Fed Signals Great Depression Playbook

SPY - The Final Pump

By: FMW

Date:5/18/20

The Fed has done the exact opposite of what it should have done (for years). The Fed placed an option on the American people knowing it would be worth-less because of the decades of Quantitative Easing. Now, we have an unprecedented market. The gap between economic fundamentals and the stock market is the widest in history. The only reason the market has surged is because the Private Fed pumped in ten of trillions of dollars.

The Fed is using the Great Depression Playbook


The Great Depression of 2020?

The unemployment rate went from under 4 percent in 1929 to 25 percent in 1933. Real GNP did not recover to its 1929 level until 1937. The unemployment rate did not fall below 10 percent until World War II.

Few segments of the economy were unscathed. Personal and firm bankruptcies rose to unprecedented highs. In 1932 and 1933, aggregate corporate profits in the United States were negative. Some 9,000 banks, with $6.8 billion of deposits, failed between 1930 and 1933. Since some suspended banks eventually reopened and deposits were recovered , these figures overstate the extent of the banking distress.5 Nevertheless, bank failures were numerous and their effects severe, even compared with the 1920s, when failures were high by modern standards. Much of the debate about the causes of the Great Depression has focused on bank failures.

At the other extreme, proponents of “liquidationist” theories of the cycle argued that excessively easy monetary policy in the 1920s had contributed to the Depression, and that “artificial” easing in response to it was a mistake. Liquidationists thought that overproduction and excessive borrowing cause resource misallocation, and that depressions are the inescapable and necessary means of correction: In the course of a boom many bad business commitments are undertaken. Debts are incurred which it is impossible to repay. Stocks are produced and accumulated which it is impossible to sell at a profit. Loans are made which it is impossible to recover. Both in the sphere of finance and in the sphere of production, when the boom breaks, these bad commitments are revealed. Now in order that revival may commence again, it is essential that these positions should be liquidated.

One implication of the liquidationist theory is that increasing the money supply during a recession is likely to be counterproductive. During a minor recession in 1927, for example, the Fed had made substantial open market purchases and reduced its discount rate. Adolph Miller, a member of the Federal Reserve Board, who agreed with the liquidationist view, testified in 1931 that:

It was the greatest and boldest operation ever undertaken by the Federal Reserve System, and, in my judgment, resulted in one of the most costly errors committed by it or any banking system in the last 75 years. I am inclined to think that a different policy at that time would have left us with a different condition at this time. . . . That was a time of business recession. Business could not use and was not asking for increased money at that time.8 In Miller’s view, because economic activity was low, the reserves created by the Fed’s actions fueled stock market speculation, which led inevitably to the crash and subsequent depression

During the Depression, proponents of the liquidationist view argued against increasing the money supply since doing so might reignite speculation without promoting an increase in real output. Indeed, many argued that the Federal Reserve had interfered with recovery and prolonged the Depression by pursuing a policy of monetary ease. Hayek (1932), for example, wrote: It is a fact that the present crisis is marked by the first attempt on a large scale to revive the economy. . . by a systematic policy of lowering the interest rate accompanied by all other possible measures for preventing the normal process of liquidation, and that as a result the depression has assumed more devastating forms and lasted longer than ever before.

Several key Fed officials shared Hayek’s views. For example, the minutes of the June 23, 1930, meeting of the Open Market Committee report the views of George Norris, Governor of the Federal Reserve Bank of Philadelphia: He indicated that in his view the current business and price recession was to be ascribed largely to overproduction and excess productive capacity in a number of lines of business rather than to financial causes, and it was his belief that easier money and a better bond market would not help the situation but on the contrary might lead to further increases in productive capacity and further overproduction.

Excessively easy monetary policy during recessions in 1924 and 1927. They argued that the Fed’s actions had promoted stock market speculation and led inevitably to the crash and Depression.

How long have we had ‘easy money’? Why couldn’t the Fed raise interest rates?

Extreme Caution is warranted here.

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