The Roaring Twenties and the Stock Market Crash of 1929

Posted by PITHOCRATES - April 23rd, 2013

History 101

The Roaring Twenties gave us the Modern World and one of the Greatest Economic Booms in History

When the steam engine hit the American farm it increased farm production.  By mechanizing the farm fewer farmers could farm more land.  Allowing American farmers to produce bumper crops.  Creating a boom in farm exports.  Especially during World War I.  As Europeans farmers exchanged their plows for rifles Europe had no one to grow their food.  So even though the mechanization of the American farm caused crop prices to fall the increase in sales volume brought in more farm revenue.  Life was good for the American farmer.  For businesses manufacturing all of that mechanized farm equipment.  And the banks making loans to farmers so they could mechanize their farms.

The1920 presidential election pitted a progressive Democrat against a conservative Republican.  The progressive promised to raise tax rates to pay down the war debt.  Andrew Mellon, Warren Harding’s treasury secretary, found that high tax rates were counterproductive.  They actually reduced tax revenue.  As wealthy people invested their money out of the country to avoid high tax rates.  So when Harding won the election they cut tax rates.  With no need to shelter their income the wealthy invested their money in the United States.  Pouring their money into the domestic economy caused great economic activity.  Great returns on investment.  And great income tax revenue.  The wealthy paid almost three times as much in tax revenue.  While the tax burden on the poor fell.  And the national debt fell by one third.

Harding died in office but Calvin Coolidge continued his policies.  He slashed government spending along with those tax cuts.  Pulling the government out of the private sector economy.  And the private sector economy responded.  Creating a lot of jobs.  Unemployment fell to as low as 2%.  And living standards soared.  For everyone.  Not just those in the unions.  In fact, this general rise in living standards weakened the unions.  For you didn’t need to belong to a union to live well.  It was the beginning of the modern world.  Brought about by a burst of innovation and manufacturing that lasted 8 years.  One of the greatest economic booms in history.  Henry Ford’s moving assembly line made the car affordable for the working man.  Auto registrations rose from 9 million in 1921 to 23 million by 1929.  An increase of 156%.  And keeping pace with the auto manufacturers were their suppliers.  Metal, steel, paint, lumber, leather, cotton, glass, rubber, etc.  And especially the oil industry.  That made lubricating oils and greases.  And the gasoline that powered all of these cars.  With so many jobs per capita income increased from $522 in 1921 to $716 in 1929.  An increase of 37%.  With people earning more home ownership soared.  And this boom in economic activity didn’t end there.

Herbert Hoover thought Government could better Manage the Economy than Messy Laissez-Faire Free Market Forces

Electric utilities were bringing the new electric power to industrial users and private homes during the Twenties.  Industry was using 300% more electric power than they were in 1899.  And it changed home life.  As electric clothes irons, vacuum cleaners, clothes washers, toasters and refrigerators became common household items by the end of the Twenties.  Households that had a telephone increased by 51% during the Twenties.  People were watching movies.  And saw the first talkies in the Twenties.  The radio also became a household fixture with some 7.5 million radio sets sold by 1928.   The economy was booming.  The middle class was expanding.  Consumer prices fell due to increases in productivity giving people more disposable income than they ever had before.  Causing an increase in consumer spending.  Allowing 1 in 5 Americans to own a car.  And increasing the number of people who could afford to fly from 40,000 in 1920 to 417,000 in 1930.  An increase of 943%.  So Americans were buying a lot.  But they were also saving a lot.  And investing.  Some 28% of American families owned stock.  Something once the exclusive privilege of the rich.  Wage earners were even buying life insurance policies to provide for their families in the event of their death.  Things were happening in the United States during the Twenties.  And the innovation and economic tsunami coming out of America had those in Europe worried.  So worried that they were discussing forming a United States of Europe to compete with the American system.

But all was not good.  During the Twenties those Europeans traded their rifles back for plows.  Reducing the export market for American farmers.  And when European governments threw up tariffs on America farm goods that export market disappeared.  Putting great surpluses into the American market.  Causing crop prices to fall further.  Crashing farm incomes.  Making some farmers unable to service their debt for all of that mechanized equipment they financed.  And when they defaulted on their loans en masse banks in the farming regions failed.  And when they did the money supply contracted.  The Federal Reserve made no effort to stop this contraction.  Which had a cooling effect.  Tapping the breaks on an expanding economy.

