My brother called a couple of days ago. His wife has $100,000 to invest and he wanted to know where I thought I should put it. I’ve made recommendations in the past and they’ve always made money; which I feel puts a bit of pressure on me because each time I feel I’ve got to live up to my own record.
It’s also tough because the investment market is so screwed up with the recent actions of the Federal Reserve. In the 1800s, investing was pretty simple, you just put your money in bonds and forgot about it. Since consumer prices went down for most of the 1800s (with the notable exception being the war-time inflation of the Greenback fueled Civil War) the return you received on bonds would be in addition to the additional purchasing power the money itself possessed. Few people invested in the stock market in those days; it was seen as a shady place where individuals like Jay Gould, Cornelius Vanderbilt, and Nathan Rothschild could use their deep pockets and insider information to force a stock price to be whatever suited them at the time. A stock exchange was more casino than sober investment house. Bonds were where the common man should put his money.
Lately I’ve been reading opinions about the market that tell their readers not to be too worried about inflation. Sure, they’ll admit that expanding the money supply correlates sharply with inflation, but they tell me that Ben Bernanke will take all that liquidity out of the system when the time is right. I have no idea where they get this idea; Alan Greenspan certainly wasn’t able to contract the money supply after he inflated it to ward off recession. Do we really believe that Ben Bernanke is going to do any better?
One opinion I read indicated that mopping up inflated money supply. After all, all the Fed had done was monetized the government’s debt. Since that debt is held in the form of US Treasury bonds, it should be easy to contract the money supply again by simply selling the bonds. The author of this opinion was rather misinformed, because they did not seem to understand that when the Fed monetizes bonds, it does so with money that it yanks out of thin air. The money then enters the system by way of the bank. Continue reading Can the Fed Tighten the Money Supply in Time?
Today the Fed made history by lowering the fed funds rate to a target of between .25% and zero. That’s right, zero. Nada. Nothing. Ben Bernanke proved that he was a man of his word. Before he was elected chairman, he said that he would lower interest rates to zero to combat the dreaded forces of deflation, and now he’s proven he’s good for it.
Ben’s Christmas gift to the world is an interest rate of nothing.
I read a lot of superhero comics as a kid, and as an adult I love the movies made from them. The figure of a guardian watching over people ready to swoop down and deal a couple of solid punches to evildoers was very reassuring to me as a child. The world painted on the pages of the comic books made the hero indispensable. Without the protection of heroes like Spider-man, the world would be overrun by criminals. Not to mention supervillains.
I’d say that the world we live in today views itself through that comic book prism. Free societies will soon be overrun by fraudsters and criminals if we don’t have super powerful regulators to protect us. Similarly, free markets would soon fall prey to their own excesses were it not for super powerful bankers who can sweep in and defeat the business cycle with a couple of handy rate cuts.
Look, up in the sky. It’s a bird. It’s a plane.
It’s… THE CHAIRMAN!
His super powers include the ability to run the printing presses faster than a speeding bullet… and in so doing make your money lose value. That’s all inflation is, you know — money losing value. Ben hopes that the tonic of a little inflation will get the markets started again. Keynes himself theorized in The General Theory of Employment, Interest and Money that inflation was the great trickster which could get labor to work for lower rates of compensation then they had anticipated. He figured that laborers would be slow to catch on to the difference between nominal wage rates (the number of dollars they were being paid) and real wage rates (what those dollars could buy). Keynes figured that by using the trick of inflation, business would be getting a discount in their labor costs (because he figured labor is slow to catch on) and would therefore become profitable.
It’s never worked, mind you. It didn’t pull us out of the Great Depression despite being tried year after year. It didn’t do a lick of good in Japan, either. Inflation has not cured deep recessions then, and it’s not going to solve this one today. In fact, it was these efforts to use the power of inflation to resist economic downturns that caused the greater downturns down the road in the first place.
In William Feckstein’s short little book, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve he meticulously traces how Greenspan did little but cut rates through his tenure as chairman. First, he did so at the start of the ’90s to prevent the ’91 recession from deepening. These lower interest rates pushed a lot of savers out of traditional interest-bearing bank accounts and into the stock market in pursuit of higher returns. Greenspan then found that he was powerless to bring the rates back up without crushing these newly-made stock market investors. So he just kept them low despite the “irrational exuberance” he felt was getting priced into the market.
The end of the millennium came, and Greenspan worried that nervous individuals would pull too much liquidity from the system with their Y2K concerns. So in anticipation, he pushed liquidity into the system and helped spike the stock market of ’99 to be one of the best stock market years on record. He again found himself unable to raise interest rates, because of the downturn that ensued after the bursting of the stock market bubble. So, Greenspan just lowered rates AGAIN, inciting a housing bubble. Now his predecessor, Ben Bernanke, is finding that he also could not raise interest rates back to where they were without crushing the bubble and causing a depression. And now he’s having to lower interest rates even lower than Greenspan ever did. To drive this point home, I took the historical data for the fed funds rate from the Federal Reserve’s website and plotted it in Excel. Have a look.
