Friday, December 26, 2008

Reminders of My Father's Sermons

From the Desk of Joe Rollins

As many of you know, my father was a district superintendent for the Methodist Church, and he directly supervised over 120 rural churches in Southwest Virginia and Northeast Tennessee. On Sundays he would often travel to visit his churches, and since I was the youngest in the family I was often brought along for the ride. Many of the churches that we visited only had 15 or 20 families as members, and after the Sunday service my father would meet with the church’s minister.

Being a child, I most looked forward to the potluck picnics that took place after the business meetings on these Sunday ventures with my dad. Since I wasn’t required to attend the business meetings, I was usually the first person in the food line at the picnic. This was a plus since my favorite dish – fried chicken – was usually the first thing to disappear. It also meant I was guaranteed a slice of pecan pie, my dessert of choice. Life was definitely simpler for me in those days…

It’s funny how certain events bring me reeling back to memories of my father. For instance, I thought I had a good deal when I bought my very first home in 1975 in Decatur, Georgia for $32,000. At that time, interest rates on home mortgages were at approximately 11%, which actually seemed relatively low given the high inflation rates in the mid 1970’s. As you may recall, this was just after the oil embargo of 1974. When I proudly went over the details of my home purchase to my father, he reminded me that after World War II, he was able to obtain a mortgage loan at 5% interest. Isn’t it interesting that 65 years later, you can actually get mortgage loans at lower interest rates than what my father was able to obtain just after World War II?

All of the recent talk in the media comparing our current scenario with the Great Depression has reminded me of some of my father’s sermons. The sermons that resonated most with me concerned events that he had lived through himself. Of course he spoke of religious events in his sermons, but I was always captivated when he spoke of more recent events when preaching. Two topics in his sermons that I found particularly interesting concerned the bombing of Pearl Harbor and the death of Franklin Delano Roosevelt.

When speaking of Pearl Harbor in his sermons, my father spoke of what a terrifying and trying time it was for Americans. As Americans were coming home from church on Sunday, December 7, 1941, they found out that the Japanese had unilaterally attacked the U.S. naval base at Pearl Harbor. Hawaii was not admitted to the Union until August of 1959, but because it had been a U.S. territory for nearly 60 years, it was considered to be part of the United States. Until the bombing of Pearl Harbor, the U.S. had basically been neutral in World War II, although we were steadily increasing embargoes and sanctions after Japan’s expansion into French Indochina. The day after Pearl Harbor was bombed, the U.S. declared war on Japan and subsequently, on Germany. Considering that Pearl Harbor wasn’t actually a part of the U.S. Union at the time of the attack, there have been only a few very minor attacks on U.S. soil since the mid 1800’s with the exception being September 11, 2001.

My father also liked to talk about President Franklin Delano Roosevelt in his sermons. As many know, FDR was elected to four terms in office as U.S. president – the only U.S. president to have served more than two terms – and he was beloved in America and throughout the world. FDR served from 1933 to 1945, during the Great Depression and during World War II. His unexpected death on April 12, 1945 left the nation in shock and in grief.

The other night, I watched a three-hour special on FDR on the History Channel, which took me reeling back to my father’s sermons. I learned an enormous amount watching the show that I hadn’t known before. Much of it had to do with economics during the Great Depression and the general state of FDR’s health. I had always heard that the real turn in the Great Depression occurred when FDR was elected in 1932 and instituted a massive public works program called the “New Deal” upon entering office in 1933. It was my understanding that this flood of spending by the Federal government on these public works programs during the Great Depression was what allowed economic recovery and prosperity. As I will explain later, the impression I had was woefully incorrect.

I also remember my father’s impression that FDR died suddenly and without warning. While his declining health had not been released to the general public, he had been looking old, thin and frail in the months leading up to his death and it was common knowledge to those close to him that he was not in good health. In fact, one of his secret service agents exclaimed that at the time of FDR’s death, he was just a shell of a person in a big suit. His body had deteriorated to the point that his eyes were sunken and he suffered almost constant debilitating pain. But the public at large was never made aware of FDR’s increasing health issues. On the afternoon of April 12, 1945, FDR died of a massive cerebral hemorrhage after complaining of a terrible headache. It seems strange today that the health of the most important political figure in the world was hidden from the public. Today, no one in public office has any secrets.

As you can see below in the chart entitled, “U.S. Unemployment vs. Dow Jones Industrial Average: 1925-1945,” when FDR took office in 1933, the unemployment rate in the U.S. was a staggering 25%. While the rate declined to 14% in 1937, it increased again from 1938 to 1940 to rates between 15% and 20% before declining to rates below 5% in 1942 with the start of World War II. Comparing the unemployment rates of the Great Depression to our current unemployment rate of 6.7%, you can see the incorrect comparisons being made by the media concerning our current economic environment and that of the Great Depression.

The chart also illustrates my misperception of the success of the New Deal, leading me to perform some research to determine why it was unsuccessful. FDR was an old-fashioned politician who believed that the government shouldn’t spend money that it didn’t have, which makes sense theoretically, but really doesn’t work. And so, even though FDR wanted to do public works projects, he didn’t want the government to borrow money to make these projects work. Therefore, from 1933 through 1940, the Federal government didn’t borrow any money in an effort to stimulate the economy.