Coolidge chose not to run for a second term.  His successor, Herbert Hoover, was a progressive Republican.  And was everything Coolidge was not.  Hoover favored a big government perfecting the country.  He was a professional bureaucrat.  He loved bureaucracies.  And he loved paperwork and forms.  Which he wanted to bury private business in.  He thought the government could manage the economy better than messy laissez-faire free market forces.  Those very forces that created the Roaring Twenties.  He wanted to partner government with business.  With the emphasis on government.  (As president he increased the size of the Commerce Department and deepened its reach into the private sector economy.)

The Smoot-Hawley Tariff caused Investors to Dump their Stocks causing the Stock Market Crash of 1929

The Federal Reserve misjudged the stock market.  They thought it was nothing but speculation.  Citing radio maker RCA’s stock price’s meteoric rise.  So the Fed tapped the breaks further to cool this ‘speculative’ fervor.  Further contracting the money supply.  But this wasn’t speculation.  The rate of growth in radio sales actually was greater than the rate of growth in the stock price.  Making it more likely that the stock was undervalued.  Not overvalued.  But the Fed went ahead and contracted the money supply anyway.  Making it difficult for business to get funding for continued growth.  Despite there still being people out there who hadn’t bought a car, a house, electric appliances or a radio yet.  And wanted to.

In 1929 a new tariff bill was moving through Congressional committees.  The Smoot-Hawley Tariff.  Which would raise taxes on imports by up to 30%.  Which would greatly increase the cost of business.  Because most if not all of American manufacturing used some imported raw materials.  Which would increase their selling prices.  Making them less competitive.  Worse, if the U.S. slapped tariffs on imports it was certain their trading partners would respond with some retaliatory tariffs.  Which would just shut down their export markets.  Much like those tariffs shut down the export markets for American farmers.  Then in the autumn of 1929 the Smoot-Hawley Tariff passed critical votes in committee.  Sending the tariff bill on its way to becoming law.  This was not good news for investors.

It was all too much.  The coming expansion of government regulation over the private sector economy.  Higher taxes to pay for this bigger government.  The contraction of the money supply.  And then the Smoot-Hawley Tariff.  Investors could read the writing on the wall.  None of this would be good for business.  It would just smother the economic growth of the Twenties.  For if you increase businesses’ costs and decrease their markets you will slash their profits.  Which will reduce the value of these companies.  And reduce the value of their stock prices.  As investors live by the adage of “buy low, sell high” they’d want to sell those stocks fast before the Smoot-Hawley Tariff sent their prices into a tailspin.  Which they did.  Causing a great selloff starting in October.  That led to the Stock Market Crash of 1929.

Now contrast that with a true speculative bubble.  The dot-com bubble.  Where investors poured money into these dot-com companies eager to find the next Microsoft.  Aided and abetted by the Federal Reserve that was keeping interest rates artificially low.  To encourage all sorts of investment.  Including ones driven by irrational exuberance.  So investors were bidding those stock prices into the stratosphere.  For companies that had no profits.  For companies that didn’t have a product or service to sell.  But these investors were looking with great anticipation at their future profits.  Even though they really didn’t understand the Internet.  They just knew that computers were involved.  Which is what made Microsoft rich.  Producing software to run on computers.  And every investor was sure their dot-com was going to produce something to run on computers.  Making that company rich.  And their investors.  But when the start-up capital ran out there were no earnings to replace it.  And the speculative bubble burst beginning on March 11, 2000.  And those highly overvalued stock prices began to fall back to earth.  With the tech-laden NASDAQ losing 78% of its value before it was all over.  Now THAT is a speculative bubble that the Federal Reserve should have tried to prevent.  Not the economic boom of the Twenties where companies were building real things that real people were buying.

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Wall Street is Doing Well because the Fed’s Inflationary Policies keep Raising Prices

Posted by PITHOCRATES - March 9th, 2013

Week in Review

Investors like rising stock prices.  They don’t like falling stock prices.  Which is why Wall Street likes inflation.  And fear deflation.  Even though the economy is still sluggish with more and more people dropping out of the labor market (which is why the unemployment rate fell) investors are bullish.  Because of the Federal Reserve and all of their quantitative easing.

