Perspectives on economics and finances with GFD

Are the Markets Up A Creek?

This year started weak. So weak in fact that the first ten trading days of January were the worst in US history. The television is rife with talking heads exuberant over who they can point the finger at. “Oil,” one shouted. “Tech,” said another. A third bemoaned turbulence on the other side of the pond in European banks staring down a dry well of capital. Lastly, on February 10, 2016, Janet Yellen, the Chairman of the Board of Governors of the Federal Reserve Bank, faces tough questions from the White House on Capitol Hill, discussing the condition of the economy and interest rate hikes. Countries all over the world feel the crunch. Venezuela, with oil declines, is near bankruptcy. Brazil is buried under a staggering amount of debt. Japan has never recaptured the magic of their 1989 highs, suffering through a perpetual twenty plus year bear market. It looks like China, the so called Sleeping Giant, fell into a coma with the Shanghai Composite dropping 50% in the last 7 months.
Top analysts on Wall Street dare to whisper the word recession. Yet there’s no denying it. The secret is out (and has been out since January). The S&P 500 has declined 15% as of this writing. Market technicians frantically adjust their support levels as the markets breach lower.  

But are they correct?

Since the inception of the United States, we’ve had twenty-five instances of bear markets (a 20% decline), the first in 1829 and the most recent in 2009. Since we’re on a downtrend, of which most everyone agrees, the question is how far will we drop? If you include all twenty-five of America’s bear markets, you’ll find that the average bear market is 41%.

The first global crisis was in 1857. The market disastrously went into a free-fall, culminating in a 65% drop. Like today’s theories, economic historians still deliberate as to the cause of the crash. Was it the failure of the seemingly too big to fail Ohio Life Insurance and Trust Company from faulty loans? It could have been Europe’s declining reliance on American grain exports. The railroad industry nearly collapsed. Perhaps the panic was the result of the United States’ increasing demand of foreign imports with our own exportation severely lacking, culminating in a trade imbalance. Finally, banks raised interest rates in 1857 in an effort to keep gold reserves in check.

Out of 100,000 people unemployed from the crash, on November 5, 1857, 4,000 marched on Tompkins Square shouting for the government to create an economic stimulus package for public works projects that would put the people back to work. The very next day, 5,000 protestors appeared on Wall Street, crying for the banks to free up credit again so businesses could get loans and hire employees. Sound familiar?  

Speculation over the causes of the Panic of 1857 reminds me of the French journalist Jean-Baptiste Alphonse Karr who said, “plus ça change, plus c’est la même chose.” (“The more things change, the more they stay the same. ”)

The question should be, are we repeating the crash of 1857? Upon a cursory glance, one would say no. But look closer and you’ll find the requisite forces are all in place.
  1. We have a commodity inflicting damage on the global economy. The oil of today was the grain of 1857.
  2. An entire industry is caving in upon itself. The technology sector reminiscent of the railroads of the mid-1800s.
  3. The banking industry, like the 1857 Ohio Life Insurance and Trust Company, both in Europe and the US, are tanking. Some are even talking about bankruptcy, mergers, buy-outs, and bailouts. After all, didn’t we learn that there is such a thing as too big to fail?
  4. Like 1857, interest rates are the talk of the town. Why else has Janet Yellen been on the Hill for two days straight now?
American markets dropped a staggering 65% in 1857. Will we go down that far? I’m not sure anyone really knows. It’s called speculation for a reason. However, if history is any indication, if we hit a bear market (1707 from a May, 2015 high of 2134), chances are we’ll plummet further, down to a nightmarish 41%. Hold on to your butts, sports fans. We’re in for a bumpy ride.

The Piggly Crisis

  The next time you go to the grocery store, pull out a shopping basket and walk down the aisles, you should think about the fact that the modern grocery store is a result of the innovations of one man: Clarence Saunders.  

Saunders’ Self-Shopping Innovation

Until the 1920s, customers did not pick up their own groceries. Instead, they went to clerks who stood behind a counter and put together their purchases for them. Think of the way an old country store was set up.

