THE
FED’S DEBT
ECONOMY
FROM
Chrisy Trudeau, Mind & Body Editor
Crystal Shi, Food Editor
THE
Sharon Kilarski, Arts & Culture Editor
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Letters to the Editor
Dear readers, global financial system and allows percent in December 2016 to 2.5 lettertoeditor@epochtimes.com
F
for ever-expanding debt. percent in December 2018.
or most Americans, The Fed has failed to prevent the These actions have sent
the Federal Reserve is boom-and-bust cycles that it was shockwaves through financial
an abstract concept—a created to prevent. On the contrary, markets, showing their reliance on
distant institution in the Fed’s pumping of money into the easy money, as well as the excessive
Washington. economy to boost employment and power of the Fed.
Going by its name, many people production sowed the seeds for all In this special edition, we explore
would think it’s a federal institution financial crises and recessions, such the origins of the Fed and its
holding America’s reserves. as those in the 1930s and in 2008. impact on the U.S. economy and
In reality, nothing could be further With the economy having financial markets; whether it is
from the truth. improved under President Donald constitutional; what we can expect
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The Fed isn’t federally owned, nor Trump, the Fed has been raising from its policies and the effects of
does it hold reserves. Created under its interest rates and reducing its those policies on markets; and the
the Federal Reserve Act of 1913, it balance sheet, as it always has fate of the institution itself.
has the power to print money. before great financial crises and
Its balance sheet—currently at over
$4 trillion—forms the basis of the
recessions. In this cycle, interest
rates have increased from 0.75
Jasper Fakkert
Editor-in-Chief TODAY
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TA BL E OF C ON T E N T S
4
The Fed Dilemma
12
Is the Fed
17
Is the Fed Right
SHUTTERSTOCK
7 19
Reserve System
10
Central banks look capitalist on Bernanke, and Yellen because
the surface, but have their roots he has had more practical
in communist thought experience in business and
15
government
22
The Fed Needs Its
Wings Clipped
Trump points to the cause of
economic instability Inflation, the Hidden Tax A clipping of a Dec. 24,
Bank Money: 1913, newspaper article
Mainstream economics tells about President Woodrow
you inflation is necessary, when ‘The Root of All Evil’ Wilson signing the Federal
in fact it is part of a larger, Waste and corruption are the Reserve Act.
unfair redistribution mechanism result of banks’ privilege to
create money out of nothing
COMMENTARY
THE FED
DILEMMA
Yes, it is responsible for market
crashes, but the origin of the
problem can be traced back to
the very roots of the institution
F
VALENTIN SCHMID agents through its raising of the federal
funds rate as well as the $50 billion per
or the most part in 2017 month reduction of its balance sheet.
and 2018, only academics The Fed balance sheet, as well as the
and easy-money cranks federal funds rate, is the foundation of
scolded the Federal the entire global financial system. For
Reserve for raising rates. every dollar by which the Fed expands its
After all, the stock mar- balance sheet, banks and shadow banks
ket was bubbling up and around the world can create many dol-
the economy was strong. lars’ worth of debt on top of it.
The economy is still strong, but the Terms like balance-sheet expansion
stock market has ended its record 10- and contraction, or quantitative easing
year bull-market run with a bang. The (QE) and quantitative tightening (QT),
20-percent drop in the S&P 500 during are fancy words for printing money or
one of the worst quarters in market his- removing money from circulation.
tory classifies as a bear market, although Since its creation in 1913, the Fed has
prices rebounded at the end of 2018. had the power to print money and fuel
Now everybody from traders to retir- booms, and contract money and cre-
ees as well as President Donald Trump is ate busts. So it has to take responsibility
scolding Fed Chairman Jerome Powell for for the vicious business cycles since its
his relentless path to higher interest rates creation, such as the Great Depression or
and a reduction in the Fed’s balance sheet. the 2008 financial crisis.
To make a long story short, yes, the Fed You can trace this game back to the
is chiefly responsible for this and other Fed’s origins, but here, let’s confine it to
stock-market routs, which often precede recent history.
recessions. There are other contribut- In 1998, the giant hedge fund Long
ing factors, such as worries about the Term Capital Management collapsed and
Chinese economy and trade, as well as almost took the global financial system
the government shutdown, which will with it. The Fed pumped money into the
reduce the $1 trillion yearly spending system and we had the dot.com boom,
spree of the federal government. But the which ended in a bust in 2000 after the
Fed is at the center of the storm. Fed had tightened credit conditions.
And the problem didn’t begin with the It then pumped even more into the
Fed’s actions over the past two years. The system to create the subprime boom,
roots of the issues we now face have their which ended in a bigger bust in 2008,
immediate origins in the last financial again after the Fed had been raising rates
crisis, but ultimately can be traced back for some time.
to the founding of the Federal Reserve To “save the system” this time, the Fed
itself. boosted its balance sheet to more than $4
trillion and lowered interest rates to zero,
The Federal Reserve building in Washington in this file
The Current Crash in an unprecedented exercise in money
photo. The Fed is one of the most powerful and most
The problem on the surface right now is printing. This has led to a bubble in
misunderstood institution in the United States.
that the Fed is taking away easy money corporate debt, student loans, auto loans,
from market participants and economic and real estate—again.