The more the Fed increases the money supply the more inflation there will be.  Investors like that.  Because inflation increases prices.  Such as the prices of their stocks.  As well as gasoline and groceries.  Making the current economic times odd.  For the stock market recently reached a record high.  Even though the labor participation rate (see THE EMPLOYMENT SITUATION —FEBRUARY 2013, page 4) continues to fall.  It is now at 63.5%.  Which means 89,304,000 people are not in the labor force.  A record high.  But you wouldn’t know this by looking at the official unemployment rate.  Or the stock market (see Stocks And Inflation: The End Of An (Abnormal) Affair? by James Picerno posted 3/69/2013 on Seeking Alpha).

The positive correlation between the market’s inflation forecast and the stock prices appears a bit looser these days, but it’s premature to declare that the link has been broken…

Normally, rising/high inflation doesn’t inspire the bulls. But the last several years have been less than normal in terms of the macro backdrop. The crowd has remained worried about disinflation/deflation, which means that signs of higher inflation in the future have soothed anxious traders…

And why not?  For when have inflationary policies ever caused an asset bubble? That burst into a long and painful recession?  Except the housing bubble that brought about the 1990-91 recession.  The dot-com bubble that brought about the 2000-01 recession.  And that other housing bubble that brought about the 2007-09 recession.  AKA The Great Recession.  So there is no worry that these record highs in stock prices aren’t just another bubble.  Just waiting to burst.  Bringing on another deflationary recession.  I mean, what are the odds of that happening again?

Actually, the chances are pretty good that 2013 will have a very painful recession.  Because we don’t have any real economic growth.  These gains in the stock market aren’t because businesses are expanding and hiring.  Not with a falling labor participation rate.  No.  For all intents and purposes we are still in the 2007-09 recession.  Only we should probably call it the 2007-(end date to be determined) recession.  Because the president’s economic policies haven’t helped the economy yet.  And probably never will.

There’s no reason to believe that the fifth year will be any better than the previous four years.  In fact, it will probably be worse.  In fact one would almost get the impression that he is not trying to help the economy.  But, instead, trying to destroy the Republican Party.  So he can win the House of Representatives back in 2014.  So he can pass even more anti-business policies.  To transform the country into something it was never before.  Less prosperous than communist China.

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Subprime Lending, Housing Bubble, Dot-Com Bubble, Enron, WorldCom and Obamacare

Posted by PITHOCRATES - August 14th, 2012

History 101

Dot-Com Companies used Venture Capital and Proceeds from their IPOs to pay their Expenses as they had no Revenue

The economy in the Nineties boomed.  President Bill Clinton and the Democrats say it was their policies of higher taxes on the rich that made it all happen.  At least that’s the argument you hear today in their arguments for returning to the Clinton era taxes on the wealthy.  Because it gave us the incredible economic explosion of the Nineties.  And balanced the federal budget.  But was the economy really that good?  No.  It wasn’t.  A lot of bad things happened in the Nineties.  Including something we’re still suffering from today.  The Subprime Mortgage Crisis.  Which gave us the Great Recession.

The Clinton administration told lenders to approve more mortgages for poor and minority applicants or face action from his justice department.  Lenders were not approving these applicants for reasons like lack of income and a poor credit history.  Common of people who lived in poorer sections of town because they didn’t have the income and credit history to move to a less poor section of town.  To avoid action from Clinton’s justice department lenders turned to subprime lending to qualify the unqualified.  To help these lenders unload these toxic mortgages off of their balance sheets the federal government’s GSEs Fannie Mae and Freddie Mac bought them and resold them to unsuspecting investors.  And we all know how well that turned out.  A great housing bubble blowing up.  Subprime Mortgage Crisis.  And the Great Recession.

