What Yellen Must Know but Can’t Say
Policy wonks billed Fed Chair Janet Yellen’s recent remarks from Jackson Hole, Wyoming as “one of the single most important speeches” she’ll give all year.
Traders yawned because they already know the answer to the one question that no politician dares to ask.
An Insult to Every Investor
I delivered a keynote speech several years ago in Bermuda to a gathering of reinsurance executives, corporate officers, and prominent financiers responsible for hundreds of billions of dollars around the world.
And, as part of that, I spoke about both the 2008-2009 financial crisis and the opportunities it would create – things we’re still tracking profitably today.
Shortly after I’d finished, I received one of the bluntest questions in a long time from deep within the room well beyond the stage lights:
“Does any nation really need a Fed?”
You may be wondering the same thing now following Janet Yellen’s most recent remarks in Jackson Hole.
The answer is still “no.”
The Fed is an abomination, and the American Federal Reserve in particular is an insult to every investor who believes in capitalism, in economic progress, and political freedom.
The individual depositors – meaning you and me – who were the intended protected class when the Fed was formed in 1913, are nothing more than financial cannon fodder today. Now it’s the big banks and crony capitalists in Washington who have become the protected few.
Honestly, I didn’t always think this way. Like many people, I once took the Federal Reserve for granted and implicitly assumed that it acted in our country’s best interest. But then the financial crisis hit and forced me to re-evaluate. Sitting down in Singapore with legendary investor Jim Rogers, a staunch Fed critic, in 2008 solidified my thinking.
The Fed Had a Beginning – It Can Have an End
A lot of people believe that the Fed has always been a part of our system. In fact, it’s just over 100 years old – formed in 1913 in an effort to prevent banking failures. What’s more, it’s actually our third Fed.
At the time, the United States had just gone through the vicious bank panic of 1907. That crisis was significant because it saw the failure of Knickerbocker Trust, which sought, but failed, to receive financial support from its peers. Unable to obtain liquidity from any source, Knickerbocker Trust collapsed.
This affected public psychology deeply because Knickerbocker’s peers didn’t just choose to not rescue Knickerbocker, but also suspended payments to each other. This would be like JPMorgan refusing to trade with Citi who, in turn, refused to do business with Wells Fargo – and so on.
This boomeranged through the system and came to roost at the retail level when the public figured out that they didn’t have access to their money, especially in “specie,” meaning in gold. Bank runs and closures became the norm.
The New York Stock Exchange fell 50% before financier J.P. Morgan famously locked banking executives in his personal library and formulated a liquidity injection that ultimately calmed everything down.
Loath to waste a good crisis, legislators stepped up to the plate by agitating for centralized banking as a means of restoring public confidence while providing the banking system with a source of liquidity that would prevent their wholesale collapse.
And they got it a few years later… in spades.
What’s really interesting to me looking back through today’s lens is how sophisticated the machinery of the time was. Powerful public and private figures worked together, often in great secrecy like they did at Jekyll Island, Georgia, to build the framework for the Fed. The Wall Street Journal published a 14-part series highlighting the need for a central bank. Citizen groups and trade organizations piled on all in the name of public good which ought to sound hauntingly familiar given today’s headlines.
And voilà… the Fed was born under the guise of a politically independent institution that would stabilize the financial system, protect the monetary supply against inflation, and maintain credit as needed by injecting stimulus when the economy flagged and withdrawing it when things were overheated.
In the terminology of the day, this was viewed as giving elasticity to the dollar which would, in turn, establish more effective control over the banking system.
None other than the office of the Comptroller of the Currency itself observed that the Fed would supply a circulating medium that is “absolutely safe.” What irony.
Fast forward to today.
Every 1913 dollar is now just barely worth US$0.04 cents. Goods and services that cost a buck back then now will set you back $24.31, according to the US Inflation Calculator using CPI data. Where’s the stability in that?
If that’s not practical enough, consider wages.
According to the U.S. Census Bureau, the median income of male workers in 2010 was $32,137 while the median income of male workers in 1968 was $5,980. On the surface, this isn’t too shabby. It’s a 437.4% increase over 42 years – or an average income gain of 10.41% a year, over the same time period.
However, if you run the numbers the other way using 2010 dollars, a very different picture emerges. You quickly see that median earning male workers actually have less purchasing power today than they did 42 years ago ($32,844 vs. $32,137).
What that means in plain English is that paychecks are going up but people receiving them are able to do less with the money. Take a restaurant cook working full time, for example. According to the National Employment Law Project, he or she earned 8.9% less in 2014 than in 2009. That’s roughly $2,185 per month in 2014, which works out to an average decline of $437 over the same time frame.
That’s roughly what an average American household spends on groceries each month… gone into thin air.
That’s your Federal Reserve at work. It’s robbing America by gradually sucking the life out of the financial system. Over time, it will cause the system to collapse. Just ask anybody in the former Soviet Union. They had a ‘Fed’ and no Soviet bank ever failed per se. However, the state eventually took so much wealth from the people that the entire system broke.
Never Met a Printing Press They Didn’t Love
Legions of spend-it-while-you-can politicians, economists, and self-interested lobbyists don’t see it this way. And neither, perhaps more importantly, does sitting Federal Reserve Chair Janet Yellen or her immediate predecessor, Dr. Ben Bernanke.
Bernanke explicitly said on November 21st, 2002, in remarks to the National Economists Club that, “by increasing the number of dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of the dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.”
In other words, he believed he could create economic value merely by printing money.
Janet Yellen does as well, which is why she’s going to remain “accommodative” even though she knows full well that her policies continue to hollow out the dollar. Like Bernanke, Yellen believes that doing so is the same thing as raising prices by managing inflation.
