We’ve been discussing Irving Fisher in our morning meetings lately, especially in context of the ever broadening adoption of Keynesians economics. As many of you already know, we are located in New Haven, CT on the fringe of Yale’s Campus, so we have an inherent interest in topics related to Yale, which is where Fisher received his undergraduate degree, PH.D, and taught for many, many years.
Famously before the stock market crash of 1929, Fisher predicted, “Stock prices have what look like a permanently high plateau.” This emphatic call from Fisher, which was incredibly wrong, proved to be the undoing of his reputation, and his personal wealth. The unfortunate side effect of the terrible market call by Fisher was that his debt-deflation analysis of the Great Depression was largely ignored and Keynesian economic ideas began their rise to prominence.
According to a recent Economist article, “Fisher was adamant that ending deflation required abandoning the gold standard, and repeatedly implored Franklin Roosevelt to do so.” The combination of going off the gold standard with FDR’s bank holiday, which stabilized the domestic banking industry, marked the bottom of the Great Depression. As many FDR critics accurately argue, true recovery would come only many years later after many missteps by FDR and his various advisors. Nonetheless, this Fisher idea of devaluing the dollar, or as we like to say, ”Breaking the Buck”, was key to the initial recovery.
Fisher wrote in “The Debt-Deflation Theory of Great Depressions” that there are two dominant factors in great booms and depressions, “namely over-indebtedness to start with and deflation following soon thereafter.” A recent report by the Bank Credit Analyst, suggested that current non-financial institution debt in the U.S. is at 190% of GDP versus 160% just prior to the start of the Great Depression. While we haven’t stress tested the 190% number, we do believe that it is directionally correct. As Fisher goes on to write, while “over-investment and over-speculation are often important; they would have far less serious results were they not conducted with borrowed money.” Thus the high debt level only serves to amplify the typical business cycle.
Many of our clients have asked about our thesis that the US dollar needs to go down for the stock market to go up. Partially this is driven by observations. We use price rule as a primary factor in much of our work and we have observed that the market and the dollar are inversely correlated, or have been for the last 3+ months. The derivative question is obviously, why is this so? In our view, it is that the market understands basic Fisher economics. Specifically, we have an emerging debt asset / imbalance that can only be solved by re-flating assets.
Fisher wrote that it was “always economically possible to stop or prevent such a depression simply by re-flating the price level up to the average level at which outstanding debts were contracted.” Without this re-flation, it is likely the deflation continues to occur such that the debt to asset imbalance becomes even more imbalanced as the price of assets decline and the price of debt, in U.S. dollar terms, stays constant, or increases.
As we have seen over the last two quarters, and as Fisher argued many years ago, fiscal stimulus will likely not be enough to stimulate a recovery in an economic environment where indebtedness is the primary factor. The risk in not re-flating is that the spiral of deflation continues.
As Fisher concluded in “The Debt-Deflation Theory of Great Depressions”, “great depressions are curable and preventable through re-flation and stabilization.” Indeed.
Daryl G. Jones