Thursday, March 11, 2010

Review of The Worst Hard Time: The Untold Story of Those Who Survived the Great American Dust Bowl by Timothy Egan

I like to read histories of the United States in the 1920s and 1930s (see my recent review of Once in Golconda) and I am always stunned by the parallels with recent experience. In The Worst Hard Time: The Untold Story of Those Who Survived the Great American Dust Bowl, an observation about conditions in 1931 rings true today:

The more things unraveled, the more it seemed like the entire boom of the previous decade had been helium.
One mistake that led to the dust storms described in the book was the plowing up of so much Great Plains grassland to plant crops. And, in a tale as old as commodities investing, the increase in acreage planted was a reaction to falling prices:
At the start of 1930, wheat sold for one-eighth [!] of the high price from 10 years earlier. At forty cents a bushel, the price could barely cover costs, let alone service a bank note. Across the plains, there was only one way out, a last gasp: plant more wheat.
You know what we really need? A financial system that can handle deflation. Falling prices are the wonderful, inevitable accomplishment of an advancing civilization. Yet, they put debtors in a bind because the real value of creditors' claims increase. What if the principal amounts in debt contracts were price-indexed? Then, neither inflation nor deflation would allow one party to be unjustly enriched.

What happened in the Dust Bowl was so excruciating and lasted so long that the telling of it can be a little tedious. But overall, I give this 3/5 for telling a forgotten story and reminding us that things could be worse.


DKenny said...

you can 'price index' your debt using derivatives. the problem isn't that the modern system couldn't handle deflation, it can't because we've had such a long period of inflation that people didn't even think deflation was possible!

looking at it from a more socionomic point of view, people taking out debt to finance everything makes deflation so devastating, and that would devastate the financial sector. but unlike many people of the more 'austrian' (a term that i hate but it gets the point across) bent, i think most of the recent financial innovation was truly amazing. the fact that these instruments were abused and counterparty risk was vastly underpriced (LTCM, etc.) shouldn't take away from their utility in a rational financial system.

what are your thoughts on this?

CP said...

Well, that's a fair point.

But how likely is it that homeowners (homedebtors as I call them) are going to hedge their house with Case Shiller housing derivatives?

[Actually, Shiller's idea is that people WOULD want to hedge various aspects of their lives:]

And since it would cost money to hedge, the average moron would probably continue to own without hedges, just like how they will expose themselves to interest rate risk if it will lower the all-important monthly payment.

Not that I think the answer is some sort of mandatory imposition of financial products on people.

But I hate being in this situation where what we need most - lower home prices that will clear the market - is not allowed to happen because it will break the current flawed system.

In the end it's a complicated question, and I have no influence on how our financial system is run, so I don't invest a lot of time in thinking about it.

DKenny said...

agree with everything you're saying. i'm still young and impressionable, and am learning by the metric boatload. i was pretty hard bent against derivatives etc., as i was an 'austrian' and thought much of it to be total nonsense and the result of a fictitious financial bubble.

while i still hold the opinion that the banks are almost wholly insolvent, i don't necessarily see it as the banks' fault (in some cases).

rather i look at what they're doing to the car industry now, and see a direct parallel. they bailed out GM and Chrysler, and Ford is now forced to compete with two failed companies that shouldn't exist in their current form. Ford will get dragged back into mediocrity, and will probably fail in the next few years as a direct result of those bailouts.

i see the same thing in the banking industry. they are largely forced to keep competing with competition that shouldn't exist. look at best buy doing relatively better after circuit city went under. that is capitalism, and it is healthy. best buy was able to stay healthy, or get even stronger even though the market as a whole is shrinking.

i know this is a bit long, but i want to reiterate that i am no shill for the banking industry. what many of them were doing and engaging in, and still engage in, is totally deplorable. but financial innovation is, contrary to my original stance, and has been, largely beneficial. it would be a shame if in the ensuing deflation, which i think is coming, the baby (some amazing hedging products) gets thrown out with the bathwater.

and this comes from someone who was enormously skeptical of 'financial innovation'. the more i learn and read about these products, the more i see just how useful they really could be.

i'm a big fan of michael pettis, and he talks quite a bit about counter-cyclical index-linked debt contracts. i don't think they would be as out of the ordinary in a much less risk-inclined society like the one we are entering.

CP said...

The more the government meddles, the worse it will get.

If there was truly a free market in finance and banking, we WOULD have financial innovation, but would NOT have insolvent banks. These banks languish because the depositors (and even bondholders!) know that Uncle Sugar is there for them.