Maybe They're Doing It on Purpose

Waiting for the 'FOMC' drop... We're all at the racetrack now... It's not supposed to be like this... What the guy who invented 'QE' thinks... Maybe they're doing it on purpose... Shades of Japan... Why the Fed might be doing this...

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I hate that I had to wait until some bureaucrat spoke before attempting to write today's Digest...

But that is the world we live in... or at least the market we trade and invest in.

Of course the bureaucrat I (Dan Ferris) am talking about is Jerome Powell, chairman of the Federal Reserve, our central bank – created by and for bankers in 1913.

The Fed's Federal Open Market Committee ("FOMC") met Tuesday and Wednesday of this week. It released the statement of its latest policy decision on Wednesday at 2 p.m. Eastern time. The statement said it had decided to raise the federal-funds target rate by 25 basis points, to a range of 4.75% to 5%.

Powell then held the usual post-FOMC meeting press conference starting at 2:30 p.m.

Why did I have to wait until then to start writing today's essay?

Because you never know what'll happen in the market once the FOMC statement drops and Powell starts jawboning. Just look at how the stock market went nuts starting around 2 p.m. Wednesday...

The S&P 500 Index accounts for roughly 80% of all U.S. stock market capitalization. I still think the Fed doesn't control markets... but I can't ignore how it seems to have us all by the neck.

We all sit around trying to figure out what it will do next...

So we can bet accordingly...

And I do mean bet.

We're all like a teeming throng of half-drunk bettors, leaning over the rail at the racetrack, spilling our beer, and screaming for that damn horse to run already.

I include myself in the group. With a small enough sum not to matter much in the grand scheme of things, I bought put options on one of the big stock index exchange-traded funds on Tuesday, the day before the big announcement. So I was feeling pretty good about myself by the end of Wednesday.

But when I do this, I'm just like every other idiot betting on the Fed's horse race. There are thousands of publicly traded "horses" in the U.S., but the big indexes really narrow it down to four: the S&P 500, the Nasdaq Composite Index, the Dow Jones Industrial Average, and the Russell 2000 Index.

The last one is the weakest filly in the field for the past month or so, and the Nasdaq is the strongest. The small cap Russell 2000 is weak because it's about 17% financial stocks. The recent bank failures have spooked small-cap investors so much the Russell 2000 is getting hammered.

Meanwhile, the tech-heavy Nasdaq is the outperformer in the group.

Yet all of the indexes gyrated Wednesday after the Fed's latest policy moves and Powell's press conference...

It irks the hell out of me that bureaucratic central planners' edicts are so important to folks who are ostensibly investing in – or just betting on – private businesses in a supposedly market-based economy.

It's not supposed to be like this...

We're supposed to be 100% responsible for the money we put at risk, based on our assessment of a business's prospects. We're not supposed to be sitting around gambling on whether a bureaucrat will throw us a bone.

How the hell did it get this way? How did a central bank allegedly created as a lender of last resort achieve a dominant place in markets?

I don't really know, but that has never stopped me from trying...

But before I tell you what I found out this week... let's just clear up one thing: I'm not saying the Fed controls markets. It's clear that markets control the Fed. The Fed's delusion that it has any type of control over a $26 trillion market economy is a huge part of its problem.

I started out trying to figure out how things got this way. But all I wound up doing was finding a story that underscores what I've said before: Central banks should not exist and can never hope to accomplish any of the pleasant-sounding goals they purport to be chasing. They will always be fundamentally in the business of increasing the suffering of most of the folks who live in the countries where they operate.

I began this week by wondering about how central banks became so powerful...

I figured if anybody knew the answer to that question, it would be Richard Werner, who invented quantitative easing ("QE"), perhaps the single most famous policy in central banking of the past three decades. He's a German economist who studied and worked in Japan for years and now teaches at the University of Winchester in England.

Werner proposed QE in a 1995 article called "How to Create a Recovery Through 'Quantitative Monetary Easing,'" with respect to the Japanese economy. At the time, Japan was in the midst of a period of stagnation that would be known as the Lost Decade which ended up lasting two or three decades, depending on who you ask. Werner explained the catalyst for QE in a Fortune article earlier this week. He said...

