The Investor December 2020

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ShareFinder’s prediction for Wall Street for the next FIVE months:

The State of Play

By Richard Cluver                          December 2020

AS most adults are likely to attest, one of the most rewarding roles one can play in life is in the raising and mentoring our young people. It is, I believe, in the respect they grant us for the benefit of the modest wisdom of a life well lived that they affirm us and encourage us to offer of our best.

Thus, in my own case, that affirmation has mostly come from young people whom I have been able to convince of the liberation that comes from living debt-free and starting an investment portfolio. It is generally a self-fulfilling thing since, once people have seen the results of their thrift and thoughtful investing, they need no further encouragement. Indeed, from my own experience, most of them become avid evangelists of the principles learned in their youth.

Furthermore, from the latter inevitably flows freedom of choices in life, for the individual who enjoys the advantage owning a capital resource never need experience the anxiety of having to borrow from an exorbitant moneylender or the fear of having to give up an unrewarding job in order to be able to branch out into entrepreneurism. It is, to my mind, what freedom is all about!

While my role has likely been no more satisfying than that accorded any other parent, grandparent, uncle or simply a trusted family friend who has perhaps nurtured a child in something like a passionate sporting code that has seen the child go on to Springbok colours, or perhaps to excel in a caring profession, I nevertheless doubt that it has been any the less fulfilling. That, in my own case through my many writings I have been able to reach out to a far wider community and, because I quite regularly hear from folk who express their gratitude for help over the years which brought them similar freedoms, the latter is surely far more gratifying than the personal freedom and comparative wealth that those ideas have personally accorded me.

That is why, today, I want to tell you about one such youthful case because it also demonstrates the value of sticking to a systematic investment programme as I shall shortly explain.

The portfolio whose graphic performance is illustrated below began with an accumulated “Birthday money” investment of R13 000 in just four JSE Blue Chips back in October 2003. And since then there have been regular re-investments of accumulated dividends and, once the “child” began earning a living, annual injections of savings. What is important to note in the graph below is that although the annual share price growth of the thus steadily-broadening portfolio was at an acceptable rate, it was the regular cash injections which put the wind into its sails to achieve a world-beating growth rate.

Moreover, though through their natural cycle of profitability a number of the early purchases are no longer the performers they once were but were seldom disposed of, their remaining presence in the portfolio inevitably had a diminishing effect upon overall growth because of the regular addition of top performers each time cash was injected! It accordingly offers a modicum of peace of mind to the average investor who often feels a sense of inferiority because he is not always “on top of his game.”

The portfolio graph represents a practical demonstration of the efficacy of a wealth-building annuity system.

Given its exponential nature as a result of the growing sums young investors are able to inject as a percentage of the overall capital value of the portfolio as their earnings normally increase quite rapidly during their early working years, these regular injections can provide a significant boost to the growth rate in its early years.

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Of course, assuming the new portfolio choices are usually high-dividend-growth Blue Chips, the “Total Return” being achieved will inevitably over time erode the boosting effect of incremental savings injections except, of course, in exceptional cases of young “high flyers.” Indeed, there will inevitably come a time in such lifetime portfolios when the overall performance will totally eclipse the effect of further savings injections.

Later too, the same principle will demonstrate the diminishing benefit of ploughing back dividend income as well. But, for most folk, this latter stage will likely be reached quite late in the life of the portfolio when items such as the provision of tertiary education costs might require one to supplement one’s earned income and, at an even later stage still when income is required to supplement a pension.

Now, as most long-term investors are painfully aware, portfolios which include shares that over a long period have risen significantly in value, become inhibited by Capital Gains Taxation. Because of the significant sums of CGT taxation that selling such shares would attract, investors naturally become increasingly reluctant to dispose of long-held shares which have become under-performers.

The logical way to maintain a high overall portfolio growth rate in such circumstances, other of course than selling such shares, is to dilute their growth resistance effect by adding increasing amounts of high-growth shares. And, in the absence of surplus disposable income with which to affect such purchases, the solution is to use dividend income for the same purpose.

That is why I advocate that, even when dividend re-investment represents a relatively insignificant sum relative to the overall capital value, it remains important to continue ploughing back as much as possible into the portfolio. In order to make this possible, I always advise investors to take a very long-range approach to portfolio-building by budgeting to draw down lesser sums of income even during the late stages of life once one is retired. My recommended target draw-down if you want to ensure you continually dilute the underperformers is no more than 50 percent.

Overcoming the trading stagnation that Capital Gains taxation subsequently introduces then becomes the sole reason for income retention. That is why I argue that, within mature portfolios, one needs to aim to draw down no more than approximately 50 percent of portfolio income in order to constantly re-invest in new growth situations with the consequence that the impact upon the portfolio of older, more mature, investments whose growth cycle has diminished or even gone into reverse, is minimised or at least diminished.

Well, that is my thinking anyway though in practice it is often difficult to adhere to the latter principle since greater wealth induces a natural desire to spend more on a better lifestyle. Fortunately for most folk who learned early to always exercise a little thrift, the lifetime habit of always setting a little aside for a rainy day usually ensures that they continue ploughing back a little even when their wealth is such that it will more than guarantee them considerable prosperity in their latter years! So, let us consider the actual portfolio graph and you will immediately see what I have been discussing:


That red trend line shows that since inception the portfolio has grown in value at an annualized rate of 22 percent. However, at interim stages it grew at considerably lower rates and in three recent phases it was declining in value. In the green phase from inception to February 2007 it grew at 22.3 percent while in the subsequent mauve phase until January 2016 it grew at 12.7 percent. Then in the blue phase until January 2018 it grew at minus 8.8 percent, in the brown phase to February 2019 it lost at an annualized 22 percent while in the most recent yellow phase it grew at an annualized 4.1 percent.

Clearly, because of the very different time lengths of the colour phases, one cannot simply create an average of the phases, but what is vital to recognize is that not in a single phase of its life did these interim growth rates ever equal the overall 22 percent.