The Nineties also gave us the dot-com bubble.  A lot of Internet start-up companies with soaring stock prices for products they never sold.  They had no revenues.  But speculators were so anxious to get in on the next Microsoft that they ran up these stock prices into the stratosphere.  And with nothing to sell these dot-coms used venture capital and proceeds from their initial public offerings (IPOs) to pay their expenses.  Giving away what they had for free.  Hoping to build brand awareness.  And to figure out a way to actually make money on the Internet.  Even cities joined in the speculation.  Spending tax dollars to build high-tech infrastructure to attract the dot-coms to their cities.  And businesses came to their cities.  Built buildings.  Filled them with employees earning good money.  It was the dawn of the new high-tech, Internet-based world.  But when all of the investor money ran out they still didn’t have anything to sell to pay their bills.  The bubble burst.  People lost their jobs en masse.  And all those new buildings sat empty in cities burdened with debt and a shrunken tax base.  While students who went to college to get degrees to let them join the dot-com world found no one was hiring when they graduated.  As few were hiring during the ‘dot-com’ stock market crash and recession of 2000-2002.

Enron Cooked their Books to Overstate Sales and Assets and Underreport Liabilities

Enron came of age in the Nineties.  They were in the electricity and natural gas business.  In both distribution and generation.  They were also into other businesses.  Too many to list.  But the energy business took off in the Nineties thanks to deregulation.  And Enron became a darling of the stock market.  With its stock price rising about 300% during the Nineties.  The value of its stock was worth about 70 times earnings.  Meaning that investors saw nothing but further growth in Enron.  Why?  Because the Clinton administration was taxing the rich at higher tax rates?  Not quite.  It’s because they cooked their books.

Investors like to see strong earnings.  Lots of assets on the balance sheet.  With not so much debt (i.e., liabilities).  So Enron strived to give investors what they wanted.  By the aforementioned cooking of their books.  Using mark-to-market accounting.  As opposed to historical cost accounting.  Where you buy an asset.  You post it to the balance sheet for the value you paid for it.  Then forget about it.  Mark-to-market, on the other hand, notes the ‘fair value’ of those assets.  If an asset grows in value a company adjusts it books to reflect the current, higher value.  Making their books more attractive to investors.  To look better on the liability side they created a lot of shell companies and special purpose entities.  Posting liabilities on these off-balance-sheet companies instead of their own books.  The combination of higher asset values and underreporting of liabilities made Enron look very strong financially.  And strong revenue growth just made investors drool.

Enron traded.  They bought and sold products and services.  Providing risk management for its clients.  Think of an airline buying a contract for jet fuel for one year to lock in low prices.  How you record this transaction on your books depends on what you’re buying and selling.  If you’re a stock broker you record only your fees as revenue.  Not the value of the stock.  If you’re a retailer you record the value of what you sell as revenue.  Enron recorded their trading like a retailer would.  Which greatly increased their revenues from these trades.  They also used mark-to-market accounting on future revenue streams.  Instead of using the retailer method of recording sales and costs for a period they would calculate the value of a contract for future sales and record them as current revenue.  Pulling future revenues into the current accounting period.  This sent revenues soaring.  Increasing some 700-800% during the Nineties.  Much of which was a house of cards built upon shady accounting practices.  Long story short, they couldn’t keep cooking the books.  And the house of cards collapsed.  The stock price fell back to earth.  And landed with a thud.  Becoming worthless.  People went to prison.  Workers lost their jobs.  And their pensions.  Valued at some $2 billion (though they got a little of that back).  Shareholders lost some $74 billion.  Their accountant, Arthur Andersen, went out of business for their involvement.  And Enron went bankrupt.  The biggest bankruptcy ever.  Until WorldCom.

The Obama Administration borrowed Accounting Practices from Enron and WorldCom to Score Obamacare

WorldCom became a telecommunications titan by buying other companies.  And then with the largest merger in U.S. history when it merged with MCI Communications in 1997.  It was huge.  And it posted huge sales.  Accordingly, its stock price rose.  As the dot-com bubble burst WorldCom’s stock price fell.  As did a lot of telecoms.  To prop up their falling stock price they, too, turned to shady accounting practices.  Inflating both revenues and assets.  And like Enron they couldn’t keep up the scam.  And the fallout was similar to Enron.  Only bigger.  Interestingly, they even had the same accountant.

But it’s just not corporations playing with their accounting practices.  Even the government gets into the action.  Case in point Obamacare.  The magic number for the cost of Obamacare over 10 years was a trillion dollars.  The same cost of the Iraq War and the War in Afghanistan.  As the wars end Obamacare takes over that spending.  Making it ‘revenue neutral’.  Well, health care for everyone without adding any new government spending would be hard to say ‘no’ to.  So how do you keep it below the cost of these wars?  You borrow accounting practices from Enron and WorldCom.