Saunders was obsessed with the idea of efficiency, and thought that customers wasted a lot of time waiting on clerks. Saunders wanted to free customers from the tyranny of clerks by letting them do their own shopping. Saunders also developed a just-in-time delivery system to get food to his Piggly Wiggly stores. This system later inspired Toyota to apply the same concept to automobiles which helped Toyota to control costs and conquer the globe. Saunders opened up his first Piggly Wiggly store on September 6, 1916 at 79 Jefferson Ave. in downtown Memphis, Tennessee. Each store had a turnstile at the entrance. Every item in the store had a price on it, another innovation, and Saunders provided shopping baskets so customers could take their items to a check-out stand in front. Saunders patented the idea of self-service stores in 1917. Saunders incorporated the Piggly Wiggly Stores Corp. in 1918. The stores were an immediate success. By 1922, there were over 1,200 Piggly Wiggly Stores of which about 650 were owned by Saunders, and by 1932, there were 2,660 Piggly Wiggly stores with sales of $180 million. Unfortunately, in 1923, Saunders had lost control over his Piggly Wiggly stores.  

Saunders vs. the Shorts

Clarence Saunders also became part of the last stock corner on the New York Stock Exchange in 1923. The corner became so prominent, that the whole affair became known as the Piggly Crisis. Clarence Saunders was generous, determined, stubborn, and well-known in Memphis. Saunders became known as the home boy who faced off the financiers of Wall Street who were using a bear raid to try and profit from a decline in Piggly Wiggly stock. The goal of shorting a stock is to borrow shares from someone who owns them and sell them. When the stock declines in price, the shorts buy the shares back at a lower price, make a profit, and then return the stock to the person they borrowed it from. In a bear raid, several shorts make a concerted effort to drive the price of a stock down so they can profit from the decline. The bulls, on the other hand, can try and beat the shorts by forcing the price of the stock up, squeezing the shorts and forcing them to sell at a loss. If the bulls can buy up the existing float, the stock is cornered. The shorts have no choice but to buy the stock from the bulls at whatever price they demand. Of course, creating a corner is risky for the bulls as well because it takes a lot of resources to buy up the float in the stock. Once the corner is completed and the shorts have covered their positions at the inflated price, little demand is left for the stock. The price of the stock can collapse, leaving the bulls with a burdensome load of debt. The whole process can end up bankrupting both the shorts and the bulls. Piggly Wiggly shares started trading over-the-counter in July 1920 and listed on the New York Stock Exchange (NYSE) in June 1922. In November, 1922, several of the independently-owned Piggly Wiggly stores in New York, New Jersey and Connecticut failed and went into receivership. Although Saunders’ corporation operated independently of these stores and was profitable, some Wall Street operators saw this as a reason to begin a bear raid on Piggly Wiggly stock. The bear raiders began selling PIggly Wiggly short and spread rumors that the company was in poor shape. Saunders took this challenge personally. He had created Piggly Wiggly stores, created the concept of self-shopping, was spreading his stores across the country, and some bears were trying to create profits by spreading lies about his stores. Saunders decided to “beat the Wall Street professionals at their own game.” Saunders not only used his own money to battle the shorts, but he borrowed ten million dollars from a group of bankers in Memphis, Nashville, New Orleans, Chattanooga and St. Louis to buy up the existing float. In the Wall Street of the 1920s, bear raids came and went. Companies didn’t go bankrupt because of bear raids, and if the fundamentals of the company were sound, the stock would bounce back after the bear raid was over. Nevertheless, Saunders refused to give in to the Wall Street city slickers. Saunders hired Jesse L. Livermore, the most famous bear on Wall Street, to help him break the back of the bear raiders. Within a week, Livermore had bought 105,000 shares of Piggly Wiggly, over half the float of 200,000 shares. The bears had shorted Piggly Wiggly stock in the 40 range, but by January, Saunders’ bull campaign had pushed the price of shares past 60. The shorts were losing money.  