Readers might think the portfolio choices in the latter stages were not very good considering the fact that following cash injections the portfolio actually lost money in two of the most recent market phases, but, if you consider the graph below of the ShareFinder Blue Chip Index over the same period you will obviously note that the very best shares the JSE has to offer have been losing value recently since South Africa fell out of favour with the international investment community.


More importantly, as the red trend line underscores, over the same period of my “Child” portfolio, the Blue Chips have achieved a compound annual average growth rate of 13.6 percent against the Child’s 22 percent. Furthermore, noting that the JSE is currently one of the world’s most undervalued share markets, it is reasonable to conclude that the Blue Chips will be the first to benefit while the “Child” portfolio can, on the basis of its past performance, be expected to soar.


I hope I have made my point that an investment portfolio started early and consistently added to is your surest guarantee of future wealth! Meanwhile, I know that everyone will want to know which shares make up this winner, so be ready to be surprised by the list on the right which details, from the left, the share name, the total price paid, the number of shares held and their value this month.


“As Long as It Takes”

By John Mauldin

Looking back on my 2007 “Thanksgiving” letter, it’s a little eerie to read in hindsight, knowing now what would unfold over the next year. I observed what was going on in subprime mortgages and credit insurers, and concluded the Fed needed to cut rates.

John Mauldin I wrapped up the 2007 article with this:

Now, maybe this is all just a fire in the trash bin, started by a subprime mortgage market gone wild. Maybe the fire sprinklers will work. But it seems to be spreading. Did someone leave a trash chute open on one of the higher floors? The Fed needs to turn the fire hose onto the problem before it spreads any more. I think we see a 3% Fed funds rate sooner than most of us think.

Gentle reader, be careful as you exit the building, there might be more than smoke. And be sure and grab some wine on the way out. You might as well enjoy it while you wait to get back to dinner.

Ben Bernanke heard my plea (or someone’s) and dropped the Federal Funds Rate from 4.5% to effectively zero over the next year. Even so, 2008 almost brought the financial system to its knees.

Roll forward a dozen years and we are in a different but no less serious bind. Instead of crazy derivatives, a troublesome virus is afflicting the economy. The Fed acted quickly last March, cutting rates and launching a massive asset purchase program. Congress helped with a giant fiscal aid package. Together, these jolted the economy back to life.

The jolt wasn’t permanent, however. The patient is now wavering again, and this time, the fiscal part of the cure is not forthcoming, despite pleas from Fed chair Jerome Powell and many others that monetary policy has reached its limits.

Ah, but this word “limits” doesn’t really apply to central bankers. Particularly the central bank of the world’s largest economy and issuer of the global reserve currency. The Fed has constraints—some practical, some legal—but is highly creative in overcoming both.

Going back to my 2007 metaphor, the Fed has the world’s largest financial fire hose and will use it if the flames grow large enough. Powell repeated this quite clearly just last week. Speaking to a San Francisco business group on November 17, he said, “The Fed will stay here and be strongly committed to using all of our tools to support the recovery for as long as it takes until the job is well and truly done.”

That is not the usual equivocating Fedspeak. Powell promised to use all the Fed’s tools, for as long as it takes, until they are well and truly done. No mention of any limits.

Powell isn’t one to make promises he doesn’t plan to keep. So if the economy begins slipping into a double-dip recession, I believe he will open the spigot again. What the barrage will look like, I don’t know, but it is probably coming.

A quick note on all the angst surrounding Treasury Secretary Mnuchin taking back some of the Federal Reserve’s CARES Act funding. First, the Fed used a little bit in the beginning but much of that money was just sitting there. My sources say Mnuchin is looking for a way to make a deal with Democrats more palatable to Republican senators. Recovering unused Fed money gives him almost $500 billion to soften their frustration with the price tag. The Senate seems to want a number below $1 trillion. With the recovered money, they could pass a “new bill” for less than $1 trillion, while actually spending more.

Whoever you blame for the deadlock, the simple fact is a bill needs to pass soon. I believe there is a serious risk of a double-dip recession without some major unemployment funding. We have about reached the limits of jobs recovery absent a vaccine. That leaves us with a real-world unemployment rate higher than the Great Recession’s worst. Waiting until February to pass a stimulus bill simply tempts the recession gods to strike again.

I wish they would just get a bill done. Forget about waiting for the Georgia elections; if Democrats take the Senate, they can pass a bigger bill later. The US has done nowhere near what the largest developed world economies have done relative to their GDP. From Grant Williams’ latest letter:

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Source: TTMYGH

Further, when you combine all the stimulus from around the world, it is a rather staggering amount in both size and variety. The Western European countries alone have provided 30 times more stimulus (in current dollars) than the Marshall plan after World War II.

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Source: TTMYGH

Total global debt will be close to $300 trillion by the end of the first quarter 2021, and global GDP will have been decimated. Every major central bank, not just the Fed, has opened the monetary spigots. It is no wonder the market is levitating.

Unlike 2008, this crisis has an identifiable end point if the new vaccines work as well as expected and are distributed in the next few months. I worry more about the damage already done. Many of those lost jobs aren’t coming back. Millions of small businesses will never reopen. Other new businesses will open, but that will take time and probably an effective, widely distributed vaccine. Some property owners will never again collect the kind of rent they used to. All that adds up, and it will take a long time to repair and adjust to. And once we do, we’ll still have the preexisting debt and other problems.

But, this being the time when we give thanks, let’s also remember the good news. The pandemic’s death toll, while much too high, could have been far worse. The crash efforts to develop treatments and vaccines will likely bear other fruit as well.

I think we are going to see some amazing new biotechnologies come out of this massive push for a vaccine. This is going to pull a lot of new health and medical technology forward from the future.

Entrepreneurs are meeting business challenges with innovative ideas. We are all going to have to figure out how to reprice commercial real estate, how we think about education, how we travel for business and pleasure, and scores of other things. Change is happening swiftly and not always comfortably. Events that would have stretched over years seem to be happening all at once, which makes it a little unsettling.