As you can see from the graph, every attempt to raise interest rates after they were lowered caused an economic downturn that necessitated still lower interest rates. As most anyone could guess, this can only go on for so long. Once the fed funds rate hits zero, there’s no more room to cut. And here we are at the bottom. I suppose it’s possible that there may be one more bubble cycle in the American economy, but that will only prolong the inevitable. In real terms, there’s nowhere for the American consumption-driven economy to go but down.
“Fear not,” our chairman, turned-superhero seems to say, “I have other ways to cause inflation.” And he does. As he detailed in his speech on making sure deflation “doesn’t happen here,” the Fed chairman can use all kinds of shenanigans to keep inflation rolling. The fed funds rate is a short-term rate, but Ben wants us to know that with the flip of a switch, the Fed can just start printing up money and using it to purchase bonds in order to drive down interest rates all across the spectrum. So we may be down to a short-term interest rate of zero, but we still have room to cut the mid- and long-terms ones next.
Of course, if one takes this to its logical conclusion, one would figure that once the Fed has manipulated interest rates all across the board down to zero, the inevitable fall that they’ve been prolonging must come to be. That’s assuming that no one catches onto the fact that the Fed is creating trillions of dollars out of nothing in the meantime and just flees the whole monetary system.
Speaking of, gold did very well today, and it’s going to do even better in the future. The more inflation Helicopter Ben forces on us, the more it’s going to reward those who flee the dollar.
My friend, James, is a graphic artist and did my book design. He’s also a Socialist, but that doesn’t seem to hinder our friendship. If anything, it makes for exciting conversations. He was asking about deflation, it’s causes, and what we should do about the auto industry. I thought some of you might find our conversation interesting:
Preston: Well, regarding the auto industry, what do you expect the government to do? Bail it out? This is not the first time the auto industry has been bailed out?
James: Yea, I know.
Preston: Is the auto industry somehow of such strategic significance to America that we must defend it?
James: Well it’s manufacturing. Which means high paying jobs for people.
Preston: Well sure. But what exactly can the government do about it? I’m reminded of the comment Bill Bonner made in Financial Reckoning Day: Surviving the Soft Depression of the 21st Century regarding the hopes that America had that Alan Greenspan would be able to bailout the economy in 2002. Bill Bonner described Alan Greenspan and the Fed as being “Like a transvestite. Having all the tools needed to do the job except the essentials.”
Preston: And really, what can the government or the Fed do? When the chips are down, businesses have to make a profit. If the businesses are unprofitable, you can throw all the money in the world at it, and the situation’s not going to change.
James: But is the industry really unprofitable?
Preston: Yes. Even in the last Greenspan inflationary boom of 2003-2007, GM did not show a profit for manufacturing cars. Instead their profit was made in the financing (GMAC) wing, and that’s obviously fallen on hard times now. When the chips are down, the combination of labor, resources, and management have to produce a product profitably on the world market or close shop.
James: Not necessarily.
Preston: How so?
James: We could put up tariffs.
Preston: Studies have indicated that the more protectionist societies have lived poorer compared to the societies that engage in free trade.
James: Poorer for who.
Preston: Well, it was like what Che Guevara and what he did with Cuba. He felt that steel was a strategic industry and that Cuba needed to manufacture it domestically. They erected tariffs making foreign steel expensive and the end result was that the price of steel caused manufacturing in Cuba to suffer. The society was made poorer compared to how it would have been due to protectionist policies.
James: But Capitalism is always focused on short term consumption.
Preston: No it isn’t. You’re confusing the society of the last thirty years with Laissez Faire, free market Capitalism. It’s not. In a free market society, savings is a virtue. Companies and individuals save and invest and prosper. Those that borrow and spend fail, which is what we’re seeing with the auto industry. Management tended to take on large amounts of debt and engage in certain manipulation of earnings in an effort to boost short term profit at the expense of long term viability, but that’s not symptomatic of the free market system as a whole. In fact, in a free market society, the firms that allow themselves to be foolishly managed go broke and the virtuous survive.
James: You live in the 1800s, but the world isn’t like that anymore and it’s not going to go back.
Preston: Well I’ve studied what the thinkers were thinking back then. It makes sense to me, and it seems that their greatest fears have all been realized in our day and age. I just keep asking we can’t go back to the good ideas that seemed to work so well for us as a country.
James: But the free market would allow for greenhouse gas emissions to run rampant.
From there our conversation degenerated into Environmentalism. James is a good man, but he has a deeply held mistrust of the power of corporations. To him, corporations must be regulated else society will become one of the savage rich versus the many destitute and I don’t seem to be able to convince him otherwise.