The Shorts Are Cornered

Piggly shares were traded on both the Chicago and New York Stock Exchanges. In January, the Chicago Exchange announced that the stock had been cornered, though the NYSE denied that a corner existed. So Saunders decided to try a new tack. He announced that he would issue 50,000 shares of Piggly Wiggly shares at $55 each. Saunders regularly advertised his stores in the newspapers, and he used some of these ads to offer shares to small investors. Saunders pointed out that Piggly Wiggly stock paid a $1 per quarter dividend, yielding 7% to investors. Since this occurred before the S.E.C. came into existence, Saunders could promise that this was a “once in a lifetime opportunity,” and get away with it. Since Piggly stock was then trading at $70, why would Saunders offer shares at $55, leaving $15 on the table for each of the 50,000 shares? The reason is that Saunders knew that once the shorts had been cornered, the demand for Piggly stock would dry up. Saunders’ stock distribution created a market where he could distribute his shares to new investors. Saunders even allowed investors to buy new shares on the payment plan, put $25 down and pay $10 a month for three months. Since the new shareholders couldn’t sell their shares until they were paid for, this would keep the shorts from obtaining these newly minted shares to cover their positions. On March 19, Saunders let it be known that he controlled all but 1,128 shares of Piggly Wiggly’s outstanding shares. He had cornered the shorts. On Tuesday, March 20, Saunders called on the shorts to deliver their shares to him. By the rules of the exchange, the shorts were required to produce the shares by 2:15 on March 21. The stock opened on the March 20 at 75½, moved up to 124 by noon, but then dropped to 82 on the rumor that the Exchange planned to suspend trading in Piggly and postpone the delivery deadline for the shorts. It was no rumor. The NYSE did suspend trading in the stock. Saunders responded by saying that he expected settlement on Thursday the 22nd by 3 p.m. at $150 per share. Thereafter, his price would be $250 per share. The exchange permanently halted trading in Piggly and gave the shorts until 5 p.m. on Monday the 26th to settle with Saunders. With this ruling, the NYSE saved the shorts. This postponement tipped the scales in favor of the shorts because it gave them several extra days to find some of the 1,128 outstanding shares to settle their accounts without having to come begging to Saunders. Was it right for the Exchange to change the rules in the middle of the game to prevent a corner similar to the one that had occurred in Northern Pacific in 1901? Or should the Exchange have left the shorts to their fate? The NYSE justified their actions on the grounds that the demoralizing effect of the corner could have spread to the rest of the market.  

Saunders Wins a Pyrrhic Victory

On Friday, the 23rd, Saunders offered to settle at $100 per share. In the meantime, the shorts were able to find enough shares floating around in Iowa or New Mexico to cover their positions. Shareholders in Sioux City who knew nothing of the Piggly Crisis were happy to double their money by selling to the shorts while the shorts were happy to get the shares at a mere $100. Saunders now had complete control of Piggly stock, but he was also deeply in debt. It is estimated that Saunders made half-a-million dollars out of his corner, but that proved insufficient to cover his costs. After Saunders paid off the banks with his proceeds, he found that he was five million dollars short, half of which was due on September 1, 1923 and the balance on January 1, 1924. Since Piggly shares could no longer trade on the NYSE, Saunders was forced to sell shares directly to the public and advertised in the newspapers once again, offering Piggly Wiggly shares at $55. Although the public was sympathetic toward Saunders and his battle against the Wall Street bears, the public was unwilling to put their money where their sympathies lay. Saunders took out another newspaper advertisement saying that if Piggly Wiggly were ruined, it would “shame the whole South.” Memphis’s newspaper, The Commercial Appeal, lined themselves behind Saunders and helped lead a campaign to convince Memphians to buy Piggly Wiggly shares and save their local boy. The newspaper planned a three-day campaign to sell 50,000 shares to Memphians at $55 a share. This was to be an all or nothing proposition. If they were unable to sell all 50,000 shares, none would be sold. The campaign began on May 8, and soon 23,698 shares had been subscribed. Despite this, skeptics began to raise questions about who was the true beneficiary of this campaign, Saunders or the public. They asked for a spot audit of Piggly Wiggly to reassure potential investors that the company was a good investment. Saunders refused the audit, but offered to step down and let a committee run the company. Skeptics also asked why Saunders was still building his million-dollar Pink Palace when Piggly Wiggly was possibly in its last throes. The Pink Palace was a huge house built using pink Georgia marble. The Palace was to include a pipe organ, Roman atrium, indoor swimming pool, ballroom, bowling alley, its own golf course, and other luxuries. Saunders promised to board up the Pink Palace and stop construction. Unfortunately, the campaign was unable to sell even 25,000 shares, and the campaign soon fizzled. Saunders responded by selling Piggly Wiggly stores, rather than stock, to raise money. Despite selling stores in Chicago, Denver, Kansas City and elsewhere, Saunders failed to raise enough money to meet the September 1 payment of $2.5 million. Saunders turned over his Piggly Wiggly Stock, the Pink Palace (which was sold to the city of Memphis for $150,000 and opened as a museum in 1930. Today, it includes a replica of the first Piggly Wiggly store, a planetarium, a natural history museum and a museum of twentieth-century Memphis) and other property to his creditors and defaulted on the loan. By Spring, Saunders was in formal bankruptcy proceedings. If Saunders had never launched his campaign against the shorts, he would not have had to borrow the money that drove him into bankruptcy. Pride went before the fall.  

