Updated: Aug 20, 2021
The Roaring Twenties
We continually compare what we've gone through over the last decade to the roaring twenties. If we go back and look at the stock market, especially the crash as we went into the thirties, a lot was going on more than just the stock market.
GWS compares what is happening currently to the twenties because of how the money supply was used: coming out of the progressive era with World War I just ending. Much of the government spending was curtailed because the war had ended, and we had an advanced period of central banking. However, there was also a legacy component of cutting government spending and taxes to stimulate the economy. But what wasn't happening in the 1920s was the rampant laws and unfair capitalism.
Money Supply in the 1920s
In the twenties, we had a currency that was outstanding with not much change. It was timed deposits, what we call Certificate of Deposit (CD) now, and demand deposits increasing behind the scenes. So, the central bank started to grow because there was a gold-backed system. We can see it can affect the money supply in Column 8 (below), rising about 70% over the decade.
Gatewood Wealth Solutions believes that the amount of money being created will make it into capital markets or capital assets first and cause an appreciation in those assets. Between 1920-21, we went through a recession with a lot of the government spending is for World War l with deflation in the system. Therefore, the federal reserve saw it in the index and began to expand the money supply.
Also, when World War I ended, Europe was very much devastated, and they needed foreign loans—allowing these foreign loans to be made by the U.S. to Europe. In turn, the loans were used mainly to buy exports from the U.S., specifically agriculture. The overall point is when we see the money supply expand, the market expands right along with it.
The graph above is looking at the annual percentage of change in the money supply. The yearly change is quite variable: 4% up to 10% of basically 0% right before the crash. However, it does not state when the money supply got near zero in terms of new and additional money into the system.
We can see (above) the money supply takes off with a lag coming out of the first recession. Then, there's a more stable money supply as growth begins to slow. Next, we get into the 24-25 period when England is trying to go to the gold standard. The Fed lowers interest rates again, and we see lag, but it corresponds to an increase in capital markets. The money supply begins to stabilize for a short amount of time with a little bit of flatness in the market. Lastly, going into 1928-29, we start to see the Fed slow, getting down to a 0.7% growth rate. Then, the crash occurs.
However, the point is, the money supply was increasing dramatically along with the capital markets. Though the money supply expanded in the right direction, we didn't see inflation growing somewhat rapidly. The Fed was expanding the money supply based on a stable basket price and allowing them to continue to raise the money supply and see the capital market.
In the Inflation Basket graph above, we can see a 68% increase in the total money supply over time, but we do not see inflation above 4% whenever we measure it as a basket of goods. Coming out of World War l, command and control components were put on the economy to provide war goods. As those were ending, a lot of the government spending was ending too. Therefore, as the economy restructured, prices were falling in the goods in the basket without stabilization. The Fed used an inflation basket to gauge how much money they should create to get to a stable price.
The economy in the 1920s
Most places that people lived were getting electricity, and with that comes new labor-saving appliances such as a vacuum, washing machine, and toaster. Also, instant communication is occurring through mass media, such as the radio. You were able to pick up a phone and connect with people across the world. The new invention of a vehicle came about to go further away to find better economic opportunities. Like today, we have a lot of new technology coming in, causing an increase in productivity.
This is all one big cycle as farms were starting to be mechanized. The tractor was becoming something that farmers were using to increase agricultural output dramatically. People were leaving the urban environment because farms could produce food. Therefore, the higher-cost producers had to go, but there was plenty of jobs at the factory. The demand for labor kept prices up, causing the production capacity of the economy to grow faster than the money supply.
However, it was causing an imbalance because food prices started to decrease. Money was being borrowed for the farm implements. Therefore, there were a lot of bankruptcies, especially whenever there was inflation. The Fed eventually slowed the money supply causing the crash.
"If we're living in something like the 1920s, will we have the same outcome?"
GWS does not think the next phase will look like the 1930s. We believe the Fed will be swift to continue to expand the money supply because they're not concerned about a rise in inflation. They would welcome inflation to offset some of the deflationary pressures.
Averaging out the average 2% will allow prices to increase. If we can't maintain this productivity gain that we've had over the last couple of decades, our experience will be more like the 1970s, where you have inflation as the outcome and not deflation.
Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.
Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested directly.
Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.