In fact, inflation is actually defined as the artificial increase in the supply of money and credit. It’s a tax by any other name. So what Bernanke did, and what Yellen is now doing, is artificially taxing the American public by debasing its currency. It’s no wonder that more people have less.
But here’s where it really hits home for me.
When the Federal Reserve was created, it was envisioned as a source of liquidity for the banking system. The presumption was that any specific failure in the banking system subject to the Fed’s oversight would be offset by the available cash from the government because it had centralized the credit risks associated with their lending portfolios.
In today’s environment, credit is diffused globally far beyond the Fed’s reach. What’s more, there’s too much of it and the banking system is now so big that the risks it holds dwarf the Fed’s liquidity capacity.
For example, there are an estimated $600 trillion to $1.5 quadrillion in derivatives products worldwide at the moment. Global gross world product is approximately $79 trillion by comparison.
Contrary to what Bernanke and others who are so tightly involved in the system believe, this crisis was not caused by a lack of liquidity. Rather, it was caused by too much money sloshing around in some sort of unregulated mosh pit with inadequate supervision and inadequate regulatory oversight.
The real villain here is that excess liquidity is leveraged by big banks and trading firms who have run amok for years. This lets big banks buy derivatives for pennies on the dollar, yet exposes them to hundreds of billions in market risk you’re now on the hook for because our leaders have socialized risk under the guise of “too big to fail.”
The key takeaway here – and what causes most people heartburn – is the realization that there isn’t a central bank in the world that can print enough money to guarantee liquidity. Heck, all the central banks in the world together couldn’t do it.
Yet they will continue to try because that’s the only way they keep the illusion going despite the mounting evidence that it doesn’t work.
Printing money and accommodative low interest rate policies are also the only way they keep a handle on their version of risk… to the system. And that brings us full circle.
Success by its very definition includes failure. People forget that the discipline of failure is integral to capitalism. When the Fed creates money out of thin air, the risk of failure does not exist. Without the risk of failure, the big banks know they can place one way bets and not worry about losses because they are literally ‘too big to fail.”
In fact, management and traders are paid to do exactly this. If the monstrous one-way bets pay off, they get up to 50% of the profits. If the bets go bad, the stockholders, the Federal Reserve, and now the public eat the losses.
So they have every incentive to act in their own interests while reinforcing incompetent management, improper risk taking and inefficient operations. Politicians and regulators are incentivized the same way, since the Fed also makes it possible for them to skirt the issue of responsibility.
The Fallacy of Free Money
Which brings me to interest rates.
The Fed spends a good deal of its time (and our money) promoting and maintaining low interest rates. It’s doing so on the assumption that low rates prompt everyone to put money to work by making savings less appealing. But ask Japan how much demand there’s been when money was free. The answer is next to none.
The trillion-dollar problem is the economic assumption presumes that savings are there in the first place. In reality, America and other ‘Fed’ nations are flat broke. There is no savings pool to draw upon, which means the foregone assumption they’re operating under is a bust.
And where there are savings?
Tiny Raiffeisenbank Gmund in Germany’s Bavarian Alps has started charging individual depositors in an effort to pass on the ECB’s negative interest rates calling it a “solidarity contribution.” Don’t think for a minute that won’t happen here eventually.
At some point, people who do not have cash cannot pay for the goods and services they need – no matter how much liquidity is in the system.
International capital markets actually exacerbate the problem because other governments and major trading firms purchase that very same excess liquidity which they, in turn, then begin using as collateral for their own expansion.
Former Congressman Ron Paul, a staunch Fed opponent, summed it up much more eloquently than I ever could in his 2009 book, End the Fed, noting that ‘those who suffer [rarely] see the connection between Federal Reserve monetary policy and the suffering that comes as a consequence of financing big government and big banking.’
Under the circumstances, is it any wonder that almost every currency in recorded history that is controlled by a central bank has failed or is failing?
Low interest rate policies have forced millions of investors seeking income into the stock market for higher returns which, by implication, come with higher risks. That drives up stock prices and makes for great headlines but does little for the economy.
Fed policy wonks believe they can set interest rates effectively when that’s something the markets do with real money – not out-of-date and badly broken financial models.
The Fed was formed to backstop solvent banks and their depositors as a lender of last resort. It was not intended to provide liquidity for the global economy and legions of functionally bankrupt institutions.
Rock solid banks don’t need the Fed.
Money will always flow to where it is treated best. Banks will not make loans to terrible borrowers and it doesn’t matter whether we are talking about individuals, companies, or even countries. Try as it might, the Fed will never be able to change this.
To think otherwise is naïve because money is not a resource. The resources are what you do with it and that’s an economic function best left up to real businesses creating real products and employing real people – which is why I concentrate on them here in Total Wealth and in our sister services, The Money Map Report and High Velocity Profits.
If you’re reflexively balking at what I’ve said today, I understand. Many people do simply because it’s not easy to see something you been led to believe is critical to our way of life get called out so harshly.
That’s okay; Copernicus was damned for saying the earth was round, too.
There isn’t a government in recorded history that has ever spent its way out of a crisis caused by too much money in the first place. However, there are plenty of governments that have taxed themselves into oblivion for having tried.
And traders know it.
Which is why the game continues for as long as central bankers and their cronies think they can win.
Invest accordingly or get left far behind.
- Prioritize Unstoppable Trends backed by trillions that Washington can’t derail
- Focus on “must-have products” produced by rock-solid companies Wall Street cannot hijack; and,
- Strictly control risk because the Fed won’t.
I’ll be with you every step of the way.
Until next time,