Federal Reserve Confusion

Jekyll-Island-Club

A number of people seem to be confused about why the Fed will be forced to raise rates. FIRST you must understand that the ORIGINAL structure of the Fed pre-1935 was that each branch was independent. The design was initially set to be a group of banks who would pool together to stabilize the banking system as J.P. Morgan did in 1907. This is why the banks technically owned the Fed for it began as an industry pool to which they contributed, not tax-payers. To “stimulate” the economy and soften any economic down-draft, the Fed purchased corporate paper – not government. This was DIRECT stimulation that would indeed PREVENT unemployment when companies could gain access to funds when banks would not lend.

Each branch was independent and would manage capital flows in its district through interest rates. If one area had too much cash, they would lower rates to deflect the capital inflows to another district whose rates were higher. So all 12 branches managed their local economies independently with the idea that capital would be attracted be higher interest rates in St Louis and move from New York if rates were lower there.

As always, it was government who cannot keep their fingers out of other people’s pockets. They alter designs for emergency reasons but never return them to the original state. The next change came for World War I. The US government needed to sell debt to pay for the war. They then ordered the Fed to buy government bonds not corporate. This ended the Fed’s ability to DIRECTLY stimulate the economy. We are to this day plagued by this idea that Fed is now a quasi-arm of government yet owned technically by banks. It was never designed for this type of function. Politicians have screwed this up – not the bankers.

1927-Secret Cental Bank Meeting

The next tinkering came in 1927. the NY Fed UNILATERALLY lowered rates to try to help Europe. The THEORY was if rates were higher in Europe, people would take their money back to Europe. This was the whole idea behind 12 branches of the Fed domestically. The European bankers convinced Benjamin Strong, head of NY Fed at that time, to lower rates in NYC to help them out.  Strong agreed. However, this had the opposite effect as people saw the Fed’s actions as a confirmation that there was trouble in Europe, not just rumor.

Head-Platter

Nonetheless, the NY Fed was then criticized for its actions in 1927 and blamed for creating the entire bull market in the USA all to accommodate Europe. This is the dominant thing today. If the Dow exploded and the Fed does nothing, they will have their heads on a silver platter. We will judge them by domestic events, not international. A crisis in Euroland is on them, not the Fed’s responsibility.

So the THEORY of capital flows and interest rates was completely different before 1935. The idea now is Europe lowers rates to stimulate borrowing even though US rates are higher. So it is all now backwards from what it was pre-1935. The Fed is NOT moving to negative interest rate just because the former Goldman Sachs boy running the ECB is moving to negative rates thanks to Larry Summers. The spread between US 10yr and German 10yr is at historical highs of over 130 bp. This is totally just insane, but it takes all their time.

Dow-Bonds

To accomplish this incomprehensible thinking process today, society’s whole ideas of how the economy works and interest rates have been inverted with Marxism. It was no longer economic driven, part of Marxism is the assumption that government is somehow in control. If they raise interest rates, on TV they will report that as the Fed does not want us to buy stocks. It is all about what government wants us to do and that is Marxist central planning control. Before 1929 in a Private Wave, the press reported rates rose so that proved there was still a bullish expectations and stocks rallied.

BookValue-DJ

 

DJ1950-1990-YThis is what Marxism has done to us. It inverted our thinking to the point people do not look at markets, but what does government want us to do. I was blamed for starting the take-over boom advising a lot of the take-over people in the 1980s that inspired the movie Wall Street and Barbarians at the Gate. But this Marxist thinking had gone so far you could buy a company, sell its assets, and double your money. It was just nuts. The Dow was 1,000 and our forecast was it will take off to 3,000 by the end of the decade 1989.95 and at 6,000 in the 1990’s. The Japanese reported that forecast and as it unfolded, our business in Japan expanded tremendously.

Trading-Tape

Zebra-HerdUnderstanding the FULL IMPACT of Marxism is critical. It was the justification that government has the capacity and ability to manipulate society. This still dominates the conspiracy thinking for to argue there is such a plot accepts Marxism as a fundamental principle. This has inverted our thinking and deflected us from reality that we are indeed our own masters. We act more like a bull in a china shop, but nonetheless, it is always a matter of just confidence. We are hard-wired like other living creatures. A herd of zebra will panic because they see others running and assume there must be some danger. Perhaps only one zebra saw a lion and he starts to run. The others run because he is running. This is the madness and delusion of crowds. We can choose to run with the herd, or rise above and understand what is really going on. It is always our choice.