Fight The Fed?

“Almost half of the 1300 employees of the Peruvian Central Bank of Reserve of are related to one another,” Bloomberg reports. Central banking is, after all, a government job. It is different from, say, the local Department of Human Resources, only in that its employees are better paid and get better press. Even the Federal Reserve – perhaps the world’s most powerful and prestigious bureaucracy – is still, like every other government agency, a scam, a sinecure, and waste of money.

At least, that is the working hypothesis of today’s letter.

Not much in life is certain. That is why it is such a comfort to have government. One of the few things you can depend on is that government officials will do the wrong thing. Even when they occasionally seem to do the right thing – it turns out later on that it was at best accidental, and at worst, the wrong thing after all.

“The last successful government program,” observed New York mayoral candidate Jimmy Breslin, ” was WWII.” Since then, there have been a number of wars declared and undeclared by Washington hawks. But in almost every instance bureaucratic instincts and motives were hopelessly wrongheaded.

In the war on drugs, as we observed here just the other day, the government seeks to put drug dealers out of business by interdicting supplies. This is just the wrong thing to do, since it increases profit margins. The more taxpayer money spent trying to keep illegal drugs off the market, the more profitable the business becomes and the more entrepreneurs rush in to fill the unsatisfied demand.

Yesterday’s USA Today brought news that the shooting war has moved to the suburbs as dealers battle it out for control of the Ectasy market – made especially rich by government decree.

If government really wanted to put dealers out of business it would flood the market with illegal drugs – give it away on street corners for free. But what profit could there be in that? Not only would it put the drug dealers out of business – it would also put the DEA out of business too.

Likewise, if the bureaucrats really wanted to win the War on Poverty – they would tax poor people at a higher rate…not reward them with subsidies and handouts. So, too, would health officials cease to coddle the sick and infirm. If they really wanted a nation of healthy people they would revoke public health insurance benefits for people who eat too much or watch TV all day, and perhaps shoot a few smokers and fat people in the streets.

Thus do bureaucrats go about their business – making worse whatever problem they’re supposed to be fighting, while actually increasing their own power. But as we will see tomorrow, it is a rare person who will not give up his dignity and his common sense in a bid for riches, fame or public office.

Even Alan Greenspan, once an Ayn Rand devotee, could not resist the lure of power. In order to get his picture on the cover of TIME, something he could never do as an ‘Individualist,’ he has become a collectivist central planner.

Unlike other activities in life – from shopping for vegetables to running a Rotary club – government distinguishes itself in a singular way: by its ready use of force. Instead of coming to terms with people in a polite and dignified way, government orders them around like prisoners of war. The results are almost always pathetic and absurd.

Could it be any different with Alan Greenspan and the Federal Reserve? Could the interest rates proclaimed by the Greenspan Fed be superior to those set by buyers and sellers? Could this be one – and perhaps the only one – instance where government is superior to the market, and where the judgment of powerful government bureaucrats is superior to that of millions of investors and lenders?

Raising these questions, I realize that I put myself directly in the path of the rush of popular opinion. ‘Don’t Fight the Fed’ blows the common sentiment.

The odds favor the Fed, it is believed. Because easy money has to go somewhere… and because stocks rise more often than they fall anyway. The Fed, clearly committed to cutting rates until the economy turns around, seems to be offering investors a no-lose wager. If at first the Fed’s cuts fail to boost stock prices… Greenspan will try, try again – and keep trying until the market finally responds. And yet, anyone betting on government bureaucrats to win the War on Poverty, the War on Drugs, or any of its other wars since 1945 would have found himself on the losing end of the wager.

Even the Fed itself has a reliable record. Charged with protecting the currency, it has done the exact opposite. In the 100 years preceding the creation of the Federal Reserve System, the dollar went up and went down, but it ended the period about where it began, worth as much in 1913 as it was in 1813. Since then, thanks to the Fed’s management, it has lost 95% of its value.

Having failed so miserably, the Fed has done just what every government agency seeks to do – expand its mandate. Now, the Fed has taken on the job of managing the economy as well as the currency.

Mr. Greenspan believes, at least publicly, that the Fed can manipulate key interest rates and keep the economy expanding almost eternally. And the public believes it, too.

Even people who have not yet begun to shave believe it. Teddy Chestnut, of Montclair (New Jersey) High School, said he was “almost positive” that the Fed would cut another 50 basis points this week. “People are losing confidence,” he explained, “and right now spending is the only thing keeping us out of a recession.”

If the Fed merely cuts rates, Teddy seems to think, consumers will be inspired to do more of what they do naturally…and the economy will continue its record expansion. It is, of course, possible that the economy functions in exactly the way Teddy imagines – with the complexity of a grandfather clock. Greenspan has merely to adjust the pendulum to make it run faster or slower as desired. This view helped Teddy’s team win $40,000 from Citibank in a remarkable competition called the “Fed Challenge.” The challenge for the kids is to think like central bankers. That is, to think like central bankers who believe that Alan Greenspan is a bureaucrat like no other…one whose decrees actually lead the nation where it wants to go.

How likely is that, dear reader? Should you ‘fight the Fed’ or not?

I will take up the issue next week.