January 2019
OFF/AFP/GETTY IMAGES
THE
HISTORICAL ANALYSIS
FED’S
BOOM
BUST
and
M
HULTON ARCHIVE/GETTY IMAGES PICTURE POST/HULTON A HULTON ARCHIVE/GETTY IMAGES
ore than 100 years
and many booms
and busts later, it can The
safely be said that the
Fed failed at prevent- contraction
ing cataclysmic busts of money and
like the Great Depression of the 1930s or
the Great Recession of 2008. But not only credit swiftly
did it fail to prevent them, the Federal
Reserve System and fractional-reserve
brought
banking—the practice of only holding the United
reserves equal to a fraction of a bank’s li-
abilities—have actually caused the booms States its first
and the busts. widespread
The Crisis All Over Again economic
All banking crises, before and since the
founding of the Fed, have been credit cri-
and financial
ses. Banks issue unbacked credit to finance depression.
loans for investment in physical capital
like mortgages and factories.
The first John D. Rockefeller benefited from the J.P. Morgan circa 1890. The bank JPMor-
Contrary to full-reserve banking, these nationwide crash of 1929. gan Chase was and is a pillar of the Fed and
loans aren’t backed 100 percent by gold has benefited from its status.
and are created out of nothing, providing boom-bust
a bad incentive for the banks to increase
credit for uneconomic projects in good
cycle had Banknote circulation jumped by 87 per-
cent from 1812 to 1816 and precious metal
sound investments during the boom,”
writes Murray Rothbard in “Mystery of
times and charging interest on them. Not arrived in reserves fell by 9 percent. This was the Banking.”
only are the projects uneconomical—think
of the subprime mortgage crisis that trig-
the United inflationary boom.
The boom was exacerbated by another
The centralization of banking and in-
terest rate management in the hands of
gered the 2008 great recession—this incen- States. privately owned and federally-chartered a few people at the Fed did not improve
tive structure leads to rising prices and bank called the Second Bank of the United this incentive system but instead amplified
more demand in the boom phase and at the From 'Mystery States (1816), which financed the reckless faulty incentives.
same time creates the oversupply, which of Banking' by lending of the many smaller banks at the
will usher in the bust. Again, real estate Murray Rothbard end of the boom cycle, which then led A History of Crises
is a good example. to the first real depression in the young All of this was supposed to get better with
The economic law of reflux would nor- United States. the Federal Reserve System, which started
mally lead to depositors withdrawing their “Starting in July 1818, the government operating in 1914. However, because the
money or demanding money in gold, driv- and the BUS [Bank of the United States] system applies the same principles that
ing the bank out of business to punish it began to see what dire straits they were led to a credit boom, the results could only
for overlending or lending to bad projects. in; the enormous inflation of money and be the same.
However, because the government—then credit, aggravated by the massive fraud, Not only could the Fed print money
as now—allows for the payment of taxes had put the BUS in danger of going under without gold backing, its member banks
with money issued by banks, bails out and illegally failing to maintain [precious issue even more loans using only a little
banks when they are in trouble, and also metal] payments. Over the next year, the bit of the Fed notes as reserves.
guarantees depositors funds, the incentive BUS began a series of enormous contrac- The federal government also made
to remove one’s money and demand pay- tions, forced curtailments of loans, con- the Federal Reserve note legal tender pro-
ment in gold is diminished or completely tractions of credit in the south and west. viding artificial demand for the printed
removed. ... The contraction of money and credit notes. Then as now, both the states and
A boom and bust cycle in the early swiftly brought the United States its first the federal government accept payment
19th century saw the federal and state widespread economic and financial de- in taxes only in money issued by private
governments relieve banks from the duty pression. The first nationwide ‘boom-bust’ banks.
to redeem their privately created notes in cycle had arrived in the United States. ... Because the anchor to gold was weak-
gold and gave artificial value to them by The result of this contraction was a rash ened and completely removed in 1971, the
forcing the people to pay their taxes using of defaults, bankruptcies of business and century of the Fed has been a century of
the same notes. manufacturers, and a liquidation of un- financial crises.
January 2019
THE FED
its good assets were sold to Nomura Hold-
ings Inc. and Barclays of the UK.
The others like Citigroup were saved
by the government with their executives
keeping record bonus payments from the
boom period.
NEEDS ITS
The history of money and banking con-
tains many more examples like the ones
cited above. And the future will, too, until
the management of money is decentral-
ized again, the government stops creating
bad incentives, and bad actors are forced to
take responsibility for their actions.
WINGS
SPENCER PLATT/GETTY IMAGES
“I
Two. Not only are stable prices pivotal for
t’s a false economy that One need not be surprised Trump The dual economic growth, the targeted focus
we’re living in. We’re in a
bubble.”
believes he is getting a raw deal. mandate is keeps the central bank out of monkey
business elsewhere in the economy. The
The man who said Chickens Coming Home to Roost a structural Fed should never have bought up pri-
that, regarding Federal
Reserve policy, was none
The awkward truth is that the rate
increases from Fed Chairman Jerome
problem well vate securities nor facilitated ludicrous
too-big-to-fail handouts for cronies, the
other than President Powell are necessary. The federal funds known to magnitudes of which boggle the mind.
