and complex, and right up to the point where the economy as a whole began to collapse as the Great Depression really took hold. Opacity and complexity here can be seen as if two sides to a same coin.

And the economy as a whole and many of the largest and seemingly most powerful and secure businesses participating in it, were functioning in effect as if hollow shells. This included so called blue chip publically traded companies, and some of the most historically renowned of them, many of which died off, closed down and disappeared during the Great Depression. And the Depression set in.

I have been promising for several installments now to consider the Smoot–Hawley Tariff Act here, which I have referred to in this context as “a stunningly flawed political economic decision.” I will do so here, with the above as background for the points that I would make regarding this specific politically driven economic decision on the part of the United States Congress.

Black Thursday took place on October 24, 1929 when the US stock market collapsed with the largest single day drop in recognized overall market valuation ever recorded as a percentage of start-of-day point value. Then on October 29, 1929: Black Tuesday, Wall Street as a whole collapsed (see Wall Street Crash of 1929.) And this rapid progression of events and circumstances is often seen as the “official” start to the Great Depression, as the house of cards: the collection of corporate and economic hollow shells that I have been noting here began to catastrophically collapse. And the events of these six days did in fact mark a significant turning point, and both in hard underlying business and economic fact and in the perhaps softer and less easily quantified but equally significant terms of public opinion. But the market actually began to rally as those with liquidity began to see business offerings that were still listed on the stock exchange as greatly undervalued there and as genuine positive investment opportunities. And then the US Congress stepped in and politicians and demagogues began to rail against foreign manufacturers, and the presumed threat of their dumping their commodities and finished goods into US markets to further their own ends at the expense of killing off American businesses and jobs. And Senator Reed Smoot and Representative Willis C. Hawley led the charge to impose punitive tariffs to foreign imports to stop this. On June 17, 1930 the Smoot–Hawley Tariff Act was passed into law, and the effect of this act of ideologically driven politicking was rapid and global in reach. Countries that had sold raw materials and finished goods to the United States stopped doing so, and they stopped buying raw materials and finished goods from the United States too. This act shut down production lines in the United States, putting a great many people out of work who had stayed employed through the stock market crash itself. And that new and expanded downturn really established the Great Depression in the United States as such. But at least as importantly and in a global sense much more so, this also made this depression expand out until it rapidly came to adversely reshape businesses and economies everywhere. So the Smoot–Hawley Tariff Act actually started this depression as the Great Depression in the United States by absolutely ending any possibility for short-term recovery, and it marked the true beginning of the Great Depression as a global depression too. And yes, at the risk of being overly repetitious here this makes the Great Depression, a direct consequence of ongoing politically grounded economic friction with ideological purity overruling both common sense and all of the empirical, visibly observable evidence that was available, and certainly by June 1930.

I am going to refer back to the three numbered points that I noted here in this posting, and the four bullet pointed examples of their consequences as offered above them, when turning to consider the more recent Great Recession, and China’s still unfolding economic challenges, and their responses to them. I will also specifically return to reconsider the narrative of Part 10 of this series, for a discussion of some apparent parallels that might be considered between Japan of then and China of now too. And I will begin addressing all of this in my next series installment. Meanwhile, you can find this and related postings at Macroeconomics and Business and its Page 2 continuation.

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