The original CBO scoring of Obamacare came in at $940 billion.  They based this on the data the Obama administration gave them.  Which included 10 years of new taxes (or spending transferred from war spending to Obamacare spending).  But only 6 years of benefits.  So that $940 billion only covered 6 years of Obamacare in that 10 year period.  Greatly underreporting the costs of the program.  No one knew it at the time.  Because they fast-tracked this bill through Congress before anyone had a chance to read its two thousand pages.  So they had their CBO scoring below a trillion.  And with some shady backroom deals, voila.  Obamacare became law.  CBO has since revised their number to $1.76 trillion that includes 9 years of benefits.  Bringing it to about $2 trillion if you cover all ten years.  And closer to $3 trillion if you put back the $741 billion or so taken from Medicare.  So the government cooked the books to conceal the true costs of Obamacare.  With the true cost being approximately 300% more than they promised the American people it would cost.  This $2 trillion scam is greater than the Enron and WorldCom scams.  But the government suffers no fallout for their gross misrepresentation like Enron and WorldCom did.  Because when they do it it’s just politics.

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FT127: “Obamacare is a lot like the Smoot-Hawley Tariff in terms of scaring the bejesus out of businesses.” -Old Pithy

Posted by PITHOCRATES - July 20th, 2012

Fundamental Truth

The Roaring Twenties gave us Automobiles, Electric Power, Radio, Movies, Telephones and Air travel

In 1921 there were 9 million automobile registrations.  That jumped to 23 million by 1929.  An increase of 156%.  That’s a lot more cars on the roads.  In the Roaring Twenties we made cars out of steel, paint and glass.  Inside we fitted them with lumber, cotton and leather.  We put rubber tires on them.  And filled their fuel tanks with gasoline.  So this surge in car ownership created a surge in all of these industries.  Extraction of raw materials.  Factories and manufacturing plants to build the equipment to extract those raw materials.  As well as the machinery to build these automobile components.  And the moving assembly lines in assembly plants to assemble these automobiles.  The plants, warehouses and automobile dealers created a surge in the construction industry.  And all the industries that fed the construction industry.  Including the housing industry to house all these gainfully employed workers.

And this was just the auto industry.  Which wasn’t the only industry that was booming during the Roaring Twenties.  Thanks to the hands-off government policies of the administrations of Warren G. Harding and Calvin Coolidge businesses introduced us to the modern world.  Electric power came into its own.  By 1929 about 80% of all installed horsepower was electrical.  And it entered our homes.  Electric lighting and electric appliances.  Vacuum cleaners.  Washing machines.  Refrigerators.  All of this required even more raw material extraction from the ground.  More manufacturing equipment and plants.  More wholesale and retail construction.  And more housing to house all of these workers earning a healthy paycheck.

And there was more.  The Roaring Twenties gave us broadcast radio in our electric-powered homes.  Free entertainment, sports broadcasts and news.  Paid for by the new industry of advertising.  Competing with radio was another growing industry.  Motion pictures.  That by the end of the Roaring Twenties were talkies.  And speaking of talking there was a lot of that on the new telephone.  In our homes.  Interconnecting all of these industries was ship, rail and truck transportation.  Even air travel took off during the Twenties.  More raw material extraction.  More equipment.  More manufacturing.  More construction.  And jobs.  More and more jobs.  The hands-off government policies of the Harding and Coolidge administrations created the great Bull Market of the Twenties.  Explosive economic activity.  Real economic growth.  Creating low-cost consumer goods to modernize America.  Increase her productivity.  Making her the dominant economic power in the world.  The Europeans were so worried about America’s economic prowess that they met in 1927 at the International Economic Conference in Geneva to discuss the American problem.  And how they were going to compete with the American economic juggernaut.  Because the free market capitalism of the New World was leaving the Old World in the dust.

Herbert Hoover was a Republican in Name Only that FDR once Admired but Calvin Coolidge Despised

This was real economic growth.  It was not speculation.  This wasn’t artificially low interest rates creating an asset bubble.  Working Americans bought homes and cars.  And furnishings.  Businesses produced these to meet that demand.  They had growing sales.  And growing profits.  Which increased their stock prices.  Investors wanted to own their stocks because these companies were making money.  And with the world modernizing these stock prices weren’t going anywhere but up in the foreseeable future.  Unless something changed the business environment.  Well, something did.