But I firmly believe we’re going to get through this and find a better world on the other side. For that, we can all be thankful.

The World Is Bingeing on Debt—and Smashing Records

By Frances Yoon

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Companies and governments have issued a record $9.7 trillion of bonds and other debt this year, as extraordinary support from the Federal Reserve and other central banks has fueled a borrowing bonanza.

The total covers the year to Nov. 26 and includes nearly $5.1 trillion of corporate bonds, as well as some kinds of loans, including riskier leveraged loans, according to Refinitiv. Both figures already exceed those for any prior full year.

More broadly, the Institute of International Finance recently said global debt had risen $15 trillion to $272 trillion in the first nine months of this year and is set to hit $277 trillion by year-end—a record 365% of world gross domestic product. The IIF is an industry group representing hundreds of financial institutions. Its figures are broader and include household debt.

The huge sums reflect how the Fed and its peers, by slashing interest rates and buying trillions of dollars of fixed-income securities, have helped borrowers ride out tough times caused by the global pandemic. As markets have recovered from panic-stricken levels in March, the extra yields, or spreads, that investors demand to hold riskier securities compared with safe government debt have also compressed.

“With interest rates remaining exceptionally low, and with credit spreads having retraced a lot, it makes sense for the public sector, financial institution and corporate clients to look to lock in funding at these very, very low levels,” said Sean McNelis, HSBC’s co-head of global debt capital markets in Hong Kong.


How to solve SA’s economic problems

Professor Brian Kantor

Investec Wealth & Investment

https://www.investec.com/content/dam/south-africa/content-hub/author-headshots/brian-kantor-colour-author-image.jpgMany South Africans are condemned to a lifetime of inactivity for want of experience and the good habits acquired by having jobs. What are some of the practical steps that can be taken to solve SA’s unemployment problems?

In a well-functioning labour market, the number of employees who quit their jobs for something better will match those who are fired. The unemployed will then be a small proportion of the labour force. And it will not be a stagnant pool of work seekers. The number of new hires will roughly match the new work seekers, slightly more or less, depending on the state of the business cycle. Most importantly, the labour market will be reassigning workers to enterprises that are growing faster, from those that are growing slower or going out of business. It is a dynamic process that makes for a more efficient use of labour, and leads to faster growth in output and higher incomes from work over time.


To state the obvious, the above scenario does not describe the current state of the SA labour market. The unemployment rate since 2008 (the first year the current employment survey of households was released) and up to the just released for Q3 2020 survey, has averaged well above 20%. It was 23% in 2008 and 30.1% before the Covid-19 lockdowns. The army of the unemployed grew from 4.4 million in 2008 to 7.1 million in Q1 2020, compounding the problem at an average rate of 4% a year.
 
The numbers employed grew from 14.4 million to 16.4 million over the same period, at a 1.1% annual average rate, but therein lies the rub. The numbers of South Africans of working age who are neither working nor seeking work, nor are economically active, and therefore not counted as part of the labour force, numbered 15.4 million in Q1 2020. This is up from 12.74 million in 2008, having grown by 1.6% a year on average over the period.

The ability of the economy to absorb a growing potential labour force, defined as numbers employed divided by the working age population, now 39 million, declined from a low 45.8% in 2008 to 42.1% in early 2020.  Even more concerning is the inability of the economy to absorb young people into employment.  Of the 10.3 million between the ages of 15 and 24 years, 31.9%, or only 3.2 million, were working or seeking work. The economically inactive numbered 7.5 million. The absorption rate for the cohort fell from 17% in 2008 to 11% in early 2020. The economically inactive part of this group numbered 8.2 million in September. Of the cohort aged 15 to 34, the proportion who were not economically active was 40.4%. 

A lifetime of inactivity

There is thus a large number of South Africans condemned to a lifetime of inactivity for want of experience and the good habits acquired on the job. What is going so very wrong in the SA labour market? We observe how vitally important it is for those with jobs to retain them. The struggle to hold onto well-paid jobs at state-owned enterprises (SOEs) such as SAA and the SABC is an understandably bitter one with so much at stake. And the sympathies of the politicians are with the threatened workers rather than with the attempts to sustain the economic viability of these SOEs in the face of an ever more padded payroll.

Being unemployed, especially for those retrenched form the public sector, is not part of a temporary journey to re-employment on similar terms. It is almost bound to be destructive of lifetime earnings. Even the competition authorities, who you might expect to focus on efficiency rather than job retention, make retaining jobs a condition for approving a merger or acquisition. Yet despite the large numbers of the unemployed and the economically inactive, the real earnings of those with jobs in the public sector have grown significantly and much faster than outside of it – by an average 2.2% a year after inflation compared with 1.52% for the privately employed. This perhaps explains why the SOEs have had such difficulty in balancing their books.

A system in SA has evolved that reinforces the better treatment of the insiders – those with jobs that are entrenched by law and practice – when compared with the outsiders who struggle. Many therefore give up the struggle to find “decent work”. A National Minimum Wage (NMW) is set at a level – R3500 per month – that regrettably few South Africans earn or are capable of earning. This is a major discouragement to hiring unskilled and inexperienced workers, particularly outside of the major cities. You would have to go well into the seventh decile of all income earners to find families with per capita incomes above this prescribed minimum wage.

It is not a low-cost exercise to fire underperforming workers of all grades. Employers have to satisfy the Commission for Conciliation, Mediation and Arbitration (CCMA), with its enormous and ever growing caseload of contested “unfair dismissals” to do so.

It is possible to dismiss or retrench workers or managers in SA. But in addition to any regulated retrenchment package, it is not a low cost exercise to fire underperforming workers of all grades. Employers have to satisfy the Commission for Conciliation, Mediation and Arbitration (CCMA) to do so. Funding a human resources department, with skilled specialists well versed in employment and unemployment procedures, to whom dealing with the CCMA can be delegated, is one of the economies of scale available to big business. The small business owner-manager attempting to navigate the system is at a severe disadvantage that will surely discourage job offers.