Donald Trump. He was right then, as rate still remains historically low and If there needs to be legislative change
a candidate, and he is right now, as even negative in inflation-adjusted economists. to stop these actions from happening
president. terms, but the incremental increases again, so be it.
Trump’s latest dustup with the have arrived far too late. That is why
Commentary
Fed comes on the back of substantial they appear discriminatory and targeted Getting the Fiscal House in Order
stock-market declines last quarter. The at Trump, who has only voiced concern If interest rates continue to rise, they
S&P 500 even briefly dipped into bear and not threatened Powell with dis- will generate enormous pressure on
market territory after a brutal sell-off in missal. the indebted federal and state govern-
December. Fed Chairmen Janet Yellen (2014– ments. Even without higher rates, in-
Hardly alone in his assessment, Trump 2018) and Ben Bernanke (2006–2014) terest payments alone will push toward
pointed to a slightly more hawkish Fed generated this mess with their out- half a trillion dollars this year, from the
policy: “It’s a correction that I think is of-hand and cowardly response to federal government alone.
caused by the Fed and interest rates.” the Great Recession of 2008 and 2009. Such heavy reliance on debt places
Bob Prince of Bridgewater Associates, Rather than allow a full correction the federal government in an extremely
an investment-management firm, for the vast bad debts that drove the vulnerable position and dependent on
explained to the Financial Times that bubble, they decided to lower interest the Fed for cheap credit. If inflation ar-
“monetary tightening could produce, rates to unprecedented levels. rives at higher levels, however, the Fed
perhaps not a big downturn, but more Yellen and Bernanke even engaged will be reluctant to provide.
pressure.” in extremely aggressive “quantitative This rising tension should be a wake
While critics have called on Trump not easing.” This is gobbledygook for buying up call for Trump and Congress. The
to politicize monetary policy, it is too government and private securities to federal deficit has hit a six-year high,
late for that. These critics fail to under- expand the money supply and inflate approaching $1 trillion, and unfunded
stand the Fed’s dual mandate, which the stock market. It quadrupled the liabilities spell worse to come. These
gives the central bank immense power Fed’s balance sheet to over $4 trillion. magnitudes crowd out private invest-
over politics, and the discriminatory You know where this strategy leads: ment and, by pushing up interest rates,
treatment that Trump is receiving. another bubble, perhaps larger than the generate a downward spiral.
previous one. Tinkering around the edges will
Chasing 2 Goals As Robert Kiyosaki noted on not suffice, nor will higher growth.
The dual mandate is a structural prob- “The Rich Dad Radio Show,” Trump was If the GOP is serious about reining in
President Donald Trump
lem well known to economists. It means dealt a bad hand. However, the opti- the deficit, it will need to address the
announces his nominee for
that the Fed is supposed to chase “both mism created by Trumponomics, par- programs known as third rails: Social
chairman of the Federal
stable prices and maximum sustainable ticularly on account of tax reform and Security and Medicare. These largely
Reserve, Jerome Powell,
employment,” as stated by the Federal deregulation, has delayed and offset in the Rose Garden at automated programs are of sufficient
Reserve Bank of Chicago. what will be an inevitable correction the White House on Nov. size to make a dent and lessen reliance
This is a problem because it as- and recession. 2, 2017. Since then, the on expansionary monetary policy.
sumes the central bank should be in president hasn’t always
the Keynesian business of so-called Inflation Targeting been happy with Powell but Fergus Hodgson is the founder and ex-
economic stimulus to promote employ- If there is to be a central bank in the has guaranteed his ecutive editor of Latin American intel-
ment. It is a recipe for the highs and lows United States, its role should be as lim- job security. ligence publication Antigua Report.
of bubbles and can be timed to favor or ited as possible. Keep in mind that the
DREW ANGERER/GETTY IMAGES
oppose incumbents. Fed only came into being in 1913, and
Further, the faulty premise of short- on account of surreptitious tactics.
term stimulus compromises the Fed’s Top-performing central banks around
capacity to restrain inflation. The Fed the world focus on one target: infla-
cannot lower interest rates and expand tion. The Reserve Bank of New Zealand
the money supply while also promoting and the Bank of Canada, for example,
stable prices. have explicit agreements to keep infla-
In this case, the timing worked against tion between 1 and 3 percent. Neither
Trump and the Republican Party in the country suffered the severity of the
midterm elections. That was because of repercussions felt by the United States
the strong perception that the midterms during and after the Great Recession.
were a referendum on Trump’s perfor- The range would be better off between
mance. 0 and 2 percent, as close to zero as pos-
Consider that Trump has experienced sible. However, at least the sole focus on
seven increases to the federal funds rate inflation recognizes that stable prices
under his watch in the first two years. are pivotal for long-term planning and
How many do you think former Presi- growth. Just ask Argentines and Ven-
dent Barack Obama faced during his ezuelans what happens when there is
January 2019
Q&A
Is the Fed
Unconstitutional?