Despite the roaring economy Calvin Coolidge did not run for a second term.  Which was a pity.  For his successor, Herbert Hoover, was a Republican in name only.  He was a big time progressive.  Who wanted to use the power of government to make the world perfect.  A devout believer in the benevolence of Big Government.  He added about 2,000 bureaucrats to the Department of Commerce.  FDR at one time admired him (before he ran against him for president).  Coolidge despised him.  Under Hoover the federal government intruded into the private sector.  His economics were Keynesian.  He, too, worshipped at the altar of demand.  He believed high wages were the key to prosperity.  For people with more money buy more.  And all that buying created demand for businesses to meet.  Even during a recession he believed wages should not fall.  Despite the fact that’s what recessions do on the back side of the business cycle.  Lower prices and wages.  And lay off people.

By the Twenties American farmers were mechanizing their farms.  Allowing them to grow more food than ever before.  Agriculture prices fell.  At first this wasn’t a problem as there were export markets for their bumper crops.  Thanks to a war-devastated Europe.  But eventually the European soldiers returned to the farm.  And the Europeans didn’t need the American food anymore.  Even places tariffs on U.S. imports to their countries to help their farmers get back on their feet.  Add in a bad winter that killed livestock.  Some bad insect infestation in the summer.  Add all this together and you had the beginning of the great farm crisis.  Debt defaults.  Bank failures.  And the contraction of the money supply.  Which the Federal Reserve (the Fed) did not step in to compensate for by expanding the money supply.  Which was sort of their purpose for being in existence.  As there was less money to borrow business could longer borrow to continue their growth.  Because of the time factor in the stages of production to expand production required borrowing money.  To make matters worse the Fed was actually pulling more money out of circulation.  Because they looked at the rising stock prices and concluded that speculators were borrowing money to invest in the stock market.  Thus inflating stock prices.  But it wasn’t speculators running up those prices.  It was an economic boom that was running up those stock prices.  Until the government put a stop to that, at least.

Bad Government Policy didn’t Create the Roaring Twenties but Bad Government Policy ended Them

The Smoot-Hawley Tariff was close to becoming law in the fall of 1929.  It was moving through committees on its way to becoming law.  This tariff would raise the tax on all imports by about 30%.  The idea was to protect domestic supplies and manufacturers.  But even in 1929 it was a global economy.  A lot of imports entered the stages of production.  Which meant costs would be increasing throughout the stages of productions.  Greatly increasing the input costs of all those businesses enjoying those high stock prices.  Which would raise their prices (to cover those higher input costs).  Reducing their sales.  And slashing their profits.  Add this to the contracting money supply and it painted a very bleak picture for business.

With demand sure to fall due to a massive new tariff that was about to become law businesses cut back.  To get rid of what was about to become excess capacity.  For they were smart.  And understood what affected their businesses.  And you know who else were smart?  Investors.  Who looked at this tariff and saw a locomotive engineer about to slam on the brakes.  And if Congress passed this into law after 1928 Coolidge wasn’t going to be there to veto the law.  So they all came to the same conclusions.  The bull market was coming to an end.  And they wanted to sell their stock to lock in their stock gains.  Which caused the great sell-off of 1929.  And the stock market crash.  Starting the Great Depression.

People still debate the cause of the Great Depression.  A popular argument is that greedy investors caused it by speculating in the stock market.  Or that greedy businesses out-produced demand.  But the economics of the Roaring Twenties don’t support this.  This wasn’t people buying big houses because interest rates were low.  This was the electrification of America.  Cars.  Telephones.  Radio.  Movies.  Air travel.  This was broad and real economic growth.  Bad government policy didn’t create it.  But bad government policy ended them.  And it was the expectations of even worse government policies that yanked the rug out from underneath the economy.  By causing a business contraction and stock market sell-off.  Much like Obamacare is doing to businesses today.  Scaring the bejesus out of them.  For they have no idea what their future costs will be under Obamacare.  So they are doing their best to prepare for it.  By not expanding their businesses.  By not hiring anyone.  And sitting on their cash.  To prepare for the worst.  Much like businesses did in 1928.  Which explains why the Great Recession lingers on.

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