The impact of Covid-19

It is not just the regulations and practices that inhibit the willingness of employers to take on more labour. Post-Covid-19 reactions reported by the latest survey of households give some important clues to the forces at work.  During lockdowns, numbers employed fell from 16.3 million in Q1 to 14.15 million in Q2, and recovered slightly to 14.7 million in Q3. The numbers counted as unemployed fell sharply from 7.1 million in Q1 to 4.3 million in Q2 and then rose to 6.5 million in Q3, after the lockdown. The numbers of those who were not economically active rose dramatically in Q2 from 15.4 million in Q1 to 21 million in Q2, when it made little sense to actively seek work. The numbers of the economically inactive then fell dramatically by over 2 million in Q3, as more people sought work and were physically allowed to do so.
 
The numbers employed in Q3 rose, but were not as many as those additional work seekers and so the unemployment rate picked up. It was a development highlighted in the survey.  It made sense for more people to look for work because it was more likely to be found, and also presumably because the declining economic circumstances of the family, perhaps the extended family on which many depend, made the search for work and additional income imperative.

Covid-19 may well have damaged the ability of the extended family to provide support for those not working or intending not to work, hence the fewer inactive members of the workforce.

South Africans understandably have a reservation wage, below which working does not make good sense. It has to pay to work. And the economically inactive in SA who are overwhelmingly low or no income earners are presumably able to survive without work by drawing on the resources of the wider family. They will not have accumulated much by way of savings to draw upon. The family resources, on which they rely, are likely to be augmented by cash grants from government and from subsistence agriculture or occasional informal employment. Covid-19 may well have damaged the ability of the extended family to provide support for those not working or intending not to work, hence the fewer inactive members of the workforce.  

The failure of SA’s mix of economic policies is revealed by what is still for many a reservation wage that remains higher than the wage employers are able and willing to pay them. Hence the discouraged employment seekers who are among the economically inactive. It seems clear that South Africans choose to some extent to supply or not to supply their labour, depending on their circumstances including their skills and earning capacity as well as the state of the economy. They have a sense of when it seems sensible to work or to seek work at the wages they are likely to earn.

16.3 MILLION

Employment figure for Q1 2020

14.15 MILLION

Employment figure for Q2 2020

14.7 MILLION

Employment figure for Q3 2020

Practical solutions

What can be done about this essentially structural issue for our economy? Businesses surviving Covid-19 have increasingly learned to manage with fewer workers and managers. Abandoning the NMW or the CCMA or reducing the legal powers of trade unions and collective bargaining would help increase the demand for labour, but this course of action is unlikely.

Meaningfully improving the quality of education and training (on the job as lower-paid interns and apprentices) to raise the potential earnings of many more over their lifetimes of work, also seems wishful thinking.

Reducing the value of the cash grants paid, so reducing the reservation wage to force more of the population to seek and obtain work, would be cruel and is as unlikely. Some form of welfare payments for work seems to be on offer in the form of the internship scheme announced recently by President Cyril Ramaphosa.

The Employment Incentive Scheme allows employers to deduct up to R500 off the minimum wage paid to workers under 29 and for all workers in the special economic zones. Employers simply deduct the subsidy from their PAYE transfers. It takes very little extra administration by either the firms or the SA Revenue Service. In 2015/16, 31,000 employers claimed the subsidy for 1.1 million workers and the scheme cost R4.3bn in 2017-18. The subsidy may well have to be raised to keep pace with higher minimum wages imposed on employers.

Raising taxes to subsidise the employment of young South Africans may be the only practical and politically possible way to provide more opportunities for them, especially if the market is not allowed more freedom to address the employment issue, by offering wages and other employment benefits that workers are willing to accept. Abandoning the NMW, the CCMA and nationwide collective bargaining agreements, all so protective of the insiders, would increase the willingness to hire and raise real wages for the least well paid in time. But it would be unrealistic to expect the unemployment rate in SA to rapidly decline to developed market norms. It will take faster economic growth, which leads to higher rewards for the lowest paid and least skilled, to make work the better option for many more. And it will take many more workers to raise our growth potential.

Climate change is not a collective action problem

By Matt Clifford

Why has it proven so hard to achieve significant progress on climate change? Conventional wisdom is that mitigating climate change is a classic collective action problem. Everyone benefits from a stable and healthy climate, but there’s strong incentive for individual countries to “free ride” and not bear the costs. An important new paper, however, suggests that this is wrong: empirically “governments implement climate policies regardless of what other countries do… whether a treaty dealing with freeriding has been in place or not” (There’s a great summary of the paper here). 

If true, this is an enormously important finding. It suggests that the binding constraint on effective action on climate change is not international deal making, but the internal politics of nation states – in particular the distributive conflict between winners and losers from moves towards carbon neutrality. The paper presents a range of empirical evidence that this, and not international coordination, should be the main focus of climate campaigners.

This is broadly good news. It suggests that progress is possible even when major countries “defect” from international agreements on climate. This helps explain developments like China’s pledge to achieve carbon neutrality by 2060, which is expected to reduce the increase in temperature by as much as 0.3C (perhaps the best news of 2020!), despite President Trump’s withdrawal from the Paris Agreement. Research into the socio-political structure of major challenges is deeply unsexy, but undoubtedly underrated. 

Can the UK achieve “green growth”?

Given the finding discussed above, it’s particularly valuable if climate change mitigation can grow the economy. That’s one lens through which to look at the UK Government’s recently announced plans for a “green industrial revolution”. This is a series of proposals to accelerate the post-coronavirus economic recovery through investment in low-, zero- and negative-carbon technologies. Richard Jones – whose work on R&D we discussed in TiB 94 and TiB 117 – has a superb analysis of the plans here.