Life After Piggly Wiggly

Although Saunders was bankrupt, he got those who believed in him to help finance new ventures. He incorporated a new company, Clarence Saunders Corp. in 1924 and made plans for a new chains of grocery stores. In 1928, Saunders started a new grocery chain called Clarence Saunders, Sole Owner of My Name Stores, Inc., about as bizarre a business name as has ever been created. Stock in Clarence Saunders Corp. stock traded on the New York Curb from November 1928 to January 1930.

Initially, the stores, known as Sole Owner Stores, were hugely successful. A millionaire once again, Saunders was able to buy a million-dollar estate just outside Memphis. Saunders also organized a professional football team called the Sole Owner Tigers which beat the NFL champion Green Bay Packers in 1929 by the score of 20-6. In 1930, the Tigers were invited to join the National Football League, but Saunders declined because he didn’t want to go to away games. When the depression hit, the Sole Owner Stores went bankrupt in 1930. Still, Saunders was able to find backers for his next venture, Keedoozle (“Key Does All”) stores, which were completely automated. Goods were placed behind glass as in an Automat. Customers would turn a key in front of the item they wanted to buy. Their purchases were placed on a conveyor belt, delivered to the front, assembled and boxed. The system eliminated shopping carts, stocking by employees and queuing at the checkout stand. The stores embodied Saunders’ obsession with increasing efficiency. Two Keedoozle stores were opened up in Memphis and in Chicago, but the machinery was too complex and expensive to compete with the quaint fashion of having people push shopping carts around the store. The stores failed. When Saunders died in October 1953, he was still trying to perfect his idea, this time with the Foodelectric system which did everything the Keedoozle did, including adding up the bill. Today, there are over 600 independently-owned PIggly Wiggly stores located in 17 states, mainly in the southern United States. It is easy to see why the S.E.C. banned stock manipulation, not only for corners, but for pools and other schemes that were used to profit from unsuspecting investors in the 1920s. The corner game ended up destroying both the bulls and the bears and benefitted no one. Had Saunders never borrowed $10 million to challenge the shorts, he never would have lost control over his stores. Since the Piggly Crisis, there has been only one stock corner in the United States, in E. L. Bruce stock in 1958. That is another story.

The Perpetuities that are No Longer Perpetual

At the beginning of 2015, the British government had £2.59 billion in undated securities outstanding, representing about 0.23% of the British government’s gilt portfolio. These bonds had no set redemption date, but could be redeemed with three months’ notice. In theory, the gilts could have existed forever. These securities had originally been issued between 1853 and 1946 and replaced securities that originated back in the 1700s. Unfortunately, they are no more. The last undated gilt, also referred to as a perpetuity because it had no redemption date, was called in by the British government on July 5, 2015. Three hundred years of financial history has come to an end.  