Constitutional lawyer Edwin Vieira Jr.
explains the history and legal structure
of the Federal Reserve System
SETH HIRSCH/THE EPOCH TIMES
The Epoch Times: Mr. ers and financiers in the Civil War legislation. the late 1800s and early World War I, you have
Vieira, what do you, as private sector on the one That system had inher- 1900s. the first depression under
a constitutional lawyer, hand and U.S. Treasury ent instability because it That is Mr. Vieira: If you inter- the Federal Reserve in
have to say about the Fed? on the other. is all based on fractional the exact preted them correctly, 1921–22.
Edwin Vieira Jr.: What That continued with the reserves and in that par- structure of you would see they were Then comes the bank-
most people don’t real- First Bank of the United ticular case, it was tied to tied to the profligacy of ing crisis after the 1929
ize is, the history of the States, which was a the amount of U.S. debt
the Federal the banks but the bank- stock market collapse. In
Federal Reserve goes back private bank chartered by that existed. Reserve ers said: 1931 and 1932, this was
really to the beginnings Congress. And then the At that time, the United System: It’s “Well, this is because the great collapse of the
of this country and Alex- Second Bank of the Unit- States government and a delegation we don’t have a lender Federal Reserve System.
ander Hamilton. ed States, which resulted
in the famous bank crisis
the people were not
interested in expanding
of some kind of last resort. If we had
someone who could
Roosevelt comes in in
1933, seizes the gold from
He wanted to combine
the big financial interests with President Andrew the debt, but bankers of monetary pump in liquidity when the American people,
of the country with the Jackson, where Jackson didn’t like that. So the authority we have these panics turns Federal Reserve
U.S. Treasury so that the essentially defeated the Federal Reserve System is to private because the fractional notes into legal tender for
big financial interests bank and the bank lost its set up again on this same parties. reserve system is col- the first time, and abro-
would be in support of charter. symbiotic relationship, lapsing; if we had that gates all of the gold clause
the new government. Another one of these the Treasury on the one EDWIN VIEIRA JR. kind of system then we contracts that existed—
That was the basis for incestuous relationships side, the bankers on the Constitutional could manage the panics. public or private.
his assumption by the was the National Curren- other, in order to stabilize lawyer We would never have
new federal government cy Act, which created the the entire system. inflation, we would never The Epoch Times: Why is
of the state revolutionary national banking system have depression.” all this unconstitutional?
war debts. So you had and is now a part of the The Epoch Times: This All right, the system Mr. Vieira: First, if you
this kind of symbiotic or Federal Reserve. fractional reserve system gets up and running in look at the currency unit,
incestuous relationship All of these national was responsible for most time for World War l in the Constitution requires
set up between bank- banks trace back to of the financial panics in 1914. But after the end of the currency unit to be a
January 2019
ANALYSIS
I
VALENTIN SCHMID
f you visit the Federal Reserve’s Face- in the hands of the state, by means of a calls for “gradually substituting paper
book page, you will seldom find a pos- national bank with State capital and an money for gold and silver coin.” This ob-
itive comment. That’s because people exclusive monopoly.” The jective was achieved, gradually, from the
who don’t care about central banking The other one gives Congress the power beginnings of the Fed in 1914 until the
won’t go to the Fed’s Facebook page. to “coin Money, regulate the Value thereof, Communist revocation of the Bretton Woods modi-
That leaves only the ones who are and of foreign Coin, and fix the Standard Manifesto fied gold standard in 1971. Since then, the
positive about it—if they exist—and of Weights and Measures.” world has operated on a global paper dollar
the ones who don’t like central banks. Karl Marx and Friedrich Engels penned calls for standard.
The right doesn’t like central banks
because of their centrality. The banks
the former statement in 1848 in their infa-
mous “Communist Manifesto.”
‘gradually Furthermore, the manifesto wanted
the “paper issues [to be] legal tender,” a
centralize power over interest rates, and Alexander Hamilton, John Adams, James substituting principle dutifully incorporated into the
the right doesn’t like central control over
pretty much anything. The left doesn’t
Madison, and Thomas Jefferson were re-
sponsible for the inclusion of Article 1, Sec- paper money Federal Reserve Act of 1913.
Under the act, “the said notes shall be
like central banks because they repre- tion 8 of the U.S. Constitution, the source for gold and obligations of the United States and shall
sent money, capitalism, and “too big to of the latter statement. be receivable by all national and member
fail” banks. So which camp is the Federal Reserve silver coin.’ banks and Federal Reserve banks and for
However, despite the confusion and in—manifesto or Constitution? all taxes, customs, and other public dues.
complicated hybrid setup of the Fed and They shall be redeemed in lawful money,”
other central banks, these institutions are National Monopoly where “lawful money” means legal tender.
more communist and socialist in nature The Fed is a national banking system and The U.S. Constitution, on the other hand,
than capitalist. has an exclusive monopoly on issuing the calls for Congress to “coin money,” refer-
Contrast these two statements from two U.S. dollar credit instrument in paper and ring to the issue of gold and silver coins
important historical documents. electronic form. and the standardization of their measure-
One calls for the “Centralization of credit The Communist Manifesto furthermore ments. The Department of the Treasury
January 2019
PUBLIC DOMAIN
INFLATION
still issues American Gold and Silver Ea-
gles, but the Fed neither coins money nor
concerns itself with the standardization
of weights and measures.
