A pervasive belief throughout both the mainstream and independent media is that when faced with the threat of an economic downturn, central banks will act unconditionally to lower interest rates and inject fresh stimulus into markets by way of quantitative easing. One theory is that they will do this to stave off a collapse of the economy amidst rising trade ‘protectionism‘. But is the idea of central banks enacting policy to avert economic disaster one that stands up to scrutiny?
To gain a broader understanding of how banks behave before and after a financial crisis is triggered, the historical actions of the Federal Reserve are a good place to start.
The Great Depression
In a 2013 article written by Gary Richardson of the Federal Reserve Bank of Richmond, Richardson candidly explains how in 1928 and 1929 – leading into an impending stock market crash – the Fed were raising interest rates. According to Richardson, they did this ‘in an attempt to limit speculation in securities markets‘.
Conditions at the time included an influx of borrowed money being poured into the stock market, which contributed heavily to the soaring price of shares. A month before the crash that eventually manifested into a depression, the Dow Jones stood at a record high of 381 points.
Today, the Dow Jones is approaching an all time high of 27,000, and since it’s post crisis low of 6,469 has increased by 317%. A combination of ultra accommodative monetary policy and corporate stock buybacks has been responsible for much of this rise.
There were two significant ramifications from the Fed’s decisions to raise rates prior to the Great Depression. The first was that economic activity in the U.S. began to slow and, to quote Richardson, ‘because the international gold standard linked interest rates and monetary policies among participating nations, the Fed’s actions triggered recessions in nations around the globe.’
Two years after the stock market crashed in 1929, the Fed responded to what was now an international financial crisis by again tightening monetary policy. They also presided over a fall in the money supply, which from the fall of 1930 to the winter of 1933 declined by 30%. Richardson pointed out that this caused increased levels of debt, reduced consumption and increased unemployment. Banks, businesses and individuals had no alternative but to file for bankruptcy.
Richardson put this down as a ‘mistake‘ by the Fed, and insisted that actions which damaged the economy were unintentional.
In an economic letter published by the Federal Reserve Bank of San Francisco in 1999, economist Timothy Cogley outlined how from January to July 1928, the Fed raised the discount rate from 3.5% to 5%, and ‘engaged in extensive open market operations to drain reserves from the banking system‘. Over three-quarters of the Fed’s stock of government securities were sold.
By comparison, since the back end of 2017, the Fed has been actively reducing the size of its treasury securities and mortgage backed securities. Over $600 billion has been rolled off so far, a total that comprises both asset classes.
In the first half of 1929, the Fed kept monetary policy on hold, in spite of a slowing economy. Cogley mentions how economists have since argued that this inaction by the Fed was the cause of the downturn that followed.
In the aftermath of the October stock market crash, the New York Fed ‘bought government securities on its own account in order to inject reserves into the banking system.’ But after the recession had begun in 1930, monetary policy ‘resumed a contractionary stance.’ This, according to Cogley, ‘contributed to a further decline in economic activity and share prices.’
As with Gary Richardson, Cogley stressed that the Fed’s actions were ‘mistakes‘, the consequences of which were ‘unintended‘.
Finally, in a document from 1965 attributed to the Federal Reserve Bank of St. Louis, the points made by Richardson and Cogley are reinforced. Interest rates moved higher in the years leading up to October 1929. At the beginning of the great depression came a respite where rates began to fall, but ‘despite the continued contraction in economic activity, interest rates rose markedly in late 1931.’
Is it a viable explanation to say that the Fed’s actions nine decades ago were ‘unintended mistakes‘? Are we to believe that each time they make a policy ‘mistake‘ that they have no awareness of what the subsequent consequences will be?
To challenge this idea, we can turn to the current chairman of the Federal Reserve Jerome Powell. Around the time he assumed office in February 2018, the Fed released the minutes from a series of FOMC meetings held in 2012. During the meeting of October 23th/24th, Powell spoke about the future reversal of the quantitative easing programme that began following the collapse of Lehman Brothers in 2008. Here is an extract of those comments:
Right now, we are buying the market, effectively, and private capital will begin to leave that activity and find something else to do. So when it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response.
I think we are actually at a point of encouraging risk-taking, and that should give
us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.
Two things stand out from Powell’s words. Firstly, that when the Fed begin reversing accommodative measures (which they did in December 2015 with their first rate hike in nine years), he fully anticipated a hostile reaction from markets. Secondly, there is an awareness that tightening policy would be a catalyst for puncturing the post-crisis bubble that has built up since the Fed cut rates to near 0% and inflated their balance sheet to hold over $4 trillion in assets. ‘You can almost say that that is our strategy.‘
The only conclusion that can be drawn from this is that the Fed ARE aware of the consequences of their actions, and have pushed on regardless with raising interest rates and off loading assets from its balance sheet. What Jerome Powell outlined is what he now presides over. He understood what would eventually happen if the Fed started to withdraw support from markets. Yet, they tightened policy anyway and continue to do so. It is not until September that the Fed plans to halt its balance sheet reduction programme.