The core of the idea was increasing Japan's total transactions in the economy by increasing the supply of money for the nation's "real economy". This could be achieved by encouraging retail banks to issue more loans to companies for investment, thus stimulating economic recovery.

Werner distinguished the "real economy" from stock market and real estate transactions that only shuffled assets back and forth without creating new wealth. He didn't want the central banks printing money to buy financial assets. He wanted them to stimulate real economic activity by encouraging lending to real businesses creating new wealth and productivity enhancements.

Of course, QE mostly hasn't been used as Werner conceived it...

It has mostly been used by central banks to buy bonds and beef up bank reserves... which hasn't worked anywhere it has been tried. Not Japan... not Europe... not the U.S. All it has done is inflate massive bubbles in stocks and bonds, including the biggest mega-bubble that has ever occurred in all of recorded history... which is bursting right now and whose pain I'm afraid we've only just begun to feel.

I watched about two-thirds of the film version of Werner's landmark 2003 book, Princes of the Yen: Japan's Central Bankers and the Transformation of the Economy, which is a must-read for every macro-aware investor on the planet.

I didn't finish watching it because I kept rewinding back to one spot in the film. I couldn't believe what I was hearing, so I wanted to make sure I understood it...

It requires a bit of background first...

In the 1980s, global governments enacted economic reforms that freed up the movement of capital around the world.

Remember, this was after the Bretton Woods system that pegged the dollar's value to gold had already collapsed. There was an international debt crisis (in 1982), and the International Monetary Fund ("IMF") took on an increased importance in global finance and lending...

Folks in Japan noticed and wanted to encourage free-flowing capital, too. Former Bank of Japan ("BoJ") Governor Tadashi Sasaki created a five-year plan designed to transform Japan's economy from the highly bureaucratic, cartel-ridden post-war system to a modern, U.S. capitalistic style.

Japan's Ministry of Finance had run the economy since the end of World War II. So it didn't like Sasaki's plan. But the idea gained traction among Japanese central bankers.

In 1986, the prime minister's Advisory Group on Economic Restructuring, headed by another former BoJ governor, Haruo Maekawa, proposed a 10-year plan intended to raise Japanese living standards to those enjoyed in the West. His proposal said...

The time has now come for Japan to make a historical transformation in its traditional policies on economic management and the nation's lifestyle. There can be no further development for Japan without this transformation.

Maekawa proposed radical changes to the entire Japanese system: economically, politically, and socially – its way of life...

As we explored in a recent Digest, humans don't like change...

And we really dislike especially massive transformations that affect every aspect of life. So the plan to overhaul the Japanese economy and everything else was heavily criticized in the press.

One problem was that the report only said what Maekawa and his advisory group wanted to do, but it didn't say how to do it... except for one key sentence...

In the implementation of these recommendations, fiscal and monetary policy have a significant part to play.

That doesn't tell you much, except that Maekawa knew the government and the central bank would have a "significant part" in changing millions of Japanese lives.

When you get to this part in the film, you might start to feel like something sinister might be brewing...

And you'd be right...

In a segment from an appearance on Japanese television, Werner describes how the Japanese Ministry of Finance ran the post-war economy, with its bureaucracies, powerful politicians, and cartels. He then ponders how that system might be changed and concludes...

History teaches that the system changes only fundamentally if there's a crisis.

The narrator of the film continues...

The commission proposed that monetary policy should be used to promote a historic crisis sufficiently large to overcome the vested interests of the Ministry of Finance, politicians, and corporate Japan.

Every system has groups that benefit from it, and hence have no desire to change it. There is probably no country in the world that has changed its economic, social, and political system in a significant way without a crisis. It is the crisis that convinces citizens and interest groups of the need for change.

Back to Werner, this time in another TV appearance...

Well then, how can you achieve this? Well, you need a crisis. And the best way to create it is to have a bubble because that's how nobody stops you.

Here's what happened next...