Hybrid Ownership
What about ownership, capital, supervi-
sion, and credit? This is where the Fed does
not meet the strict manifesto standard.
Legally, the Federal Reserve System is a
public/private hybrid, with private banks
THE HIDDEN TAX
owning the shares or capital of the sys-
tem and the government providing some,
though not all, of the supervision.
So the Fed does not operate on state capital.
However, it shares its profits with the Trea-
sury and most of the important decisions
are made by publicly appointed officials. The
president appoints seven of the 12 members
of the Fed body that decides monetary policy
(the Federal Open Market Committee) and
they are then confirmed by the Senate. So
it does sound like the “centralization of
credit in the hands of the state,” or at least
the power to manipulate credit.
Credit is not centralized in one bank,
but rather in the one Federal Reserve
System, which includes thousands of pri-
vately owned banks that issue credit to
their customers. This goes against the call
for “suppression of all private banks and
bankers,” because they still exist. How-
ever, the system has central control over
credit due to regulation and tinkering with
the interest rates.
The Fed can control how many reserves
the system banks must hold and how
much money (credit) they can lend. The
open market operations that determine
the interest rate on the reserves also incen-
tivize banks to free up or contract credit.
Mainstream economics tells you inflation is
In fact, setting short-term rates and
manipulating long-term rates centrally
necessary, when, in fact, it is part of a larger,
through large-scale asset purchases, like
the Quantitative Easing program, is akin
unfair redistribution mechanism
to communist central planning.
In the free market, private banks com-
pete for savings, and the interest rate is set VALENTIN SCHMID much money chasing too few goods. For Children play
T
in a competitive bidding process between example, the broader money supply fig- with stacks of
different economic actors. Not so in a cen- he Federal Reserve (Fed) ure called M2, which includes most bank hyperinflated
trally controlled system. targets 2 percent infla- deposits, has multiplied 46.5 times since currency during
Lastly, Marx and Engels got their wish tion and full employment. the beginning of 1959, the first time the the Weimar
written in 1848: “In most advanced coun- While this sounds benign, data was recorded. GDP, not adjusted for Republic in
tries, the following will be pretty generally it is part of an inefficient inflation, only went up 38.1 times, so the Germany in 1922.
applicable,” with “the following” includ- and unfair economic sys- money supply grew faster than produc- Currency became
ing centrally controlled credit and other tem that leads to waste, and to boom and tive output. worthless when
demands of the manifesto. bust cycles. Over the same time, every dollar spent post-World War
Today, the only countries without central The famous goal of 2 to 3 percent infla- by the average U.S. consumer lost 88 per-
I Germany was
hit by one of the
banks are the micro states of Monaco, Nauru, tion targeted by the Fed is supposed to be cent of its purchasing power. This is not
worst cases of
Kiribati, Tuvalu, Palau, Marshall Islands, a sign of a growing economy and healthy a coincidence.
hyperinflation in
and the Federated States of Micronesia. demand by households and businesses. Proponents of inflation economics, recent history.
Because both sectors earn more, they mostly followers of the Keynesian school,
Communism is estimated to have killed can spend more, which leads to higher say that this does not matter, as wages
around 100 million people, yet its crimes prices. rise in proportion to the loss in purchas-
have not been fully compiled and its This is sometimes true, but most of the ing power.
ideology still persists. Epoch Times seeks time inflation is a hidden tax on pro- If all prices in the economy indeed rose
to expose the history and beliefs of this ductive businesses and households that by the same proportion, then the whole
movement, which has been a source of rewards the government and financial notion of inflation would become mean-
tyranny and destruction since speculators. ingless, as relative prices would stay the
it emerged. Price inflation arises when there is too same. In practice we find that per-
January 2019
it would take the form of forced selling current Federal Reserve policy, specifi- hikes so far
of leveraged assets, as happened during cally about raising rates too fast or too Lost Opportunity
the subprime crisis. But benign defla- much. As Trump noted himself, the mandate of
have not only
tion in a stable money system originates And it is true: the timing of the rate Yellen in the Fed was a lost opportunity. caused no
from gains in productivity higher than hikes and the brisk commentary coming Yellen and the Fed delayed urgent and damage to
the prevailing interest rate for loans. out of the Marriner S. Eccles building justified rate increases despite a bull
As for the government, it would have in Washington seem odd to many who market and high liquidity due to the fear the economy
to learn to live within its means, as it have gotten used to continuous Fed sup- of a negative market reaction ahead of but have
could not rely on banks to print money port for financial markets, whether in the 2016 election.
to finance its debt. And with money the form of jawboning or various easing And it’s not that Powell is acting rash-
helped
increasing in purchasing power and programs. ly. His Fed is conducting the rate hikes strengthen
being literally risk-free, it would be
hard-pressed to find investors to buy
We all remember how then-Fed Chair
Janet Yellen all but suspended the in-
with months of warnings and detailed
communication. Because the economy is
growth
its bonds. tended tightening policy just before the growing above 3 percent, wage growth while
With less financial speculation and presidential election in 2016 because of is also at 3 percent and unemployment is investment
less government waste, capital could market jitters. So Trump is right to won- at record lows.
find the most productive uses, leading der why the current incumbent admin- The rate hikes so far have not only returned.
to higher productivity and, ultimately, istration does not get the same treatment caused no damage to the economy but
cheaper consumer prices. And who from the Fed as the previous one. have helped strengthen growth while
wouldn’t like that? However, leaving the political tim- investment returned.