Jones is broadly positive, though worries that there’s too much hope invested in getting breakthroughs from relatively small sums invested in R&D. As Matt Clancy (again!) shows in this interesting post, it usually takes around 20 years to get from scientific breakthrough to real-world impact – which is a long time in climate change on our current trajectory. Jones’ blog is a treasure trove of thoughtful pieces on the underlying opportunities, including nuclear, hydrogen and carbon capture (but do read in conjunction with this new profile of Stripe’s impressive work in this area).

The post directly addresses one of the biggest questions for (non-US, non-China) policymakers today: what can and should a medium sized power do? As Jones notes, most countries should expect to be consumers, not producers, of most of the necessary innovations, so (as in startups) problem selection is key. Jones suggests that the UK has strong competitive advantages in offshore wind – and highlights nuclear fusion as a more speculative, but important, bet. As Jones says, the proposals are “patchy and insufficient”, but still important and, perhaps, a hopeful step forward. 

Clearinghouse Certificates during the Great Depression: A Non-example of “Unaccounted Money”

By Clifford F. Thies Eldon R. Lindsey

Chair of Free Enterprise Professor of Economics and Finance at Shenandoah University

QJAE According to Paul Krugman (1999, 8–11), a contributing cause to a depression is hoarding. Because of hoarding, the government should issue massive amounts of money to prevent recessions from turning into depressions. But, why must the government do this? Why can’t the private sector issue money during an emergency? At one level, the answer is easy: the government has monopolized money and prohibits the private sector from issuing money during an emergency. At another level, the answer is complicated.

Relying on numismatic sources, Richard Timberlake (1981, 860) demonstrated that the private sector repeatedly issued massive amounts of money during the hard times of the early to mid-nineteenth century. While there appears to have been some number of issues throughout the period, private, non-bank issues of money mostly appeared during certain times (1814–17, 1837–40, 1857–58, and 1862–64). Timberlake describes this money as “unaccounted.” Subsequent research has documented other instances of unaccounted money including Michigan when the state was nearly without banks (Baily, Hossain and Pecquet 2018), and New Orleans when it was occupied by northern troops during the Civil War (Pecquet and Thies 2010). During the National Bank Era, clearinghouse associations took the lead in issuing money during financial crises (Dwyer and Gilbert 1989, Gorton 1985). So why was there no clearinghouse money during the Great Depression of the 1930s?

In 1999, when Krugman wrote The Return of Depression Economics, it was received strangely. It was a thin book, written in large type, short on economics and long on story-telling. Supposedly, it was about Japan’s “lost decade,” when—according to Krugman—they had not increased their national debt enough. Yet, Japan’s national debt had grown to 200 percent of GDP. Krugman updated the book, The Return of Depression Economics and the Crisis of 2008 (2008). In the update, his concern was that the U.S., with a budget deficit of 12 percent of GDP, was not adding to its national debt fast enough.

To illustrate the problem of hoarding, Krugman used the example of the Capitol Hill Baby-Sitting Co-op of Washington, D.C., of the 1970s. As Krugman describes this co-op, it consisted of lawyers and other such well-heeled persons who decided that, instead of hiring baby-sitters, they would take turns baby-sitting each others’ children. The co-op required that its members only obtain baby-sitting services from each other, and use chits distributed by the co-op for the service. But, the members of the co-op hoarded the chits they had (in order to have them available when they really needed baby-sitting services), rather than use them freely in order to go out. And, since few people were purchasing baby-sitting services, nobody could be sure of acquiring chits through the offer of baby-sitting services, which only served to reinforce the urge to hoard chits.

After trying various New Deal-type “solutions” to the hoarding problem, such as requiring members to go out at least twice a month, the Co-op happened upon the idea of distributing more chits. The additional chits allayed members’ concerns that had led to the hoarding problem, and the market in baby-sitting services picked up.

What does Krugman’s story of the hoarding of baby-sitting chits have to do with depressions? During depressions, people lose confidence in their ability to earn money by offering their labor and other productive services. They therefore seek to build up cash reserves, i.e., to “hoard money.” But, the Keynesian story goes, the hoarding of money lowers the demand for labor and other productive services, resulting in a further loss of confidence, and intensifying the urge to hoard.

Other examples of hoarding come readily to mind. During the coronavirus panic of 2020, there was a run on toilet paper. Because people were not confident in future supplies of the item, they rushed to buy it, and emptied the shelves. Voila! stores ran out of toilet paper, just as panicked shoppers feared. But the shortage was only temporary, and the supply chain quickly restored retail inventories.

Throughout most of the world, replacement kidneys are in short supply as most people “hoard” their extra kidney not being confident of being able to obtain a replacement kidney if the need should arise. But not in Iran, where the authorities allow an internal market in kidneys. In that country, replacement kidneys are in good supply (Fry-Revere 2014).

In 1834, in conjunction with the failure of one bank (the Bank of Maryland) and rumors about others, there was a run on the banks of Baltimore. People lined up at banks to demand their specie (Niles’ Reporter, March 29, 1834). But, as the day wore on, those in line saw others leaving their banks with their bags and wheelbarrows heavy with coins, and—their fears allayed—people began leaving the line. Later in the day, some who had earlier gotten their specie were returning their coins to their banks. Accordingly, there was no general suspension.

Each of these examples indicates that a government intervention is not always needed to solve a hoarding problem (interpreting allowing a market in Iran as reduced involvement by government). Even the example cited by Krugman was resolved by the Baby-Sitting Co-op without a government intervention.

There is more to what is called the “hoarding” of money than the impact of income uncertainty on what the Keynesians call aggregate demand.1 Historically, times of hoarding were times of bank suspensions and of runs on the bank, and sometimes they were also times of uncertainty regarding the gold standard and runs on the dollar.2

The impact of hoarding can be particularly severe with a fractional reserve banking system. In a fractional reserve banking system, every dollar removed from banks forces a multiple reduction of the money supply. Furthermore, a “run on the bank” might result in banks being forced into suspension, immobilizing the funds still in them. The run of the bank can force a suspension even if the bank has positive net worth and reserves sufficient to meet the run because maintaining a certain amount of reserves is required by law or regulation.

