The Fed’s Worst Nightmare
In 1802 Thomas Jefferson said “I believe that banking institutions are more dangerous to our liberties than standing armies…
“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property — until their children wake up homeless on the continent their fathers conquered.”
Central banks all over the world are fighting deflation by printing trillions of dollars. Deflation is harder to fight than inflation. The central banks are printing money to prevent the stock market and economy from crashing. This is why the crisis we are in today is the most dangerous in world history.
The middle-class millionaires-next-door have enjoyed the boom caused by inflation over the last decade. What are they going to do if the market deflates? What happens if their home prices, stock prices plummet?
Theory of Great Depressions
In October 1933, the great American economist Irving Fisher published an article in Econometrica entitled “The Debt-Deflation Theory of Great Depressions.” It explains why the global economy is at risk of collapsing into a new great depression today. Once the dynamics of the debt-deflation spiral are understood, then it is easy to see why government policymakers have enacted the policies that they have to prevent that from occurring.
We are teetering on the edge of a deflation death spiral of the kind detailed by Fisher. The only reason we have not spiraled down into a new great depression already is that the governments around the world keep creating more credit to replace the credit that is destroyed when the private sector defaults on its debt.
This has been going on since 2008 when the great financial crisis began. Whenever the debt-deflation dynamics begin to gain momentum, the governments take some reflationary action that checks and temporarily reverses that momentum. Programs like TARP and quantitative easing and trillions of dollars of government budget deficits around the world are all examples of such government action.
Think of the global economy as if it were a big rubber raft that has been inflated with credit instead of air. Floating on top of the raft are all the stocks, commodities (including gold), and the world’s seven billion people.
But the raft is defective. It’s full of holes on all sides and the credit keeps leaking out as it gets destroyed by defaults. For years now the raft’s natural tendency has therefore been to sink — just as the global economy sank during the 1930s.
And every time it begins to go under, global policymakers have reflated it by injecting more new credit into it.
The Fed’s Worst Nightmare
When the stock market began to fall in March of 2000, the Federal Reserve lowered interest rates. One reaction to falling stock prices and interest rates was a rise in real estate prices. Not only did lower interest rates encourage people to move into real estate, but lower interest rates also punished savers. By lowering interest rates, the government was sending a signal to savers to get their money out of the bank and into the marketplace.
In November 2002, (then) Fed Governor Ben Bernanke made the most important speech of his life. It was called “Deflation: Making Sure It Doesn’t Happen Here.” In that speech he said, “I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States…”; and he outlined the “means” he had in mind.
First, the Fed would cut short-term interest rates (the Federal Funds Rate) to zero. And, if that didn’t do the trick, it would print money and buy long-dated bonds issued by the government and by Fannie Mae and Freddie Mac, to push down long-term interest rates, too.
The question is: What happens when interest rates go back up if they go back up?
In the late 1970s and into the 1980s as gold, silver, and oil prices rose, interest rates went over 20% before coming down again. Will that happen again? Only time will tell. If after years of a low-interest-rate environment, the pendulum swings the other way and interest rates begin climbing again, stand by for massive changes in the economy.
One of the greatest losses to Americans has been the loss of the value of their money. That is why it is important to pay attention to inflation, interest rates, the price of gold, and government debt.
Where I’m Investing
What concerns me is that all booms bust, and since the world’s economy now floats on the U.S. dollar, which has been declining in value, who knows how big the next bust will be. This is why I’m hanging on to my gold, silver, and Bitcoin.
In the very near future, there will be either hyperinflation or hyper-deflation if the Fed doesn’t get its financial house in order. Either way, the results will be tragic for the unprepared and uneducated.
Since I don’t know which way it will go, have strategies that can handle either situation. I say that I have my “fake money” (the dollar) invested in real money (gold, silver, Bitcoin.)
Play it smart,
Editor, Rich Dad Poor Dad Daily