Perpetuities Begin

To understand why perpetuities existed, you have to go back to the beginning of Britain’s financial history. Originally, loans were made direct to the sovereign, rather than to the government. This put the lender at risk because the king could default on a loan, and the lender had little recourse to collect his money. After the glorious revolution in 1688, loans were made to the government, not the king. The government tried various ways of raising money, such as issuing lotteries, or issuing annuities, which were paid for the life of the annuitant. Naturally, lenders tried to game the debt by having children buy annuities in order to maximize the flow of interest payments until the purchaser died. Eighty-year old men did not buy annuities. Rather than trying to keep track of every annuitant and selling annuities to children, the British government introduced perpetuities which paid interest forever. To further simplify things, the British government consolidated all the outstanding annuities and other bonds into a single security paying 3% interest. The 3% annuity had been issued in July 1729 and was converted into the 3% Consolidated Loan in July 1753. The 3% Consolidated Loan was refunded into a 2.75% Loan on April 5, 1888 and was converted into a 2.5% Loan in April 1902. The Consolidated Loan provided an unbroken source for data on British bond yields from 1729 to 2015. Until World War I, almost all of the government’s outstanding debt was in the form of undated gilts. In 1910, of the £762 million in outstanding government debt, £567 million was in 2.5% Consolidated Debt. By the time the 2.5% Consolidated Loan was redeemed in 2015, only £162.1 million was outstanding. The idea of issuing bonds to be redeemed one, five, ten or thirty years from maturity and refunding these issues when they matured was the exception. The British government mainly issued debt when there was a war and redeemed debt during peacetime. The government had yet to figure out how to run a deficit every single year, even in peacetime. Britain was not alone in issuing perpetuities. Most European governments had perpetuities outstanding which represented a large portion of their debt prior to World War I.  

The Impact of World War I

During World War I, the British government had to issue large amounts of debt to fund the war. Because interest rates rose as a result of war-time inflation, lenders were unwilling to provide funds at 2.5% anymore. The British government was forced to issue large amounts of debt at higher interest rates. Nevertheless, during the 1920s and 1930s, after inflation had subsided and interest rates returned to pre-war levels, the British government once again consolidated its outstanding war loans into perpetuities. The government issued the 3.5% Conversion Loan on April 1, 1921 in exchange for the 5% National War Bonds. This issue could not be redeemed before April 1, 1961. The 4% Consolidated Loan was issued on January 19, 1927 in exchange for various War Bonds and Treasury Bonds paying between 4% and 5% interest and could not be redeemed before 1957. The largest of the War Loan issues was the 3.5% War Loan issued on December 1, 1932 in exchange for the 5% War Loan due between 1929 and 1947 and could not be redeemed before 1952. This loan represented £1938.6 million. All of these issues were outstanding in 2015. In addition to these three conversions of War Loans, the British government had issued 2.5% Annuities on June 13, 1853 in exchange for South Sea Stock, Old South Sea 3% Annuities, New South Sea 3% Annuities, Bank of England 3% Annuities from 1726 and 3% Annuities from 1751. Thus, the direct descendants of the remnants of the South Sea Bubble of 1720 were still around until they were finally redeemed on July 5, 2015. When the British government nationalized the Bank of England in 1946, it issued 3% Treasury Stock in exchange for shares in the Bank of England. There was £54.6 million in these securities outstanding when they were redeemed on May 8, 2015. Two other securities, the 2.75% Annuities, originally issued on October 17, 1884 and the 2.5% Treasury stock issued on October 28, 1946 were also redeemed. No undated gilts were issued by the British government after 1946.  