In the past, when banks suspended, a great deal of the money people had in their banks became illiquid, meaning that it was unavailable as a medium of exchange. The combination of reduced consumer confidence, job insecurity, a reduced money supply, money tied up in banks in suspension, concerns for additional bank failures, and speculation on gold caused people to cut back on their spending either for lack of income or in order to build-up a cash reserve, and deprived the economy of a portion of its medium of exchange.

To be sure, hoarding might not have been a primary cause of a recession. Hoarding might have only broken out when the public became concerned for the soundness of money and/or of the banking system, and thus may have been a secondary cause making a recession worse. In the monetary history of the United States, money generally disappeared only after banks were forced into suspension.

The great champion of the gold standard Ludwig von Mises recognized the usefulness of money substitutes to deal with bank panics. “[I]t has repeatedly happened in times of crisis that confidence has been destroyed,” he said (Mises 1953, 371). This loss of confidence in bank deposits would result in “a collapse of a part of the national business organization” if allowed to run its course. In England, the Bank of England emitted additional bank notes; and, in the United States, which had no central bank, clearing house certificates were emitted (372). Even though such actions seemed to violate the “rules of the game” of the gold standard, Bordo and Kydland (1996, 85) say these actions may have supported the commitment to the gold standard in the long run.

F.A. Hayek (1967, 109), in an often-misunderstood passage, described the phenomenon as a “secondary depression.” Walter Bagehot’s dictum, that central bankers should lend freely on good collateral to solvent banks at high interest rates during panics, would seem to obviate the effects of hoarding; but, what if there is no central bank (as during the National Bank era); and, what if the central bank does not follow his rule?

2. CLEARINGHOUSE ASSOCIATIONS

During the National Bank Era, and with some acquiescence by law and regulation,3 the market developed an effective method to deal with the problems of bank suspension and hoarding through the issue of scrip, or emergency money, by banks and their clearinghouse associations. Originally, this emergency money was used only among banks. But, over time, at first in the South and then elsewhere, this clearinghouse money came to have a more general circulation. To be sure, clearinghouse money was not the only measure employed by the market to deal with the bank suspension and hoarding problems. But clearinghouse money became, by far, the most significant measure during the National Bank Era. According to A. Piatt Andrew (1908), following the Panic of 1907, when $238 million of clearing house certificates were issued, $96 million of other forms of scrip were also issued. The largest component of these other forms of scrip were payroll checks written by employers.

As A.D. Noyes (1909) details, following the Panic of 1893, the New York Clearing House issued $38.3 million in clearinghouse certificates, and other clearinghouses across the country issued a total of $69 million. These certificates circulated for about 19 weeks, at which time, the panic having ended, they were withdrawn from circulation, and normal operations resumed. Following the Panic of 1907, the New York Clearing House issued $85.4 million in clearinghouse certificates. Including clearinghouses across the country, a total of $238 million was issued. These certificates circulated for about 22 weeks.

Clearinghouse certificates had been issued following prior panics, in 1873, 1884 and 1890. Table 1 gives the amounts issued by the New York Clearing House from 1873 to 1907. An antecedent of clearinghouse certificates was utilized as early as 1857. That year, a form of clearinghouse certificate “backed” by securities issued by New York State and the U.S. Treasury was used for inter-bank settlements (Gibbons 1968, p. 364). This expedient was subsequently utilized several times during the 1860s.4

It was in 1873 that certified checks payable through clearinghouses were first issued as hand-to-hand currency. For example, soon following the decision of the New York Clearing House to adopt the Clearing House Certificate method for inter-bank clearings, the Louisville Clearing House suspended payments in legal tender currency (“greenbacks”) and paid out, instead, small checks based on the pledge of securities with the clearinghouse ([Memphis] Public Ledger, September 29, 1873, p. 2).

In 1893, clearinghouse certificates were first issued as a hand-to-hand currency (Cannon 1910, 3). These retail-level certificates were mostly issued by clearinghouse associations in the South. In addition, checks issued by banks, manufacturers and others, suitable for use as a hand-to-hand currency, became commonplace. The Richmond Dispatch (August 12, 1893, p. 2) reports that these expedients worked well. Thousands of workers were paid in the scrip, which was in turn freely accepted by merchants.5 A numismatic catalogue details dozens of specimens of certified checks issued by banks, clearinghouse certificates and manufacturer’s payroll checks that were issued during this financial panic (Shafer and Shaheen 2013).

In 1907, small-denomination clearinghouse certificates were issued by clearinghouse associations in several regions of the country. As discussed above, the dollar amount of clearinghouse certificates issued approximately doubled the amount issued in conjunction with the financial panic of 1893. Hundreds of specimens of scrip issued by clearinghouses, banks, manufacturers and others are described in Shafer and Shaheen’s (2013) catalogue.

In 1914, to offset financial tightness upon the outbreak of World War I, clearinghouse associations issued $200 million of inter-bank clearinghouse certificates (see Table 2), and “currency associations” organized by national banks issued $400 million in (emergency) National Bank notes under the Aldrich-Vreeland Act of 1907 (“The 1914 issue of …” 1915, 509). These banknotes were not backed by U.S. Treasury bonds, but rather by qualifying securities such as state and municipal bonds and commercial paper; and, the issue was subject to a penalty interest rate. Because of the penalty interest rate on these issues of National Bank notes, they were quickly retired from circulation when the period of financial stringency passed, as were the clearinghouse certificates. Shafer and Shaheen’s (2013) catalogue contains only a few specimens of scrip for this period.

3. HOW DID CLEARINGHOUSE CERTIFICATES WORK?

Initially and in the case of the New York Clearing House until its aborted issue of 1933, clearinghouse certificates were issued by clearinghouses in the making of loans to member banks in large denominations, secured by “good funds” attested to by the clearinghouse association, for the purpose of inter-bank settlements. As demonstrated by Gorton and Tallisman (2018), soon after the issue of these clearinghouse certificates by the New York Clearing House, the premium on currency relative to certified checks fell from about 5 to about 1 percent, restoring liquidity to the nation’s financial center. Bank and stock market suspensions were minimized or avoided altogether.

