In Part I of my little “history of the US markets in four reads,” we looked broadly at a template of mistakes which began with the Great Depression and continue to the present.
The template/premise we opened with was simple: i) all market bubbles are born from easy credit/debt and the “hot” money that follows; ii) euphoric speculation (and leverage) comes next, as do inflated assets classes; iii) eventually a “trigger” pops the euphoria and a crash ensues; iv) thereafter, policy makers look for quick rather than sober solutions and the cycle continues anew…
As we move forward today, we sadly discover that history and current events confirm that very few straight-talkers emerge from banks or political office to apply unpopular reigns on dangerous levels of easy money or mountains of debt—including the Everest-like mountain the US markets stand before today.
Instead, the majority of our “elites” (elected or nominated) want the bubble party (served by a punch bowl of easy FED-made dollars and low rates) to go on forever. But as any party-animal/college graduate knows, a never-ending binge is neither realistic nor healthy. To believe otherwise is a kind of delusion.
Restraint & Humility?
Free markets demand periods of restraint and humility so that lessons can be learned from the hangovers of too much debt and diluted currencies. Yet somehow in the drunken course of events since the days of Adam Smith, policy makers, hedge fund managers, Fed chairs, Wall Street elites, and Main Street dreamers seem unwilling to exercise these two key components of market wisdom: restraint and humility.
Eventually, however, market events force heavy doses of both.
When it comes to lacking restraint and humility, Richard Nixon serves as the second logical turning point. In 1971, he was staring down the barrel of an economy on the brink of bad news. The gold standard, revived by the restraint and humility of the Post World War II Bretton Woods Accord, meant the dollar was once again tied to a restraining asset upon which global markets and trade partners relied.
Nixon didn’t like this.
In short, the Gold-standard was to Nixon what a chaperone is to a frat party: a real bummer.
Tricky Dick was in a pickle. Other nations trusted our gold-backed Dollar and were thus buying lots of gold-exchangeable dollars. Unfortunately, the US gold reserves were woefully low compared to the number of dollars in circulation. To honestly and correctly rectify this imbalance, an heroic Nixon would have had to initiate a painful yet necessary recalibration of gold to the dollar, which would have meant short-term pain at home, and hence election-time risk for him.
But Nixon was no hero…
Given the choice between doing the right or wrong thing, he, alas, did what almost all elected officials do, namely: what was best for him. In a move similar to FDR in the 30’s, he jettisoned the Bretton Woods gold exchange standard and thus once again welched on US dollar holders and currency-honest trade partners overseas.
With the currency untied to any standards, reigns or “chaperones,” Nixon was thus free to once again devalue the dollar and lower rates to encourage short-term economic activity to boost his pre-Watergate election chances. He won by a landslide.
This “stimulus” mentality (repeated to this day by current policy makers) was tantamount to doping the economy for a quick fix at the expense of inevitable inflation (remember the late 70’s?). Nixon’s policies once again strengthened the template for a now trend-setting perversion of the role of central banking via a familiar pattern of: 1) removing the dollar from a gold standard, 2) lowering rates to encourage short-term speculation which 3) ends in unnaturally large market bubbles and corrections.
This pattern of myopia and political narcissism also perverted the natural sticks and carrots needed to keep free markets free. Instead, and from 1971 forward, markets were to be manipulated by a visible policy of stimulus as opposed to the invisible hands of supply and demand.
Nixon’s 1971 decisions also set the stage for a global perversion of currency exchanges, which haunt markets to this day. By removing gold from the global currency models, we now face the problem attendant to all floating currencies, namely the fact that free markets no longer set exchange rates, national policy makers do, and they do so selfishly—again: Realpolitik.
The US is a poster-child of such economic Realpolitik, meaning it is able to export and monetize its deficits (i.e. other nations are forced to import its inflated/devalued dollars) and thus spread and encourage reactive inflationary policies overseas. US bubble policies have therefore spawned global bubble policies.
Today, international “my-nation-first” currency markets are the scene of state sponsored manipulations where central banks (from the ECB, to the Bank of Japan and the Chinese star chamber) can buy their own sovereign debt pegged to thin air rather than an actual asset (i.e. gold) as part of ongoing trade battles to beggar-thy-neighbor via currency wars.
Without this gold backing, currencies have no discipline. Today, in France, I paid 5 Euros for a Starbucks coffee… Our dollar ain’t even as strong as a broke(n) Euro…
Profiles in Courage—Truman, Eisenhower, Martin and Volker
Despite the examples of Nixon, FDR and a handful short-sighted Fed Chairmen/woman I like to beat up on, there have been moments where economic policy makers put national interests ahead of self-interest, and showed restraint where others sought politically beneficial quick fixes.
JFK’s famous work, Profiles in Courage, celebrated statesman who personified such courage. The policies of Presidents Eisenhower and Truman, for example, as well as Fed Chairmen William Martin and Paul Volker are worth highlighting here
Truman, for example, fought the Korean War the old fashioned and honest way, that is, by raising taxes rather than debt levels. His successor, Dwight Eisenhower, was a warrior who bravely fought to balance the US budget by addressing excess military costs. Despite two unpopular recessions under his watch, Ike refused to cut taxes until the US budget was balanced, thus risking popularity and votes for the sake of the larger good.
Boy…policies like that seem almost a fantasy in today’s backdrop of campaign promises paid for by more debt, more military and more can-kicking…
Ike wanted small government, and understood that tax cuts can only be earned through spending control. Federal spending under his administration was an exemplar study of humility and restraint.
Again, we’ve seen no examples (red or blue) of this Presidential wisdom since.
In fact, Eisenhower was the last president to see inflation-adjusted spending shrink rather than grow while in office. The Kennedy-Johnson period, for example, saw a budget increase of 50%, the Reagan era a 22% increase, and the G.W. Bush White House lead a 53% increase in spending while in office. The subsequent and current regimes were/are no better…
Once Upon a Time: A Smart Fed
Federal Reserve Chairmen William Martin and Paul Volker deserve equal note for exercising unpopular courage by standing up to bull-market temptations. In 1958, Martin took away Wall Street’s “easy money” punchbowl as soon as he saw that the economic recovery had morphed into greedy speculation.
Paul Volker, faced with rising inflation (nod to Nixon’s legacy) in the late 70’s, showed similar courage when sternly and swiftly raising interest rates and putting tight reigns on an economy “gone rodeo” from too many years of Nixon’s easy money.
Comparing Fed Chairmen like Volker and Martin to the contrasting policies of low-rate setting Bernanke, Greenspan and Yellen, is indeed a comparison of black to white, apples to oranges. The latter, who share an unusual subservience to Wall Street needs rather than national productivity and discipline, have shown little profiles of courage in the midst of bull runs to pursue unpopular yet necessary monetary policies.
Instead, rather than take away the “punch bowel,” the contemporary crop of Central Bank leadership has only added more moonshine each time Wall Street has so much as a toothache. The result has been the creation not only of an ethical moral hazard in the towers of Wall Street, but the perpetuation of ever-increasing asset bubbles with ever-increasing degrees of pain when they implode.
In Parts III and IV of this blog series, as we look at a series of market cycles/bubbles lead by less-than-courageous monetary policies, this theme will acquire greater clarity.
For now, I’ll leave with an event some of us may not even remember (I was in High School then), but which matters as a lesson in the familiar…
Black Monday, October 19, 1987. In even that pre-CDS and CDO uber-leverage world, markets in the late 80’s once again reminded us that any significant degree of easy credit and leverage (by then computerized) leads to equal amounts of pain, which can come, seemingly, out of nowhere.
The spark which set off the crash of 87 was the ironic fear/rumor that the new Fed Sheriff in town (Alan Greenspan) might put an end to the Wall Street party by raising rates in a “Volker 2” scenario. And so in a single day, the stock index dropped 23%–double the 13% declines on the worst day of the 29 Crash. This accounted for $500B in paper losses (a lot of money then) based on banks using more and more leverage to assume counter-party risk on increasingly inflated assets.
But even more astounding than this Black Monday was the Lazarus-like resurrection of the market buy orders on the Tuesday to follow. By 12:30 PM the next day, the market saw massive buy orders that in a miraculous swoop stopped the panic. The Greenspan Fed was clearly no “Volker 2” and came to the rescue of wayward markets.
In short, Greenspan was the Chaperone who brought beer kegs rather than curfews to the Frat House…
In doing so, policy makers once again distorted the invisible (and often painful) hands of the free market. Rather than allow painful corrections (i.e. natural market hangover) to teach investors a lesson about derivatives, leverage and other mines dotting the S&P futures pits (which dropped by 29% in a single day) and larger markets, the Fed once again came in with buckets of money and thus destroyed any chance for the cleansing tough love of natural markets.
This, once again, created the moral hazard of letting investors behave like the spoiled nephews of a rich uncle: spending with impunity until the next crisis, as there’s always Uncle Fed to bail you out—at least until that uncle is himself insolvent (which, ironically, and unknown to most, is where we are heading today—nod to yet another debt ceiling this fall…)
In Part III, we’ll see how this spoiled market behavior later revealed itself in a cancerous derivatives market, the time bomb at Long Term Capital Management, the dot.com mania/bubble of the late 90’s, irrational M&A deals, LBO’s, hedge fund DUI’s, real estate bubbles and the pre-amble to the crisis of 2008.
August 16 2017