America was the China of the early 20th century

Oct 23, 2015

- By Bill Bonner

Bill Bonner
Lausanne, Switzerland

Mario Draghi set off a riot yesterday. Investors rushed the stock market, like looters hoping to score a new TV set. By the end of the day the Dow was up 320 points.

The proximate cause of this hullabaloo was Draghi's hint that the European Central Bank may go back into the market with more QE. That, and a good report from Mickey D, was enough to erase the last of this autumn's losses.

But why would Draghi be ready to take up QE again?

Maybe he's been looking at sales figures for the yellow machines. Caterpillar tells us that not only have sales been falling every month for the last 3 years, they're also getting worse and worse. In September, not a single one of its reporting regions saw an increase; all were going down.

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Either CAT is a terribly mismanaged company...or something else is going on.

It is a nice day here in Lausanne. Cloudy, but not too cold. Or too hot. We have had a good night's sleep. We are in a good mood. So let's take a look at the part of the glass Draghi must be studying...the empty half. After all, Draghi must have some reason to be talking about another round of QE. (We'll set aside our darker suspicions that it is purely an inside job...that the real purpose is just to help banks unload some of their mistakes onto the ECB and the public.)

Taking the train from Baltimore to New York, you go through the great metropolis of Trenton, NJ. There, in full view of the passengers is a faded sign, evidence of the burg's faded glory:

"Trenton makes; the world takes."

That sign must have been put up in the '20s or '30s...when it was true. By the '80s, Trenton was doing the taking. And one of the places from which it took the most was China.

America was the China of the early 20th century. It was the world's lost-cost producer, its leading exporter of manufactured goods. In WWI, it was to the USA that Britain - then, the world's leading empire - turned. Britain needed food, fuel, guns, trucks and everything else it took to fight a war. The US happily took the orders until Britain went bust.

But that was not the end of the story. After the war, gold continued to come into the US in payment for war debts. Gold was the foundation of America's money supply, and this larger foundation provided the stage for a huge economic boom. The 'Roaring 20s' was fundamentally an economic and financial bubble. It was the result of having more money to lend and spend, and from central bank manipulation. In 1927, the Fed decided to lower interest rates in the US in order to reduce the value of the dollar. As far as we know, this was the first time the Fed intervened in the credit market, seeking to improve the economy. And it was a disaster.

Stocks shot upwards. Moms and pops jumped into the stock market, hoping to get rich. Margin debt. Factories added capacity. Spending soared. And then the market collapsed.

The situation probably would have resolved itself fairly quickly had not the spirit of activism also infected the rest of the government. Hoover was on the case...followed by Roosevelt, both clumsily trying to 'do something' to stop the correction. Their actions stretched a normal correction into the Great Depression.

But that is a long story. The story we are telling today is about how monetary 'stimulus' sent an economy into hyper-drive, leading to a crash and a depression. It happened to the world's leading export nation -- the US -- in the '20s and '30s. Arguably, something similar is happening to the world's leading exporter now.

Now it's China that makes. Trenton and the rest of the US take. But China's real growth rate may be only half of the reported 7%, according to some analysts. Many people say China works according to different rules, that it follows a different set of economic principles. Yeah. Yeah. 'This place is different...'

But our bet is that gravity works in China just as it does elsewhere. And after its own Roaring '80s, '90s and '00s...China must be coming back to earth. And falling too are many other things. When Chinese factories make less noise, they need less iron, copper, tin, and oil. And when they need less of these resources, the countries that provide them have less money to spend.

But they're not the only ones. China expanded to meet the demand from its overseas customers - many of them in America. Now, those customers have less to spend too. Less money goes to China...its foreign currency reserves fall...its money supply drops... its economy slows...

And the whole world economy slows with it.

Most likely, that is the meaning of Caterpillar's latest report --- with global sales down for 11 months in a row at double digit rates.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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