Outside of New York, financial panics often had lingering effects, including (1) partial or full suspension of cash withdrawals from banks, (2) difficulties in meeting payrolls, (3) dislocation of domestic exchange, (4) hoarding, (5) a currency premium, and (6) the issue of hand-to-hand money substitutes (Wicker 2000; James et al 2013). Banks and clearinghouse associations issued scrip to the public, variously described as cashier’s checks, certified checks and clearinghouse certificates, in small denominations suitable for a hand-to-hand currency. The clearinghouse certificates were typically “backed” by identified assets of clearinghouse member banks, and mutually guaranteed by the clearinghouse member banks. In addition, manufacturers and other businesses issued payroll checks in the manner of due bills, payable upon resumption of normal banking or by a certain date; and, merchants issued scrip redeemable in merchandise.

The bank and clearinghouse scrip were typically lent to an employer, who used them to meet a payroll, or else issued to depositors looking to make withdrawals during a time of suspension. Workers and depositors who received the bank and clearinghouse scrip then tendered them, like money, to various merchants (which is not to say that the merchants had to accept them, since they were not legal tender). Receivers of the scrip might use them to repay their loans from banks, or to make deposits in accounts at banks. Otherwise, they might themselves use the scrip as money. As long as the supply of bank scrip and clearinghouse certificates is small compared to the need of debtors to banks for money with which to make their loan payments, the bank scrip and clearinghouse certificates would pass at or near par.

Thus, among the ways the bank scrip and clearinghouse certificates worked is that they were created in the process of making loans, and destroyed in the process of paying off loans. Also, they were issued to depositors during the time banks were in suspension, and destroyed when used to pay off loans or when re-deposited. During the brief time of their existence, they circulated as money for a temporary period of time under emergency conditions.

4. SCRIP DURING THE GREAT DEPRESSION

If bank scrip and clearinghouse certificates moderated the effects of financial panics during the National Bank Era, why were they not issued during the Great Depression? The reason bankers did not, during the Great Depression, rescue the country from the worst series of bank panics in U.S. monetary history, is, first, the job of lender of last resort had been transferred from clearinghouse associations to the Federal Reserve; and, second, the government stopped the banks from issuing clearinghouse certificates. The clearinghouse associations, spontaneously and motivated by self-interest, developed the expedient of clearinghouse certificates to deal with financial crisis. The newly formed Federal Reserve, contrariwise, was to act with discretion and in the public interest. In hindsight, it is clear that clearinghouses acted dependably and even reflexively as a lender of last resort; while the Federal Reserve during its formative years thrashed about.

During March 1933, following the suspensions of many banks, several state bank holidays, and a looming national bank holiday, the bankers of the country, joined by merchants and others, were ready to issue hundreds of millions of dollars in clearinghouse certificates. But the government intervened and prevented it.

Prior to 1933, bankers had mostly resisted the call for scrip. Nevertheless, a number of localities had availed themselves of the same. According to the New York Times (January 15, 1933, IV:8), by early 1933, about 500,000 people were using some form of scrip. Some municipalities issued scrip in the payment of salaries to their workers and for other purposes. For example, Atlantic City, New Jersey, issued scrip during 1932, receivable by the city for payment of back taxes. Again according to the New York Times (March 3, 1933, p. 36), “The scrip [of Atlantic City] has had a wide circulation and much of it has reached the office of Tax Collector Lewis L. Mathis for delinquent bills.”

In other cases, voluntary associations issued scrip in conjunction with work relief efforts. In Freeport, New York, for example, the Freeport Committee for Unemployment, with the support of “virtually all stores” in the town, issued $50,000 in “stamp scrip.” This emergency money was to be issued to persons in payment for work on make-work projects, and was then to be spent in the stores of the town that would accept it. It was to re-circulate within the town for the next year. A fund for the redemption of the scrip was to accumulate through the purchase of stamps for affixing on the scrip, at the rate of 2 percent of its face value per transaction or per week.

While the stamp scrip idea was one of the more inventive schemes that arose during the Great Depression of the 1930s, it should be considered that such difficult times often give rise to panaceas that, somehow, “solve the underlying problem” of a market economy (Myers 1940).

The private issue of scrip during the 1930s was given some impetus by the issue of wooden currency in 1931 by the chamber of commerce of Tenino, Washington (Brown 1941, 22–25; Preston 1933).6 This scrip ranged in denomination from 25¢ to $10, was printed on a thin slice of wood composite material, and was backed by the frozen assets of the suspended local bank. The scheme, born out of the need of the town for a medium of exchange when its one and only bank suspended, caught the fancy of the nation, and became something of a novelty item for tourists. Many subsequent issues by chambers of commerce and similar business groups, individual merchants and other community-based associations featured elements of both novelty and need. Table 3 describes some of the characteristics of the scrip outstanding in 1933.

Notice, in Table 3, how dramatically different were the issues of scrip outstanding in 1933 from those of the prior two major financial crises. During the prior two financial crises, banks and their clearinghouse associations made the majority of issues of scrip; and, together with manufacturers and others in the private, for-profit sector, dominated the issue of scrip. In contrast, in 1933, there was no clear locus. Issuers of scrip were simply diverse. Also during the prior two financial crises, almost all scrip was in denominations of at least $1. In contrast, in 1933, a lot of scrip was fractional currency. The changed composition of scrip reflects the more deranged financial conditions of the 1930s. Bankers, with their ability to recognize value in loan-making and, hence, to enhance the liquidity of the assets and earning power securing those loans, were being replaced by amateurs.