Additionally, the Federal Reserve System believed that it shouldn’t interfere with banks and instead allowed those that were unsuccessful to fail, causing thousands of bank failures in the United States during the 1930’s. Comparatively, 25 banks have failed in the U.S. during 2008. Also, since the Federal government was not collecting as much tax revenue due to the poor business environment, Congress – in its misplaced wisdom – increased taxes on an already failing economy. The combination of no deficit spending, a Federal Reserve that was draining cash out of the system and higher income taxes led to almost a decade of high unemployment and devastating economic conditions in the United States.

In early 1941, the United States was forced to enter World War II. At that point, we had no choice but to use deficit spending to create the armaments necessary to fight the war on two fronts. I’m sure all of you have heard about Liberty selling war bonds – these are now known as the U.S. government-guaranteed bonds that we read about in the papers today. As you can see from the chart, once the government began deficit spending, the unemployment rate fell dramatically in the early 1940’s. Coupled with the enlistment in the armed forces and the manufacturing necessary to make war products, the U.S. economy moved into high gear with virtually full employment in 1944 and 1945.

This chart also shows the Dow Industrial Average for the years of 1925 to 1945. As you can see, the market crashed in 1929 and continued to go down through 1932. It then rallied upward, even in spite of the most horrific economic news possible. After a downturn beginning in 1936, it began moving upward at the beginning of World War II. This chart is on the Dow Jones Industrial Average only; it doesn’t include dividends. In any case, those of you who believe that it took 25 years for the stock market to recover after the crash of 1929 can plainly see that that’s not the case. If you include reinvested dividends in the average, the full value of the 1929 crash was recovered in approximately 10 years.

I am writing this to illustrate that the Federal Reserve’s action this fall relatively assures us that the economy will snap back rather quickly. As noted on the chart above, the economy continued to struggle with no improvement during the time that the Federal Reserve was not deficit spending. However, immediately after the Federal Reserve began borrowing money and pouring it into the economy, unemployment decreased and the stock market exploded upward. The chart above clearly demonstrates the dynamic impact of flooding the economy with cash. Not only is the effect positive, it is also incredibly fast.

Over the last several months, I’ve been discussing the Federal Reserve’s techniques for putting money into the economy. Interest rates have been reduced to virtually zero, and the Federal Reserve has also used their open market capabilities to fund and purchase distressed assets from banks and become the lender of last resort for a frozen economy. The Fed has additionally pumped money into virtually every business in need of short-term liquidity. It’s now estimated – probably conservatively – that the Federal deficit for 2009 will be close to $1 trillion. While that number is enormous, it is necessary in reviving our economy and recreating the confidence required to move the U.S. economy forward.

I have also provided a chart below of the Federal Reserve’s money base entitled “St. Louis Source Base: Billions of Dollars: NSA.” All the money in the U.S. economy begins with this base of cash generated by the Federal Reserve System. Please note that the chart moved up gradually from 2002 through 2008 before it exploded and virtually doubled over a relatively short amount of time. As you can tell, the actions by the Federal Reserve today are completely different from those taken during the 1930’s. In the 1930’s, taxes were increased, cash flow was decreased, the money supply was decreased and the government did not utilize deficit spending. In 2008, however, taxes were decreased, the money supply was increased to the point of explosion and deficit spending was used to create commerce. Those of you who fear that this recession will be prolonged just do not understand the dynamic impact of flooding our economy with this much cash.

In my last post, I tried explaining why the Federal Reserve System is making cash the equivalent of trash as it pertains to investing. If you haven’t read that post, here’s the link – Cash Is Trash. Some readers questioned what safe alternatives there are to CD’s, money market accounts and other investments of that nature. Something that always escapes me is why someone would be willing to invest in a money market account making less than one-half of 1% annualized when there are viable alternatives.

For example, you can currently purchase something like Consolidated Edison, which has an annualized return on dividends of 6.1%. Utility companies have no competition since they are a monopoly in the New York area. Even more interesting is that the almost miniscule interest being earned on money market accounts is taxed at a maximum rate of 35%. Dividends earned from Consolidated Edison are only taxed at 15%. Which seems like a better investment to you? I can almost understand the reluctance to make such an investment if the rates were similar, but when you can earn almost twelve times the rate of return with the very conservative investment of Consolidated Edison as compared to a money market account and also enjoy a significant tax benefit, then further analysis at the very least seems to be warranted.

It seems like the media has become the proverbial Grinch that stole Christmas. I awoke this morning to another depressing headline on Yahoo: “One in Five U.S. Adults Have More Credit Card Debt than One Year Ago.” I suppose it would’ve been a reach to explain that four out of five adults had less credit card debt than one year ago. Leave it to the media to emphasize the negatives, but maybe I suffer from “glass half full” syndrome.

It also seems like everyone is proclaiming that this Christmas season will be the worst for retailers in over 40 years. From a totally unscientific standpoint, every retail operation I’ve visited over the last month has been tremendously busy. It wouldn’t surprise me to see the figures in January reflect that retail sales are flat – not negative – for December.

As we get through the holiday season and investors once again have the confidence to open their investment account statements, I hope they will closely evaluate the investments that offer the opportunity to earn many times the rate of return currently offered for cash. Just as the Federal Reserve wants you to believe, cash as an investment is poor as compared to higher yielding investments that have very little risk attributes. Once this tremendous supply of cash is reinvested, the stock and bond market will get back to its normal range and the potential for profit will be enormous.

We wish you and yours very happy and healthy holidays.

Best regards,
Joe Rollins

No comments: