Surviving the Age of Turbulence
Today's comment is by John Pugsley, our Chairman, and one of the original founders of The Sovereign Society.
Dear A-Letter Reader,
For those who've been playing in the fields of finance over the past 30 years, Alan Greenspan's newly-released book, The Age of Turbulence, is a memoir of captivating intensity. It is also a reminder that the current sub-prime mortgage troubles are just surface symptoms of profound stress in the world financial system.
The stress is evident. Last week, just as the stress was threatening to start a domino effect in the financial markets, Mr. Bernanke came to the rescue by cutting the Fed Funds rate half a percentage point. The Fed subsequently injected another US$9.75 billion into banking-system reserves two days ago through two-day repurchase agreements. There is also an expectation of even further cuts.
The Fed's action was expected and the market response was euphoric. It has happened so consistently that most investors conclude that the Fed's loyalty is to the stock market, and that it will always be ready with a safety net if Wall Street gets in trouble. After all, didn't the central bank bail out investors in the wake of the October 1987 crash, then again after the dot-com bubble burst in 2000?
Well, yes it did. However, as Martin Wolf of London's Financial Times put it, "...saving Wall Street from its follies is not the Fed's objective. It is an (unfortunate) by-product of the attempt to do its job."
What's the Fed's Job Really?
Those who gamble and lose should be the ones punished for their folly, so they shouldn't be saved at the expense of either taxpayers or dollar holders.
According to the finger-pointing politicians, the real culprits in this cycle are the sub-prime lenders that duped innocent home buyers into taking on mortgages that could only be paid off if real estate prices continued their relentless rise. The innocent public shouldn't have to suffer a depression because of a few greedy lenders.
In order to keep the broad economy from being sucked down the vortex of an uncontrollable collapse, most observers, including Wolf, believe the Fed must come to the rescue. The common opinion is the Fed should always bail everyone out even if the speculators who caused the problem escape their well-deserved fate. Rescuing Wall Street is merely an unfortunate by-product when the Fed attempts to do its job.
What is the Fed's job? Beneath its image as a "savior," every central bank's real mission is not to save the world. It's to keep the banking system solvent and prosperous.
The Federal Reserve System is owned by its member banks, and controlled by those same bankers. Bankers borrow money from depositors and lend to borrowers. When borrowers default, banks can't repay depositors, and the banks are threatened.
Just this past week, Northern Rock, Britain's fifth-biggest mortgage lender, ran into trouble because of the current credit squeeze. This trouble ignited a panic that led to thousands of customers lining up to withdraw their deposits. Of course, the Bank of England rode to the rescue with an infusion of freshly printed cash.
What Came First? Credit or Central Banks?
It's an oft-repeated story. "The late 1980s was [the banks] worst period since the Depression; hundreds of small and medium-size banks failed," writes Greenspan, "and giants like Citibank and Chase Manhattan were in distress. Their problem, as with the S&Ls, was too much speculative lending: in the early eighties, the major banks had gambled on Latin American debt, and then, as those loans went bad, like amateur gamblers trying to get square, they'd bet even more by leading the whole industry into a binge of commercial real estate lending." [Emphasis added.]
Once again, speculative lending spawns the crisis, and once again the central bank rides to the rescue. But should central bankers be applauded? In truth, without the continued expansion of bank reserves by these central bankers, credit would never have been available to the speculators in the first place.
The Age of Turbulence provides a gripping exposé of the inner workings of the Fed, and it should be a wake-up call for all of us.
Greenspan clearly shows just how close the world came to economic collapse over each of the past crises. He outlines the stock market crash of October 1987 that came within a whisker's width of bringing on a depression equal to the 1930s. He details the narrow escape during the S&L industry collapse just a few years later, and then again after the Russian default that led to the demise of Long-Term Capital Management in 1998. In all cases, the world was closer to the cliff than we (outside the inner sanctum of the central banks) ever realized.
What Will Happen Next?
What of the future? The current real estate bubble is far from deflated. The sea of fiat currency sloshing around the world has not come to rest. Just as the easing by the Fed after the East Asian and Russian crises of 1997 and 1998 fueled the subsequent stock market bubble, pouring more fiat money into the banks to solve the sub-prime mess has already fueled the next one.
Will Mr. Bernanke and his central bank counterparts be lucky enough to successfully resolve the next crisis by another infusion of dollars? Don't bet your future on it.
Each time a recession is averted by money creation, the nightmare of price inflation comes closer. Those risks may seem small at the moment, but the bankers' own survival instincts cause them to ultimately choose inflation over depression and a banking system collapse.
As Greenspan notes, "...containing inflation through higher interest rates will be as unpopular in the future as it was when Paul Volker did it more than twenty-five years ago. ...to keep the inflation rate down to a gold standard level ...the Fed would have to constrain monetary expansion so drastically that it could temporarily drive up interest rates into the double-digit range not seen since the days of Paul Volker."
And many around the world know this. While the stock market rebounded after the current cash infusion, the U.S. dollar continued its slide against other currencies, and gold, the ultimate inflation hedge, climbed steadily. Many dollar holders see the future - the dollar is no longer the safe haven it once appeared to be. It will fall much further against both stronger currencies and against gold.
JOHN PUGSLEY, CHAIRMAN
P.S. The central goal of The Sovereign Society is to help you achieve individual sovereignty over yourself and your assets even while living in a world of fiat currencies. Click here for a good place to start. Along with Jack Crooks, editor of World Currency Options, I will be at the 34th annual New Orleans Investment Conference, to be held October 21-25 at the New Orleans Marriott Hotel. Called “the greatest investment show on earth” by Money Magazine, the New Orleans Conference the ultimate source of information on how to survive and prosper in the turbulent times ahead. For information and registration, call 800-648-8411 or click here.
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