Bill Bonner
Santa Fe, New Mexico
May 17, 2001

*** Yesterday, Mr. Market reconsidered the significance of the Fed’s recent rate cut. Upon further reflection, he determined that what had at first seemed a non-event was in fact an extraordinary and economically transforming event. Why this is so, he is not exactly sure. But he is sure that it is so. At least for one day.

*** The Dow soared 342 points. In so doing, the indomitable index reclaimed and promptly surpassed the 11,000 level to close at 11,215.

*** The Dow, which last reached 11,000 – albeit in the reverse direction – eight months ago, now stands little more than 500 points below its all-time high. The NASDAQ, although still several 3-woods away from its all-time high, put in a solid day’s work on Wednesday by advancing 3.9%.

*** ‘If this is a bear market, let’s have more of them!’ investors must be thinking. But Daily Reckoning readers are cautioned that Mr. Bear is a wily animal. The DOW rallied 50% from its 1929 crash low of 195.4 to its April 1930 peak of 294.1, before resuming a decline that carried the index down to the ultimate bottom of 41.6 in 1932.

*** “After the initial stock market crash in October 1929, the country remained sanguine,” writes Fred Hickey of the High Tech Strategist. “The Harvard Economic Society issued a series of optimistic forecasts, including one in May 1930 that claimed that business ‘will turn for the better this month or next, recover vigorously in the third quarter and end the year at levels substantially above normal.’ Does this sound familiar?

“In 1930 President Hoover famously declared, ‘Prosperity is just around the corner.'” It is no small bit of irony, Hickey points out, that Leo Reisman and His Orchestra first recorded “Happy Days are Here Again” in November of 1929.

*** “The most important lesson that can be learned from studying past manias is that, with no exceptions, every completed mania has seen stock prices fall until they are below the original starting level,” writes a reader of Bill Fleckenstein’s Market Rap. “History does not favor the current bear market ending soon, despite daily predictions of a bottom from Wall Street media.”

*** If, as the saying goes, markets make opinions, the opinion now being made would seem to be that Greenspan’s got the cure. The economic plague is over. Celebrate! Kill the fatted calf, make merry, buy tech stocks and, if at all possible, break out the credit card to buy a little something nice for the spouse and kids.

*** “If at all possible” is a high bar for the consumer to clear these days. “Not only is consumer debt outstanding at a record relative to disposable personal income, interest payments are also,” the ISI Group points out. US consumer installment debt now totals a record 21.7% of disposable personal income, while the payments necessary to satisfy that debt total 3.1% of disposable personal income, also a record. Looked at another way, US private debt now equals a record 147% of America’s Gross Domestic Product. ISI concludes, “To be sure, consumers and corporations are the most highly leveraged they have ever been going into a slump.”

*** The latest auto sales reports suggest that happy days are not quite here. GM and Ford both reported 16% sales declines in April. Non-Mercedes Chrysler’s sales fell 18%. Maybe the reason is as simple as: Consumer wants to spend. Can’t.

*** “Just maybe the consumer will draw down credit lines only to maintain a satisfactory standard of living,” suggests, “forgoing the new Jeep Liberty or Maytag dishwasher in favor of keeping his already heavily indebted head above water.” The article goes on to state that “likewise, corporations will borrow money for ‘general corporate purposes’ like paying officers’ bonuses. Not, we repeat, not to buy routers from Cisco, trucks from Volvo and blocks of airline seats from American Airlines.”

*** Charles W. Peabody, the brilliant bank analyst from Mitchell Securities, Inc., observes that revolving home equity and credit card loan growth both peaked in January. “This may be the first indication that the consumer doesn’t have the appetite for more debt,” he writes. “The big question is whether this diminished appetite is because the consumer is losing confidence, and thus, unwilling to spend or can’t spend anymore because his debt service burden is already too high. Either answer bodes poorly for the economy over the next six to nine months.”

*** Amidst the frenzy on Wall Street yesterday, a little bit of buying sloshed over into the gold market as well. The precious metal continued its winning ways on Wednesday by climbing almost $4 per ounce to $272.40. The Amex Gold Bugs Index soared more than 10%.

*** “No joke: Newmont Mining has outperformed Cisco the last two years,” writes Eric J. Fry of “Shares of Newmont, the Denver-based gold producer, managed a 16% gain over the last 24 months, compared to CSCO’s 26% loss.

“Might these archetypes be sending a message?” he asks. “As the tech sector abdicates its throne, are resource stocks laying claim to it? Chairman Greenspan’s seemingly inflationary monetary policy improves the odds. By expanding the money supply at double-digit rates and cutting the fed funds rate five times into the face of a rising CPI, the Fed may be spurring greater demand for gold than for PCs and cellphones – for the time being at least.”

*** Even Amazon rose yesterday. But Dan Ferris sends me this note: “Amazon’s 5 year return on capital, -103.2%. Yes, that’s NEGATIVE 103.2%.”

*** Dan is also the source of the following comments on credit quality: “The median corporate bond rating stands at BBB, weak investment grade, the lowest since 1981, the first year that statistic is available. Also, just 28% of the junk-bond universe holds the top junk rating, according to Moody’s Investors Service, the lowest proportion in at least 80 years, a span including the Depression.”

*** I am in Santa Fe, New Mexico, where I will be attending my son’s graduation from St. John’s College this weekend. Santa Fe has a style all its own. I lived here, briefly, about 30 years ago. But the place has changed. It’s gone up-market. I hardly recognize it. More to come.