A few newspapers recently dared to describe the U.S. recession of 2008 with the d-word [1], depression. While the problems across the globe have yet to approach the seriousness of a depression, I thought it might be valuable to share my observations of having lived through a stock market crash [2] and subsequent depression [3] not too long ago.
A Brotherhood of Babushki
But how could someone who isn’t at least 85 years old know about a stock market crash or a depression? Easy, one happened in Russia [4] and many other emerging markets between 1997 and 2001. While there aren’t millions of us “survivors” back working in Western markets, there are probably enough of us to swap stories with veterans of the Great Depression [5] of the 1930s.
I. Déjà Vu All Over Again
In the fall of 1997 the Russian Trading System (RTS) Index of top liquid Russian shares traded in Russia hit a peak value 571.66 in US Dollar terms. By early October 1998 the index would make a low at 38.53.
[6]
The market declined 93% from peak to trough in one year for a number of reasons, many of which U.S. and other global investors will find similar to the situation now:
- Russian banks and industries of the late 1990s were value subtractors [7]. That is, the value of labor plus resource inputs was higher than the value of outputs. Today’s similarity: housing, auto makers, airlines.
- The government debt was not reasonably payable, deficits were unsustainable and the state sector was unable to finance massive social obligations. Today’s similarity: federal debt, federal deficit, nervous treasury markets, strained State budgets.
- The government burned billions of IMF bailout money [8] in July and August of 1998 in an attempt to defend the rouble exchange rate. The attempt was unsuccessful leading to a banking collapse due to the sovereign debt default (counterparty risk) and rouble devaluation. Today’s similarity: TARP funds going for M&A deals not asset repurchases, counterparty risk reflected in LIBOR due to CDOs/solvency issues, Iceland, Pakistan, Ukraine.
- Long Term Capital Management [9] (LTCM), a leveraged fund exposed to concentrated risk potentially caused a large market disruption. Today’s similarity: Bear Stearns, Lehman, AIG.
II. Stories from the “Depression of 1998”
What the U.S. and other countries face is not necessarily what Russia faced in 1998 for a number of reasons. Chief among them is that the U.S. can apply massive resources to tackle the problem and the U.S. has more and better infrastructure than Russia did at the time. While historical accounts from the 1930s [10] are important, it may be worthwhile to look at how events that have happened in the recent past could occur in a real depression.
When Credit Cards Go Haywire . . .
Whether credit or debit, much of modern society depends on plastic transactions. In 1998, after the August debt default and collapse of most banks, Russian debit/credit cards were frozen (note that few “credit” cards existed at the time). To highlight the problems this caused, here is the story of one of my friends who was nearly separated from his family due to the crisis.
K worked as a banker in Moscow, K’s family lived and worked in Africa. K reserved a plane ticket to go to his family at the end of August 1998. He had the money in his account to pay for the ticket, but when the crisis occurred, all of these funds were frozen, as was his card. The airline would not accept payment in cash, only debit/credit cards. K was lucky in that since most Moscow ATMs were closed, I needed cash and he needed his plane ticket. I purchased the ticket for him with my working U.S. credit card, he paid me cash in roubles. K got to visit his family, I made my rent payment.
. . . Prices Aren’t What They Seem
A few days after the default and devaluation, I took a client of our bank to a local hotel for dinner. The dinner was relatively inexpensive on first appearance. Most menu prices still quoted dollar-equivalent prices, though by law all charges were in roubles at a specified exchange rate. The dinner was around 60 U.S. Dollars. However, credit card transactions don’t actually post for a few days, and as the rouble/dollar rate recovered slightly during that time (at least the spread between the hotel and the credit card did), the dinner charge in the end wound up being around 75.
III. Lessons Learned
There are a few things that we can learn from the Russian experience in 1998. The top prognostic indicators are:
- Debt is sustainable only as long as someone else is willing to pay for it. In other words, that which can’t go on, won’t.
- Half-measures only make things worse.
- Predictions of economic strength (“the fundamentals of our economy are sound [11]” or “the crisis is contained [12]”) are lies.
- Similarly, predictions of economic doom are speculative at best (“sell everything [13]”). In my career I have heard officials of Russia, Ecuador [14] and Argentina [15] all say they would never EVER default on their debt. They did. Similarly, many predicted Russia’s doom in 1998 [16]. If you bought $10,000 of the RTS on January 1, 1999 and sold today (November 18, 2008) you would have $90,797! Had you sold this time last year, you would have $356,729. No buy/sell recommendations here, but a lesson that markets always prove you wrong.
If the worst does happen, there are a number of things we can do. Thinking about the positive makes all of the scary 1930s images the media throws at us a little better.
- Family and community are critical during hard times. My story of K and his plane ticket underscore just how important it is to have friends. In our world of commuter bubbles, suburbs and nuclear families we have largely lost this skill. Many of the survival stories from the 1930s and from what I saw in Russia were people relying on family, friends, neighbors and social organizations for shelter, food, advice, transport and so on.
- Learn skills. Few people in our modern world know how to sew, cook, grow plants, perform CPR, make stitches, ride a bicycle, swim, care for farm animals, pluck chickens, pull a tooth, fix a toilet, hang a picture, make a table, repair their computer, wash clothes by hand, and so on. Most people in the 1930s knew how to do these things as did (and do now) most people in Russia. In a depression, medical care, food, shelter and other comforts are not always reliable so one has to learn these skills for oneself.
- Get healthy. Economic hard times means a lot of walking, lifting, fixing things and even stress. We handle this better if we are fit and trim not lazy and fat.
IV. Not the End
One of our traders in Moscow during 1998 summarized the plunging market this way, “well, there were just more sellers than buyers today.” Remember that the market can make you rich, it can also make you poor. One thing it cannot do is make you happy, I think our trader was trying to tell us that. Another thing to remember is that on other days there will be more buyers than sellers.
. . . And that’s how it goes