January 2019
Signal Effect
If the Fed did not raise rates as an-
nounced, it would send a negative
signal to the world—that things are
Years of low rates reduced capital liquidity at all-time highs? Very little. much worse than the economic data
expenditure and fueled a dangerous And while the Fed is getting prepared shows. Even worse, it would not act as
bubble. Now, real investment is back. for an eventual downturn, it is precisely The mandate a positive driver for risky assets like
Gross fixed capital formation was up 8
percent last year after years of stagna-
the positive effect of this administra-
tion’s supply-side measures that keeps
of Yellen stocks and bonds.
These are falling now because of
tion, and capital repatriation exceeded jobs, wages, investment, and growth in the Fed excessive valuations and the slow-
$300 billion.
The reason why Powell can and should
above global trends.
was a lost down in emerging markets and the
eurozone, factors that have nothing
use this period of superior growth to Strong Dollar opportunity. to do with the Fed’s normalization
build a buffer for the future is because The U.S. dollar needs to remain the and everything to do with the exces-
the Tax Cut and Jobs Act has helped world reserve currency and the safest sive fiscal and trade imbalances built
prolong the recovery, which has started asset, and this can only happen if the by those economies in the period of
to reach the middle class. Savers and Fed normalizes its monetary policy as it low rates and high liquidity. As noted
workers benefit from a stronger dollar has announced. above, those markets are down much
and moderately higher rates. Now, as the The United States can absorb the rate more than the S&P 500.
interest rates on even the shortest-dated hikes because the evidence shows it The Fed needs to normalize in order
and safest Treasury bills are above 2 per- becomes a safer and better investment to avoid making the mistakes of the
cent, conservative savers are starting to option compared to the rest of the world. ECB and the Bank of Japan, but mostly
see their disposable income and savings And even though the S&P 500 has re- to maintain the status of the United
improve. cently dropped sharply and is 10 percent States as the world reserve currency.
off the record highs, European markets A sound monetary policy and defend-
Easy Fed Money trade 20 percent below their 2015 highs, ing a strong currency is good for the
It is important to note that policy re- which never reached the 2007 highs, clear majority of the economic agents of
mains highly accommodative compared which never reached the 2001 highs. an economy. No country has collapsed
to historical standards. The yield on 30- As the U.S. economy improves and due to a strong currency. Many have
year U.S. Treasuries discounting infla- others face the saturation of past stimu- fallen due to constant destruction of the
tion is less than 0.08 percent and credit li, it is only logical that the United States purchasing power of their currency.
conditions remain robust. Money supply sees a high inflow of funds from abroad. A moderate rate-hike policy and
growth continues to be strong and above And that is good. It keeps U.S. Treasury a strong currency are also essential
nominal GDP growth despite the Fed yields low, stimulates demand for bonds to keep the world reserve currency
reducing its exposure. The private sector and equities—at least relatively speak- status. If a small proportion of the U.S.
is offsetting the unwinding of the Fed’s ing—and provides a steady flow of capital economy suffers from a strong dollar
balance sheet. investment into the U.S. economy. due to low competitiveness, it is a price
More importantly, if the Fed does not The U.S. economy can accept a strong worth paying in exchange for being
build a buffer for an eventual downturn dollar and moderately higher rates. the world’s most used currency, a
by reducing the balance sheet and rais- It only exports around 10 percent of reserve of value, and a worthy invest-
ing rates while the economy is strong, GDP, and less than 30 percent of the ment for the rest of the world.
the negative consequences will be profits of S&P 500 companies come from If Trump wants to strengthen the
significant. exports. More importantly, the United domestic market, increase disposable
We see in Europe how the European States exports high added-value goods income for the middle and lower class-
Central Bank (ECB) has not raised rates, and services, which don’t suffer much es, and end the perverse incentives
and now the slowdown of the second from a stronger dollar. created by years of excessive demand-
half of 2017 has accelerated, leading the In the past nine years, devaluing the side policies, he needs to accept the
central bank to exhaust all its tools to currency and lowering rates has hurt prudent path outlined by Powell.
support the economy. the middle class, savers, workers, and
If there is a possible recession, what high productivity companies—those that Daniel Lacalle is chief economist at
can the ECB or the Bank of Japan (BoJ) voted for Trump to change the mistakes hedge fund Tressis and author of “Es-
do when rates are at all-time lows and of the past. cape From the Central Bank Trap.”
January 2019
Who Is
Jerome Powell
FED CHAIRMAN
F
or decades, the Federal Re- The main difference between him and stock-market reactions, and exceptionally
serve has run not on a gold his predecessor Yellen? He doesn’t seem to aware of the risks in a market extremely
standard but on a Ph.D. Unfortunately care what the market does and just follows oriented toward external stimuli.
standard. Academics such
as Ben Bernanke and Alan
for Powell, his policy of rate normalization, based on a
strong economy and the Fed’s mathemati-
For market operators, having a new Fed
chair with such an unpolitical and market-
Greenspan thought they he is now in cal models. agnostic profile may not seem like good
could manage the most com- The first press conference by Powell as chair- news. But it is. Too many investors play the
plex and most important price of the mar- the hot seat man of the Fed in March betrayed as much. “bad news is good news” game. That is, to
ket economy—the interest rate—with a few
mathematical equations.
when the next Powell was clearly cautious with long-
term estimates, an Achilles’ heel of a Fed
expect poor macro data so that monetary
stimulus is perpetuated.
