With markets heaving - futures are currently limit down at 5% - there will be widespread calls for the Fed to 'do something.' Lost in this Pavlovian response for Fed succor is the realization that today's chaos is a direct result of the Fed interfering in markets in completely unprecedented ways. Alan Greenspan's term at the Federal Reserve was a watershed in this country's history. Prior to Greenspan's time at the Fed, the US had only been subject to one economy-altering asset bubble. Of course this was the 1920s stock bubble, and the Fed in the form of Ben Strong played a leading role in the formation of this bubble. (1)
However, since 2000, the US has suffered from three economy (and society) altering asset bubbles. The bubbles in tech stocks (2000) and housing (2008) have already collapsed while today's 'everything' bubble may now (finally) be deflating. What could possibly explain this dichotomy? How could the economy go six decades without an asset bubble to speak of and then suffer three huge bubbles in just twenty years?
Its the sort of question that answers itself. The three huge bubbles of the past twenty years didn't occur when they did by coincidence or some sort of cosmic joke. They occurred when they did as a direct result of the Federal Reserve's herculean effort to interfere with the price mechanism functioning as it should. Starting with at least the Tequila Crisis of 1995 - where the Exchange Stabilization Fund was used to bailout investors in Mexican debt - the Fed constantly intervened in markets to prevent losses. However, the forces that were producing these losses can't be suppressed forever. The longer these forces are kept from acting, the larger the economic distortions (bubbles) become Consequently, when these forces finally exert themselves, the damage is catastrophic. It is no surprise that the housing bubble was bigger than the tech stock bubble. It is equally unsurprising that today's 'everything' bubble dwarfs the previous two bubbles put together.
So, here is a timeline of the Fed's myriad interference in the market's price discovery mechanism. As this timeline should make clear, the Fed's interference didn't solve any problem; instead, this interference just made existing problems bigger.
The chart plots the Federal Funds Interest rate, data from the St. Louis Fed, and the NASDAQ for the period January 1, 1993 to the present. The three vertical black arrows highlight the peak interest rate seen with the tech stock bubble, housing bubble and today's "everything" bubble respectively. Note in particular, in 2007-2008 the Fed was unable to return interest rates to the highs seen during the tech bubble era without the housing bubble first collapsing. As the chart makes clear it will be virtually impossible for the Fed to "normalize" interest rates now without the stock market collapsing first. (2)
Also shown on the chart are twenty-eight events related to Fed policies. These events are captured on the chart with the black triangles. Of these twenty-eight events, six are particularly important and are highlighted in pink. These events are as follows;
- MAY 94 - Greenspan takes credit for diffusing the stock bubble
- FEB 95 - Greenspan & Robert Rubin bailout Mexican bondholders
- DEC 96 - Greensan's "irrational exuberance" speech (KEY)
- OCT 97 - Greenspan claims "ideas" more important than production
- JUL 98 - Greenspan, Rubin & Lawrence Summers (all dunces) fight to keep the market for derivatives deregulated
- OCT 98 - "Most irresponsible act" in Fed history - Greenspan engineers a between meeting rate cut after hedge fund LTCM collapses (KEY)
- FEB 99 - Time magazine calls dunces Greenspan, Rubin, and Summers "the committee to save the world"
- NOV 99 - portions of Glass-Steagall repealed (KEY)
- MAR 00 - Greenspan speaks at Boston College, extols "new era" economy days before NASDAQ peaks
- DEC 00 - speaking for most other economic PhDs, Paul Krugman (Dunce #31) claims economy can almost always be controlled by manipulating interest rates alone
- FEB 01 - a senior Fed officials claims the post-tech bubble hangover can be cured if enough people "go out & buy an SUV."
- JUL 01 - Greenspan confuses rapidly escalating home prices with real wealth
- AUG 02 - Greenspan speaks at Jackson Hole, WY and disavows any responsibility for the tech bubble
- NOV 02 - Ben Bernanke delivers his "helicopter speech" and claims financial system is "well-regulated" (KEY)
- FEB 03 - w/ interest rates at historic lows, Greenspan recommends homeowners use adjustable rate mortgages (ARMs)
- NOV 04 - Bernanke claims the Fed's monetary policy has led to a "great moderation" of reduced economic volatility
- JUL 05 - Bernanke dismisses prospect of a housing bubble
- JUN 07 - Bernanke clams the "mortgage debacle" won't negatively impact the economy
- JAN 08 - Bernanke claims the economy is in the process of "healing itself"
- JUL 08 - Bernanke claims the two mortgage giants, Fannie Mae and Freddie Mac, will "make it through the storm"
- SEP 08 - acting on its own volition, the Fed initiates a $100-billion bailout of AIG (really a gift to AIG's trading partners)
- NOV 08 - Fed launches its first round of quantitative easing (QE1) (KEY)
- NOV 10 - Fed launches QE2
- SEP 12 - Fed launches QE3
- JUN 13 - Fed threatens to "taper" QE, market throws a "taper tantrum" (KEY)
- OCT 14 - Fed halts QE
- DEC 15 - in the only interest rate hike of the Obama presidency, the Fed raises rates (0.25%) for the first time since the crisis
- DEC 16 - perhaps not coincidentally, after the election of Donald Trump the Fed initiates a series of interest rate hikes; soon after the market begins to stagger (KEY)
There is a Chinese proverb which states, "may you live in interesting times." Because of the Federal Reserve and other central banks, we certainly do!
Sugar Land, TX
March 08, 2020
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2. People who want to credit the Fed - particularly Bernanke and Yellen - for "saving" the economy through its programs of Quantitative Easing (QE) and zero interest rate policy (ZIRP) fail to acknowledge that completing these programs includes returning rates to "normal." The simple fact of the matter is the US economy is still trapped in the experiments of the Fed's mad monetary scientists