Stocks

Liquidity Problems Could Overwhelm Inflation’s Effects

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LIQUIDITY PROBLEMS – 1929 

In 1928 and 1929, the Fed raised interest rates for the purpose of curbing rampant speculation in stocks. At that time, investors could borrow as much as 90% of the stock price for their proposed investment. The banks were just as aggressive as investors and were happy to oblige.

Raising rates did not slow stock speculation by investors or banks, however.

What it did do was cause a slowdown in economic activity. Thus, as economic activity declined, the stock market continued its rise, unabated.

As the decline in economic activity continued, both businesses and consumers were affected negatively. The money was available for investors to buy more stocks, albeit at a higher cost; but, businesses and consumers struggled with liquidity problems.

STOCK BUBBLE BURSTS 

The crash in the stock market brought illiquidity issues to light. Layoffs in the financial industry were numerous and swift. The ranks of the unemployed ballooned.

If you were an investor who had purchased stock with 10% down, it would take only a 20% decline for you to have lost twice as much as your original investment.

Now, imagine the plight of the banks who had lent money to investors using stocks as collateral. The collateral was worth as much as 30% less after one day of trading. Bank failures became almost commonplace during the Great Depression that followed.

FED RESPONSE

As might be expected, the Fed did purchase government securities in the open market and lowered the discount rate. It also assured commercial banks that it would supply needed reserves.

Unfortunately, “too little; too late” became the common descriptive phrase used when referring to Federal Reserve response to the crisis which it had caused. That is because the economic devastation was overwhelming.

Unemployment soared to as much as 25% and prices declined (deflation) by more than one-third. The aggressive, free-spending social programs of the 1930s government could not stop the slide and contributed to the length and breadth of the depression. At the depths of the Great Depression in 1932, the stock market had declined by 90%.

The stock market crash was not the cause of the Great Depression, though. The Great Depression was caused by a Fed policy of higher interest rates. Whatever the intention or merits of the action (the higher rates were imposed for the purpose of curbing rampant stock speculation), it led to a reduction in economic activity which was well underway before stocks crashed.

INFLATION, DEFLATION, AND THE FED 

The Federal Reserve officially implemented an interest rate policy of “higher for longer” almost three years ago. Rates moved up rapidly and bond prices have lost one-third to one-half of their value since then, depending on length of maturity. (see “And So Rates Will Be Higher” – Jerome Powell)

It matters not what the intention was or whether it was correct. What matters at this point are the circumstances in which the Fed finds itself now.

Most, or all, of our serious financial and economic problems are the result of a century of intentional inflation. The effects of that inflation lead to a loss of purchasing power in the currency (U.S. dollar). When the Fed intervenes in the markets either directly (by purchasing or selling securities) or indirectly (manipulating interest rates), it creates distortions which have ripple effects and are amplified.

In addition, those effects are unknown with regards to extent, duration, and timing. Remember being surprised at the higher increases in consumer prices post-Covid and economic shutdown. Those increases are attributable to government (and central banks) actions in response to the ‘pandemic’.

The economic shutdown was forced upon society by government – rightly or wrongly. As a result, the decline in economic activity led to huge financial and economic problems for society, including supply chain issues. These problems were met with phenomenally huge financial largesse (inflation) by governments and central banks, which, in turn, led to higher consumer prices (effects of inflation).

After more than one hundred years of trial and error, it is apparent that…

  1. The Federal Reserve causes the problems and crises with which it continues to grapple.
  2. The Fed is doomed to a role of reacting to crises of varying intensity (worse) and frequency (more often).
  3. Serious deflation and economic depression would overwhelm efforts by government to reverse the effects or contain the damage.

CONCLUSION 

There is no path to financial stability from the current point that does not involve a cleansing of huge magnitude. The cleansing will be accompanied by serious financial and economic pain. The Fed is continually dancing with its own devils amid music which is horribly out of tune. The only option left is to wait until the music stops. (also see If The Markets Turn Quickly, How Bad Can Things Get? )

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

5 Investments To Avoid In 2025

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INVESTMENTS TO AVOID IN 2025

While most other analysts usually tell you where to invest, I prefer to tell you where NOT to do so; at least at this particular time. The backdrop of a deteriorating world economy, recurring financial catastrophes and the volatility which accompanies them, plus exacerbation of existing problems by governments and regulatory agencies, make it difficult to recommend investments on a fundamental basis.

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If The Markets Turn Quickly, How Bad Can Things Get?

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HOW BAD CAN THINGS GET? 

Pretty damn bad. Which means that it will likely be much worse than most of us can imagine. Other than Covid and its forced shutdown of economic activity by governments world-wide, the most recent learning experience for investors is the Great Recession of 2007-09. Beginning in October 2007 and ending in February 2009, the S&P 500 Index lost 53%…

 S&P 500 Index 2007-09

 

Most of that loss (38%) occurred during calendar year 2008. It was the largest single, calendar-year decline since a similar -38% in 1937. Both the NASDAQ (-53%) and DJIA (-50%) declined by similar amounts.