The 64-year-old Jerome Powell could recession that consistently missed its own inflation This carry trade leads market participants
prove to be different, because he has had
more practical experience in business and
or financial and growth expectations. His response to
a reporter on his predictions for 2020 was
to bet on cyclical assets and inflationary
themes, while expecting economic stag-
government than Greenspan, Bernanke, crisis hits, and perfect: The Fed has to monitor the changes nation and more expansionary policies. This
and Janet Yellen, who, apart from their time that are taking place right now and avoid is dangerous.
with the Fed, have been academics. Powell hit it will. giving optimistic estimates that only make What Powell explained is very important,
is a trained lawyer who made a career in them lose credibility. and the path of rate increases is clear. The
investment banking, private equity, and And now, credibility is key, as the Fed “buy anything” party is over. And that’s
public service, and has been serving as a doesn’t have much of it left. good.
Fed governor since 2012. Powell was technical, correctly agnostic to The U.S. economy can absorb a rate-
January 2019
Will He Blink?
However, with the market down more than
20 percent as of just before Christmas, his
resolve will be put to the test.
In 2012, writing on what was then the
latest round of easy money (in the form of Who Is
quantitative easing), fund manager Paul Jerome Powell?
Brodsky said, “After professionally watch-
ing Fed chairmen cajole, threaten, persuade, Powell is a lawyer
and manage sentiment in the markets since who made a career
1982, we argue this latest permutation is in investment
understandable, predictable, and, for those banking, private
willing to bet on the Fed’s ultimate success equity, and public
in saving the banking system (as we are), service and has
quite exciting.” been serving as a
He argued that the Fed’s congressionally Fed governor since ple,” said Ritholtz. “Bank of America gets Traders work on the floor of the New York
mandated objectives of maintaining price 2012. He does not nationalized, which really means Uncle Stock Exchange as the Federal Reserve
stability and full employment are second- have a degree in Sam provides debtor-in-possession financ- Board Chairman Jerome Powell holds a
ary to keeping the banking system solvent. economics. ing. This is really what happens normally news conference on Dec. 19, 2018.
Given that the Federal Reserve System with small companies. Someone who takes
is owned by its private member banks, this them out of bankruptcy gives them some
analysis is not too far-fetched, and borne operating money to keep functioning. The
out by history. equity gets down to zero—senior manage-
Whenever a financial crisis threatened ment out the door. There is certainly a layer
the banking system (that is, the Federal Re- beneath, which can get promoted without
serve System), the Fed and its chair would do a problem.”
whatever it took to save it from collapsing. In comparison, Yellen’s job was relatively For market
Greenspan oversaw the bailout of sav- easy: She just had to make sure rates didn’t
ings and loans in the early 1990s, as well as rise too quickly as to cause stock and bond operators, having
of hedge fund Long Term Capital Manage-
ment (LTCM) in 1998, both private-public
markets to crash, and hope there wouldn’t
be an external shock (for instance, China)
a new Fed chair
initiatives greased with Fed liquidity, loan on her watch that would push the fragile with such an
guarantees, and lower rates. The bailouts system over the brink.
led to what economists call moral hazard, Unfortunately for Powell, he’s now in unpolitical and
in which participants think they can take the hot seat when the next recession or market-agnostic
excess risk because they will be bailed out. financial crisis hits, and hit it will. Then,
“When LTCM was rescued, there was his background in business will cease to profile may not
a general thought: ‘Hey, these guys are
on the job if we screw up. They’ve got our
matter, and he’ll probably continue the un-
official Fed policy of keeping the banking
seem like good
backs,’” said Barry Ritholtz, chief invest- system afloat, just like his predecessors. news. But it is.
ment officer at Ritholtz Wealth Manage-
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January 2019
BANK
Federal Reserve on a
U.S. banknote.
MONEY
‘The Root of All Evil’
Waste and corruption are the
result of banks’ privilege to create
money out of nothing
VALENTIN SCHMID ate new money whenever someone applies
for a loan.
The one force that causes the most harm in Let’s assume you apply for a mortgage
our economy also happens to be the least of $450,000. Once it’s approved, the bank
well-known and understood. simply credits your account with $450,000
While the left blames greedy corpora- in the form of a deposit, which you can
tions and individuals, and the right blames then use to spend on your house. This is the
the government, it is in fact the collusion bank’s liability. On the bank’s asset side, it
between the government and private credits itself with a loan of $450,000 to you, monopoly, the new money created doesn’t
banks that leads to problems like envi- which you will pay back over the course of Instead of measure production and savings, but actu-
ronmental degradation, unemployment,
income inequality, and many more.
30 or so years, plus interest.
For this process, no savings are neces-
taking in ally changes them.
