Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Why the Fed's US Interest Rates Policy Will Fail

Interest-Rates / US Interest Rates Oct 01, 2007 - 08:28 AM GMT

By: Gerard_Jackson

Interest-Rates Best Financial Markets Analysis ArticleIt was only it was last August that I told readers not to be surprised if the fed cuts the funds rate. (US financial markets rocked — what is really happening ). Lo and behold, on September 18 the fed cut by 50 bps, reducing the funds rate to 4.75 per cent. The cut immediately ignited share prices, with the Dow Jones industrial average surging by 335 points. The only surprising thing is that anyone was actually surprised. That the first effect of a credit expansion is usually felt on the stock market seems to have eluded the commentariat 1 .


There is no doubt in my mind that the inability of financial and economic commentators to get it right on so many economic issues boils down to a combination of lousy economics and an ignorance of economic history. Now economic history is not much help unless you have the economic theory to go with it. So let us once again take a trip down memory lane to the year 1927. It was July and the inter-central bank conference in New York was winding up when Benjamin Strong, Governor of the Federal Reserve Bank of New York, told Charles Rist, Deputy Governor of the Bank of France, that he was going to give the US economy a boost.

I'm not as hard on Strong as some people. The man — like so many then and now, including Bernanke — had bought into the price-stabilization fallacy. So when the productivity-induced fall in prices made its appearance in 1925 and into 1926 Strong felt the need to do something. Hence his comment to Charles Rist. To get a perspective on the consequences of Strong's monetary policy we should note that the Standard and Poor index 2 for June 1921 stood at 65.5. By June 1927 the index had risen to 148.9, a 127 per cent increase. Thanks to Strong's lack of economics his “injection of liquidity” sent the index zooming from 148.9 to 313.0 in September 1929 — an increase of 52.4 per cent in about 2 years. The following chart will give you some idea of just how quickly the stock market was affected by Strong's monetary meddling.

share market
 Source: The Cleveland Trust Company Bulletin, October 15,
1932, Vol. 14, No. 10. Cited in C. A. Phillips, T. F. McManus
and R. W. Nelson's A Study of the Great Depression in the
United States , The Macmillan Company, 1937.

 

So much for the “New Era” and “permanent prosperity”.

Strong's monetary policy was described by Keynes as a “triumph” — a triumph whose economic and political denouement was the Great Depression. Yet Keynes became the hero while Fisher — who had also agreed with Keynes that the boom-bust cycle had been conquered — lost his fortune and his credibility while Keynes was praised for his “economic wisdom” and “genius” .

(There is a cruel irony here. Irving Fisher argued that “stock prices have reached what looks like a permanently high plateau”. Now in his paper Is There Inflation in the United States?, 1 September 1928, Keynes enthusiastically endorsed Fisher's optimism, only to admit in 1930 that he had been mistaken about inflation. Yet Keynes' views were simply flushed down the memory hole by his rapidly-growing band of disciples).

The 1930s economic tragedy brings us to the present. Despite the lessons of the past the fallacy of a stable price level is still strongly held by the overwhelming majority of economic commentators including professional economists. This is due to the peculiar belief that falling prices are by definition deflationary and will thus depress business activity and raise unemployment. This view makes no distinction between a money-induced fall in prices caused by a monetary contraction and falling prices caused by rising productivity.

This argument is frequently used by the likes of Tom Nugent and Lawrence Kudlow who believe that so long as prices are comparatively stable there is nothing to worry about. But as soon as increased productivity begins to lower prices they call for an expansion of the money supply to meet the additional “demand for money”. But as Lord King rightly pointed out in 1803:

...it must follow that there is no method of discovering a priori the proportion of the circulating medium which the occasions of the community require; that it is a quantity which has no assignable rule or standard ; and that its true amount can be ascertained only by the effective demand [emphasis added]. ( A Selection of Speeches and Writings of the Late Lord King , Longman, Brown, Green, and Longmans, 1844, p.72).

What today's commentariat has not grasped — with the exception of the Austrians — is that falling prices due to rising productivity benefits everyone by spreading the fruits of increased investment more in line with market-induced changes in the value of factors' productivity, particularly labour. By attempting to stabilise the price level and hence the purchasing power of the monetary unit the fed effectively distorts this process. In doing so it Inadvertently denies many American workers the increases in real incomes that they would have otherwise enjoyed. It was the dangerous policy of stabilisation that drove Phillips, McManus and Nelson to charge that

the end-result of what was probably the greatest price stabilisation experiment in history proved to be, simply, the greatest depression. (Ibid. p.176).

Sound economics and economic history teach us is that these monetary injections eventually work themselves out leaving the market to liquidated the malinvestments and the over-valued shares. Of course, the fed can make further monetary injections, but this would not merely delay the unavoidable adjustment process it would make it even more painful. Unfortunately, fed officials and the majority of politicians are not in the market for an alternative economic analysis.

1. Credit expansion does not always stimulate output. No matter how low interest rates may be, so long as there is no apparent prospect of profits very little investment will take place. This is exactly what happened in the 1930s thanks to the ‘economic policies' of Hoover and Roosevelt.

2. Taken from Standard and Poor's and Cowles data monthly series on stock prices, dividends, The original price index was multiplied by ten.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

Gerard Jackson Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in