Prior to the Great Recession, post-Y2K markets collapsed in a heap on the heels of the most profitable decade in U.S. financial and economic history. For more than 2 1/2 years, between February 2000 and September 2002, stocks were in a tailspin led by the NASDAQ which declined by 80%. The carnage is pictured on the chart below…

NASDAQ Composite 2000-02

 

The extent and breadth of the declines and accompanying bankruptcies of hundreds of dot.com companies is rivaled only by the Stock Market Crash of 1929 which is shown on the chart (source) below…

Dow Jones – 1929 Crash and Bear Market

Over an excruciating three years (September 1929 – July 1932), stocks declined by 90%. Stocks did not recover their original pre-crash levels until 1954, twenty-five years after the September 1929 peak. The accompanying economic depression lasted until 1941, although a significant portion of what is termed a resumption of economic activity, was accounted for by war-related industrial activity. Economic conditions on the homefront were characterized by rationing, price controls, and shortages.

WHAT MIGHT CAUSE A MARKET CRASH? 

Stock market crashes like those described above don’t happen spontaneously. There are a number of factors which lead to eventual corrections of significance. They include the evolution of normal business and economic cycles, duration and extent of previous stages of those cycles, intervention and manipulation by governments and central banks, the need for corrections and rebalancing due to poor judgement and market excesses, and political and economic factors.

U.S. economic activity has been declining broadly for more than a year or two. That is partially attributable to changes in interest rates which have caused a reassessment of cost factors and undermined the credibility of various investment strategies. The manipulative expansion of cheap and easy credit over the previous four decades resulted in excesses that weren’t fundamentally justified and which distorted the financial landscape. Highly disproportionate availability of cheap credit led to serious misallocation of resources and capital. 

In addition, the use of leverage has exacerbated the problem. The unfathomable and unexplainable derivatives monster has the potential to wreak incalculable damage on the financial markets. The use of leverage throughout all markets – stocks, bonds, commodities – and including the use of options, futures, and other more precarious derivatives, currently rivals its pre-1929 use which approached 90%.

The  currently added recent market excesses are based on expectations for a return to cheap credit. It is assumed that once the Fed announces a rate cut, that a return to the good old days is right around the corner. As much as a 50 basis point cut is already factored in to current stock and bond prices. What happens when that cut is announced? (see What Happens After A Rate Cut Is Announced?)

MORE ABOUT THE FED

The Fed will likely NOT pursue a series of significant rate cuts UNLESS there is an acceleration of the current decline in economic activity. It makes no sense to simply return to the hell that was brought about by its own intentions and actions previously, and which forced them to try to navigate a return to a more normal and reasonable, higher level for interest rates. On the other hand…

Since the Fed is occupied mostly with slaying dragons which it birthed by its own errant monetary policy, including more than a century of intentional inflation, they are doomed to a life of putting out fires and containing collateral damage. For investors, it is time to wake up to the fact that the Fed is not your financial savior and its purpose and goals, irrespective of any so-called mandates, are not aligned with yours.

CONCLUSION

It is possible that a deepening recession (official or not) could morph into something worse – an economic depression. Even if the Fed cuts rates aggressively, it might not be enough t0 stop the cascading waterfall of lower prices for all assets priced in dollars; including stocks, bonds, commodities, real estate, etc. A collapse in the credit markets such as that which occurred in 2007-08 would likely overwhelm any efforts by the Fed to stop the hemorrhaging.

It would not be unreasonable to see prices decline by  50% or more initially. Further declines would be likely as it is unlikely that an event of this nature at this particular time could be reversed in timely fashion. The prevailing conditions of unemployment and shuttered doors spawned by wholesale financial destruction would be too much for a beleaguered Fed.

It may or may not happen, but investors who ignore the possibility could be in for a shock. I do not consider the likelihood of such an event, or the reaction of the Fed or the government, to be altered in any significant way regardless of November election results. (also see: Default – Deflation – Depression)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Investors Are Forever Blowing Bubbles

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INVESTORS BLOW BIGGER BUBBLES 

(source)

“Blowing soap bubbles is child’s (investor’s?) play, but surprisingly, physicists (economists?) haven’t worked out the details of the phenomenon.” (source)

After all-time closing highs in both the Nasdaq and S&P 500 yesterday, investors drove both indexes higher again today following the release of the latest CPI number and the Fed’s decision to leave their target Fed funds rate unchanged for now. The bond market followed suit with bond prices increasing and the 10-year yield dropping to its lowest level in more than two months.

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Stocks, Bitcoin, Gold – How Much Are They Worth?

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STOCKS – BITCOIN – GOLD 

Stock prices, according to the S&P 500, are up seventy percent from their lows last April. The Nasdaq Composite at its most recent high point was up even more, sporting a ninety-five percent increase from its nadir. A number of individual stocks have done even better.

For the entire year 2020, however, stocks were up a more modest sixteen percent (S&P 500) and only seven percent for the Dow Jones Industrial Average.

However, the outsized performance of the Nasdaq was even more apparent on a full calendar year basis. For 2020 the Nasdaq was up forty-three percent. Relative to its peers, the average Nasdaq stock was up more than three to four times as much as non-Nasdaq stocks.

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