The End of Perpetuities

Between February 1, 2015 and July 5, 2015, all eight outstanding undated gilt issues were called in by the British government. Great Britain was the last country to have perpetuities outstanding. Other than Great Britain, all countries had redeemed or their perpetuities by the 1950s, and no country issued any perpetuities after World War II. Some governments, such as France, have issued 50-year bonds, and some companies, such as Disney, have issued 100-year “century” bonds (known as Sleeping Beauties), but no government or corporation has issued undated bonds. The only perpetual financial instruments that still exist are common stock issued by corporations. Common stock has no redemption date and exists as long as the corporation does, but when a corporation is taken over, the common stock ceases to exist. Of the 5000 listed securities traded in the United States, only 13 date from the nineteenth century. The longest dated security is JPMorgan Chase & Co. which started trading as The New York Chemical Manufacturing Co. (later the Chemical Bank) on June 26, 1824.  

JPMorgan Chase & Co. 1824-2016

The others securities that were originally issued in the 1800s and still exist are the Providence and Worcester Railroad Co. (1853), American Express (1856), ADM Diversified Equity Fund (originally Adams Express) (1866), Consolidated Edison Co. (1885), ExxonMobil (originally Standard Oil) (1886), Texas Pacific Land Trust (1888), Laclede Group Inc. (1889), NL Industries Inc. (originally National Lead) (1891), General Electric Co. (1892), UGI Corp. (originally United Gas Improvement Co.) (1895), Kansas City Southern Industries (1897), and Exelon Corp. (originally the Philadelphia Electric Co. (1899). Three of them, Laclede Group, Inc. NL Industries, Inc. and General Electric Co. were part of the Dow Jones Industrial Average in 1896.

One thing that was nice about the undated gilts was that you could easily calculate their yield (assuming the loans weren’t called in three months) by dividing the yield by the price of the bond. So the 2.5% Consolidated Loan yielded 5% when the loan was at 50 (2.5%/50) or 3.33% when the loan was at 75 (2.5%/75). The chart below shows the yield on the Consolidated Loan from 1729 until 2015. Inverting the chart provides the price of security. Enjoy this record of financial markets over the past 285 years because we will be unable to update it anymore.  

Biddle’s Bank

“I sincerely believe, with you, that banking institutions are more dangerous than standing armies.” – Thomas Jefferson
At the end of the Bush administration’s time in office, the government, to the chagrin of some and applause of others, instigated one of the biggest bail outs in history. In 2009 the Obama administration continued Bush’s policies in this regard, however, they hoped they’d use the government’s generosity as leverage over the banking industry, arguing for lower bonuses and concessions on increased transparency and regulation. Fast forward to the 2016 presidential election and we have Democratic hopeful Bernie Sanders criticizing fellow Democratic hopeful Hillary Clinton for her acceptance of over $600,000 in speaking fees from banking giant Goldman Sachs. Sanders implies Clinton’s personal financial gain from Goldman Sachs and other banks which have paid her for speaking fees indentures her to the banking industry. Whether or not that is true, few people know. Many believe politics and banking have never been so closely tied, that our leaders have never been as beholden to banks as they are today. Politicians and banks have been holding hands since the founding of America. It was Thomas Jefferson’s ardent belief that banking was not to be trusted, not because it wasn’t necessary, but its influence could pressure politicians and further, the government itself. On the other hand, Alexander Hamilton, George Washington’s Secretary of Treasury, fought hard for the establishment of a national bank. Modeled after the Bank of England, the First Bank of the United States was chartered in 1791. In 1811, The First Bank’s charter expired, however by then America was once again at war with Britain in the War of 1812 wreaking havoc and disorder among the US’s financial system. This turbulence forced Congress’ hand and they soon passed new legislation to establish the Second Bank of the United States. In 1816 President James Madison appointed Nicholas Biddle, a senator from Pennsylvania as director (and subsequently president of the Second Bank of the United States after his predecessor retired). Between 1816 and 1828 the Second Bank grew in stature and importance, so much so that it was considered an essential agency of the government. Biddle, as the head of the Second Bank, developed the concept of central banking. Under his guidance, the Second Bank controlled America’s money supply, interest rates, lending policies, and held the government’s deposits. In 1844, the Inquirer, a newspaper published in Philadelphia, said about Biddle, “no man was more courted or eulogized.” He had taken an upstart bank and turned it into a powerhouse of fiscal policy.