Aside from the balance sheet, the betting now is that with the U.S. economy slowing, the Fed will reverse course in the short term and cut interest rates, and move towards introducing a forth round of quantitative easing to prevent an economic collapse. But when you look as far back as the Great Depression, and then to the more recent financial crisis of 2008, there is no precedent for them to do this.
The Fed neither prevented the Great Depression nor the crash of 2008. Their actions leading into both periods served to ensure a crisis was inevitable. Through monetary policy they knowingly built up unsustainable economic bubbles. Rates were rising in the run up to the 1929 crash, and were rising as late as June 2006 leading up to the 2008 downturn.
Granted, the 2008 crisis was different in the sense that the Fed began cutting interest rates in September 2007. But their actions were not enough to prevent a full blown financial crisis twelve months later.
What we are witnessing today looks increasingly similar to that which occurred ninety years ago.
When Donald Trump won the U.S. election in November 2016, interest rates were at 0.25%. Rates have moved higher eight times since, and currently stand at 2.25%. Back in 1929, just months prior to the stock market crash, the Fed paused on raising rates any higher. They did not cut rates until AFTER a crash had begun. And even this was short lived, with rates moving higher as the Great Depression took hold.
Ten years ago, when commenting on the Federal Reserve’s response to the financial crisis, then Fed chairman Ben Bernanke remarked that the Fed’s policy in the 1930s was ‘largely passive‘, and that political upheaval made ‘international economic and financial cooperation difficult.’
Assuming that the Fed do not raise rates in the near term, this description of circumstances ninety years ago will mirror the present day.
Some might be surprised to learn that the Fed have themselves admitted responsibility for causing the Great Depression. In 2002, four years before being made chairman of the Federal Reserve, Bernanke told a gathering at a conference to honour the 90th birthday of Milton Friedman:
I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.
In my view this is exactly what they are doing. If so, then it points to The Fed as knowingly and purposefully inducing an economic collapse. The difference between 1929 and 2019 is that this time the Fed have a ready made scapegoat to conceal their intent behind – that being the actions of the Trump administration in regards to trade.
Incidentally, the Great Depression of the 1930s saw a rise in ‘protectionist‘ trade policies, chiefly through the imposition of tariffs. A contraction in global trade soon resulted.
As I have written about previously, the most recent Fed communications confirm that they intended to carry on conducting monetary policy in accordance with their mandate for 2% inflation. To develop this position, consider the latest soundings from the Bank for International Settlements.
Last weekend the BIS released their Annual Economic Report, along with a speech by General Manager Agustin Carstens. The subject of global trade was dominant throughout. On speaking about trade tensions, Carstens said that they ‘bring up questions about the viability of existing supply chain structures and the very future of the global trading system.’ This corresponds to an article I posted back in October 2018, which looked at how the International Monetary Fund, The World Bank and the World Trade Organisation had published plans for ‘Reinvigorating’ and ‘Modernising’ the W.T.O.
I have long since argued that the model which globalists routinely utilise to instigate widescale ‘reforms‘ is to use crisis scenarios as opportunities. It is unlikely to be a coincidence that as trade tensions increase, internationalists are seeking to redefine global supply chains and the institutions which preside over them.
In his speech, Carstens also commented that because of trade tensions and slowing growth, the normalisation of monetary policy was now ‘in a holding pattern‘. He spoke of how ‘the course towards normalisation has called for some deviations.’
Deviations, but in the Fed’s case not as yet a U-Turn.
On the international level the policy position remains that monetary accommodation should be maintained where inflation is below target, and withdrawn where inflation is close to or above target. But Carstens made it clear that ‘monetary policy cannot be the engine of higher sustainable economic growth.’
The editorial of the annual report expands on this. With central banks putting ‘the very gradual monetary policy tightening on pause‘, it warns that ‘should inflation start to rise significantly at some point, it would induce central banks to tighten more.’
The trade conflict initiated between the U.S. and China, a potential escalation of tariffs with Mexico and the EU, and the possibility of no withdrawal agreement upon the UK’s departure from the EU, is a powder keg for a resurgence in global inflation. I will be discussing this further in an upcoming article.
The Federal Reserve’s next interest rate decision is at the end of July. If as I suspect the Fed make no immediate movements, with the economy continuing to slow and economic activity weakening still further, it will be important to recognise that this would not be without precedent. They have done this before and been the cause of economic catastrophe. It would not be a surprise to see history repeat itself, and for the Fed to once again oversee the premeditated decline of the economy.