Panic and Booms, a lesson from 1897

Readers: Paper Money Illusion Jail Break recommends the following article with a 8/10 rating.

Thanks to Patrick for an absolute gem.  Earlier this week, he linked to a fantastic newspaper article written in 1902.  That article actually reprinted a paper written five years previously, entitled “Panics and Booms” by L.M. Holt.  When Holt wrote the paper, the economy was at the tail end of a depression.  Holt argued that booms always follow busts, so folks should anticipate the return of flush times.  Fast-forward five years, a new boom was in full swing, and the newspaper republished Holt’s paper as a warning that the next depression was due around 1910, give or take.  The Bank Panic of 1907 arrived a bit ahead of schedule.

It’s a great read, particularly now when most observers remain conflicted about what kind of economic funk we’re in.  Mr. Holt described quite clearly the economic conditions we face today, a depression created by over-indebtedness.  And he offers a prescription for how to dig ourselves out: pay back debt.  It’s a prescription I endorse wholeheartedly.

The paper is so good, for posterity’s sake, I have reproduced it here in full.  Another reason: Irving Fisher generally gets credit for having created the “debt deflation theory of depressions,” but Holt beat him to it by 36 years.  Enjoy!

“Panics and Booms”

L.M. Holt

Ever since the establishment of the human race on this planet there has been a gradual increase of population and a more rapid consumption of wealth.

Wealth is the result of labor, and without labor there can be no wealth.

Men live and pass away, but as they cannot take their wealth with them a large percentage accumulates for the benefit of their successors. Hence the wealth of the world today, per capita, is much greater than ever before, and it is continually on the increase.

The transfer of wealth, or property, from one person to another creates business.  Under favorable conditions, transfers are numerous and business is brisk.  Under unfavorable conditions transfers are few and business is dull.

During periods of business activity there is work for all, and this of itself makes greater business activity.  During periods of business depression there is not work for all, and this of itself makes business dull and unprofitable.

The existence of either one of these conditions leads necessarily to the other.  It is an impossibility for either prosperous times or depressed times to continue permanently.

This is where it starts to get good…

During prosperous times, there being work for all, all are supplied with the means of accumulating wealth, and thus all are enabled to provide themselves, and families with all the necessaries, and many of the luxuries, of life; and hence, during the prosperous times the demand for goods and property increases and soon the demand exceeds supply, and then prices advance.

This rule, which is applied to the laborer, is also applied to the business man.  Prosperous times induce business men to branch out in their several lines of trade….The volume of trade being large, each gets a corresponding proportion of it.  Many business men find that they can do more business than is allowed by their limited capital.  They then buy on credit.

Prices are continually advancing, therefore they are able to make margins of profit not only on the capital furnished by themselves, but on the capital furnished through their credit.

This rule also applies to people dealing in real estate.  The country is growing; money is easy; the times are good; business is prosperous and therefore speculation is favored.  A man worth $5000 can buy four times that amount of property using his credit, and sometimes he buys ten times that amount or more.  While prices are advancing he not only gets the benefits of the advance in the price of the property represented by the capital furnished by himself, but also on the capital furnished by his credit.

When prices of property and goods during a period of business depression are falling, the loss does not come on the entire property, but only on that portion of it represented by the cash capital the man has invested in it.  The debt never shrinks until the real investment is all gone.

A fantastically simple description of leverage, that is, investing with borrowed money as a way to amplify potential gains at the risk of greater losses.  How quaint that Holt seems impressed by “ten times” leverage.  He would blush at the leverage ratios permissible today.

Panics and Booms, a lesson from 1897 | Analysis & Opinion |

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