The creation of “money,” in the form of
Commentary
In the United States and most other coun- sary. The only thing the bank has to do savings from the loan and deposit, required nothing to
tries, the government grants private banks
the right to create money out of nothing
from a regulatory perspective is keep a very
low fraction of its assets in cash or bal-
companies and be produced and nothing to be saved. The
production only begins later, when the
and forces individuals to accept said money ances at the Federal Reserve (Fed), so it can individuals and contractors start building the house—al-
as legal tender and to use it to pay their
taxes.
pay out some cash on demand if needed.
This is often not more than 1 percent of its
then waiting though even that is not guaranteed, given
that many mortgages or other loans are
The Coinage Act of 1965 states, “United assets, hence the term “fractional reserve” for a suitable used to buy up existing assets, which drives
States coins and currency (including Fed-
eral reserve notes and circulating notes of
banking.
borrower, up prices.
Even loans that finance new construc-
Federal reserve banks and national banks) The Root banks use tion alter the economy in unnatural ways:
are legal tender for all debts, public charges,
taxes, and dues.”
The popular saying has it that money is the
root of all evil. However, the original quote
a simple bankers’ prejudice directs production in-
stead of consumer demand from their own
Today, the “notes” are mostly electronic from the Bible would be more accurately accounting savings. And the bank, which can repos-
credits in the form of bank deposits, but the
same law applies. So much for legal tender—
applied to the process described above,
wherein banks are allowed to create money
trick to create sess the collateral unless the loan is repaid,
gets something for nothing.
what about creating money out of nothing? out of nothing and charge you interest for new money The principle at work here is pure love of
Don’t banks take savers’ deposits and then
loan them out to borrowers?
the trouble: “for the love of money is the
root of all evil.”
whenever money—nothing more. The bank does not
need to expend any effort but can “earn”
The short answer is no. Instead of taking Money itself, of course, cannot be evil. someone the interest on the loan, which is the same
in savings from companies and individu-
als, then waiting for a suitable borrower,
It merely measures the value of goods and
services produced and the value of capital
applies for as a private tax on the money supply. It is
the equivalent of a few designated individ-
banks use a simple accounting trick to cre- saved. However, under the bank money a loan. uals being allowed to keep a money press
January 2019
The Solution
Of course, it doesn’t have to be this way. If
banks did not have the privilege of creating
money out of nothing, and instead had to
source their loans from real savings, their
incentives would change immediately. It
would also help if there were no govern-
ment bailouts.
In that case, investment would equal real
savings and would by definition be limited,
because savings require a reduction in con-
sumption. This is harder to achieve than
simply printing money. Resources would,
therefore, be economized. Opportunities
for accumulating extravagant wealth,
while still present, would also be reduced,
and there would be a natural tendency
toward a more even wealth distribu-
tion—not one engineered by a centralized
bureaucracy.
If banks and borrowers had skin in the
game, capital allocation decisions would
be examined not according to the “love for
money” principle, but rather according to
how productive the investment would be.
More productivity means produc-
ing more with less, thus saving natural
at home, which they could then use to and sponsor politicians with campaign resources. Less capital investment would
$63.5
print cash, make loans, and charge interest contributions, they can always rely on the mean more room for humans to
against. Meanwhile, everyone else is forced government to bail them out when the participate in the economic process.
to use those printed loans to make invest- house of cards collapses. This is not a prob- Prices for capital and goods would
ments. Clearly, this is not fair. lem of too little regulation, but instead of be more stable.
the wrong kind of regulations, perpetrat- This is not a dream, nor a vi-
The Problem
The ease with which banks can create TRILLION ing a systematic theft of public resources.
Even this is just the tip of the iceberg.
sion of Utopia. Honest banking
and honest money have existed
money explains the recurring colossal Because the capital allocation process in before in history. The first step
The total amount
blunders in risk management and loan cre- this system is so flawed, the private sector to solving this problem is to
of credit market
ation, of which the subprime crisis is only is encouraged to spend funds on inefficient become aware of the problem.
debt created by the
the most recent manifestation. Because and unnecessary vanity projects—real
banking system. It
money is free, it makes sense for banks to estate is the most obvious, along with mas-
has been growing at
loan out as much as possible. After all, they
an average annual sive industrial overcapacity. Contrary to
don’t have to do anything to source the
compounded rate Because big corporations have better ac- popular opinion,
SHUTTERSTOCK
funds, but get to reap the interest payments cess to big banks, they have better access to the Fed doesn’t
of 8 percent since
as the loans are repaid. this artificial “capital,” and they can there- even create most
the fourth quarter
If the market for money were not com- fore crowd out smaller players that may be of the money
of 1951.
pletely cartelized by the government for able to service their communities better. in our financial
the banks, even this perverse mechanism SOURCE: FEDERAL RESERVE BANK
Too much real estate development and system. It merely
provides the basis
OF ST. LOUIS
would have its limit, and would ultimate- industrial overcapacity also put the most
ly lead to the demise of the participating strain on environmental resources. for private banks
banks—just as what played out in the The process leads to the centralization to create credit
2008 crisis. and bureaucratization of everything, not money.
However, because banks, regarded as too just the government. Big corporations,
big to fail, collude with the government paying lower interest charges than their
TRUTH and TRADITION
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