By March 1933, the problems with bank suspension, bank holidays and hoarding had become unbearable. Following the election of Franklin D. Roosevelt, and the possibility of radical legislation or even rule by decree, people throughout the country rushed to withdraw their money from banks. Banks were failing in droves, and, in one state after another, bank holidays were being declared or else withdrawals of deposits were being restricted to 5 percent of balances. In some places, moratoria were being declared on debt payments, and there was a growing suspicion that gold would be embargoed.

Instead of allaying the fears of the public, these bank holidays and other interventions only made things worse. Money started disappearing, including in particular coins and small-denomination paper currency. There was a run on the change-making machines at laundromats, and retailers stopped accepting high-denomination bills for small purchases.

On March 4, when New York Governor Herbert H. Lehman declared a two-day bank holiday, banker sentiment shifted sharply in favor of scrip. That day, the New York Clearing House announced a rush plan to issue clearinghouse certificates upon the re-opening of the banks. At the printing facilities of the American Bank Note Company in the Bronx, crews started working round the clock to deliver up to $200 million in scrip to the New York Clearing House, in denominations from $1 to $50, with additional orders by bankers in Baltimore, Boston, Chicago, Detroit, Philadelphia and elsewhere.

Throughout New York City, merchants and other vendors started announcing their readiness to accept the scrip, as well as bank checks, and their willingness to extend store credit to regular customers. According to the New York Times (March 7, 1933, p. 5), “There was something naïve in the anxiety of the public to get its hands on the promised new medium of exchange.” But representatives of the New York, Philadelphia, Baltimore and Richmond clearinghouse associations were then called to Washington, D.C., by the Secretary of the Treasury. After a few days of negotiation, including an apparent approval of the bankers’ plans, authority to proceed with the issue of clearinghouse certificates was denied. Instead of allowing clearinghouse certificates, the administration pushed the Emergency Banking Act of 1933 through Congress. Among other things, this act gave the Federal Reserve enormous new power to issue currency.

This was soon followed by executive orders and other legislation fundamentally changing the character of money and banking in the country.

5. PROBLEMS WITH SCRIP

From time to time during the National Bank Era, bank scrip and clearinghouse certificates served a useful function. They ameliorated the problem of deflation characteristic of a fractional reserve banking system during and immediately subsequent to a bank panic. Being illegal, bank scrip and clearinghouse certificates depended on forbearance by authorities, and quickly disappeared after the emergency was over. They did not permanently add to the money stock. With a gold standard, there was a meaningful link between the money supply and gold, although an elastic one because of fractional reserve banking. During normal times, there was a tendency for the money multiplier and therefore the money supply to increase. During banks panics, the money multiplier and therefore the money supply fell precipitously, with macroeconomic consequences. There were problems attendant to returning to the gold standard after a wartime suspension, and to the periodic discoveries of gold and improvements in the technology of gold mining. Still, the gold standard provided an anchor to the price level. If bank scrip and clearinghouse certificates were permanent additions to the money stock, the price level would become indeterminate. This only happened during the 1920s, when the Federal Reserve became enamored with the Real Bills Doctrine (Humphrey and Timberlake 2019).

Bank scrip and clearinghouse certificates were an inferior form of money to legal tender currency and demand liabilities issued by banks; and, the menagerie of local currencies issued during the 1930s were even more inferior. These emergency forms of money circulated only locally and, because of their small scale, subject to a significant discount by brokers even when received at par within their locality, where brokers made markets in them. Brown (1941, 40–42) gives the example of Detroit’s municipal scrip, that exchanged for legal tender currency at a discount of 5 percent. To some extent, appeals to community-mindedness overcame the inferiority of these various forms of emergency money. But, for the most part, the emergency money was only put into circulation through the payment of wages by state and municipal governments and private sector employers during a time of high unemployment. While there are only a few known cases of counterfeit scrip (again, Detroit’s municipal scrip is an example [Brown 1941, 40–42]), this might simply be due to the fleeting existence of most issues of scrip.

6. STATE PREROGATIVE OVER MONEY

The market has exhibited tremendous ability to identify goods useful as media of exchange, from cattle and grain in the ancient world, to cowrie shells and wampum, to beaver pelts and deer skins, and from tobacco in colonial Virginia and cigarettes in WWII prison camps, to giant rocks on the island of Yap. George Selgin (2008) describes the private issue of coins during the industrial revolution in Great Britain. Nevertheless, the assertion of a monopoly over the medium of exchange by the government—what is called its prerogative over money—has frequently cut short the private issue of money; in some cases, with devastating consequences. Sometimes, there have been rather transparent attempts to evade restrictions on privately issued currency. For example, some money substitutes during the nineteenth century were declared redeemable in train fares or in merchandise so as to look like coupons and not a general medium of exchange (Timberlake 1981, 861–62). With the shortage of coins during the U.S. Civil War, some privately issued tokens in the form of copper pennies were inscribed “NOT ONE CENT”, as in “Millions for defense, but NOT ONE CENT for tribute.”

During the 1870s, the use as money of payroll checks and due bills issued by the mining companies of Michigan’s northern peninsula was abruptly ended when these money substitutes were declared subject to the federal government’s prohibitory tax on private banknotes (Thies 2019). In 2009, the issuer of the “Ron Paul dollar” was convicted of violating the federal government’s law against issuing anything designed to circulate as a medium of exchange (Ramsey 2008).

In contrast, the issuers of the Ithaca dollar and other “community currency” (Collom 2005, Kim, Lough and Wu 2016) have not been prosecuted, possibly because they did not threaten the system. From 1933 to 1977, the federal government not only banned the private ownership of gold and abrogated the gold clause in bonds, it banned all forms of indexation (McCulloch 1980).

The failure of banks to issue scrip during the Great Depression of the 1930s was not a market failure, but the result of an intervention. Instead of resorting to the proven expedient of clearinghouse certificates to meet an emergency need for a medium of exchange, the incoming administration had much bigger plans. It would be like a babysitting co-op deciding that the way to deal with the hoarding of babysitting chits is to take children away from their parents and put them into orphanages run by the co-op, instead of simply issuing enough additional chits to bring liquidity to the babysitting market.

 


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