The BoJ ramped up credit to banks. Folks used the money to buy real estate and play the stock market, leading to massive increases and a huge bubble in the price of real estate and stocks.

Japanese stocks rose 240% from January 1985 to December 1989 and real estate prices rose 245% during the same period. The garden surrounding the Imperial Palace in Tokyo was valued higher than the entire state of California. Though the U.S. is roughly 26 times the size of Japan, Japan's land value was four times higher.

Now you know why I call this period in Japanese history a "mega bubble."

The film, Princes of the Yen, is one hour and 32 minutes long... And everything I just shared with you happens before the 26-minute mark. I watched it past that point but kept coming back to the part I just described to make sure that I understood what I'd heard...

The Bank of Japan engineered the massive financial mega bubble knowing it would lead to an economic crisis that would rock the fabric of Japanese society like the earthquakes that have rocked its islands for eons.

They did it on purpose.

I can't get it out of my head.

It sounds like tinfoil-hat conspiracy stuff. But that's what happened...

The bubble eventually burst, starting in 1989, shortly after the BoJ stopped increasing its money supply and started hiking interest rates from 2.5% to 6% to cool the real estate market...

That helped put an end to rising land prices, but also sent Japan into a horrible recession which lasted decades. The stock market cratered, then went sideways, and it hasn't yet returned to its 1989 bubble peak – 33 years later.

And though the BoJ gained legal independence in 1998, it didn't matter. The country still hasn't recovered from the blunder the BoJ created. It tried QE, but it had no effect... until recently, when it seems to have done exactly what it did in the U.S. – push inflation to multi-year highs.

The BoJ's manufactured crisis went horribly wrong and led to a multi-decade economic downturn. It shows without a doubt that power corrupts and absolute power corrupts absolutely... and it also shows that central banks don't control markets and economies.

Beyond a few basic legitimate functions, governments break everything they touch. I doubt central banks have a legitimate function, so it's no surprise that they're just giant economic wrecking balls.

Either way, they're not meant to be some enormous central power. They're supposed to do their one job and leave us alone the rest of the time.

Central planning never works out as expected... There's just no way to manage a massive economy with tens of millions or more people in it. Markets and economies aren't created by human beings. They're not even managed by human beings.

They simply happen to human beings. And they benefit us and create prosperity only to the extent that we stay out of their way and let them do the mysterious, wonderful thing that only they can do.

So what the hell is our own central bank doing?

It's hiking interest rates to do what?

To create a crisis.

You can't listen to what Powell has been saying since last year and conclude that the Fed is doing anything other than what the BoJ did in the late 1980s.

Powell is creating a crisis on purpose, alleging that it's best for everyone. Tell me he didn't admit it when he said this at a symposium in Jackson Hole, Wyoming on August 26, 2022...

Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

Below-trend growth... softening of labor market conditions... pain to households and business. And I promise you, there is more pain to come.

Everybody knows by now that central bank policy actions don't affect the economy until months after the Fed executes them. The Fed started its most aggressive rate-hiking cycle since 1980 one year ago. One year later, Treasury bonds have had the worst performance of their entire history, and banks are failing.

Why would the Fed do this?

Why would it inflate a huge bubble, start hiking rates to make it burst, purposely downplay the role of inflation for too long, then tell everyone that they'll keep hiking rates until they cause enough pain?

I have an idea what the answer might be, which Werner also mentioned in his Fortune article... central bank digital currencies ("CBDCs").

We've been moving money around digitally for some time. But not central bank digital money.

In his Fortune article, Werner notes the connection between the pandemic lockdowns and heightened urgency about CBDCs among central bankers...

At the same time as the UK government imposed the first lockdown in March 2020, the Bank of England (BoE) issued its first major discussion paper (and held a first public seminar) about its perceived need to introduce a central bank digital currency. (It is noticeable how many central banks seemed spurred on in their plans for digital currencies by the COVID digital vaccination passport concepts that were advanced during the pandemic.)

CBDC would be centralized, trackable digital money. The central bank would have absolute control over the use of its CBDC. Such control could be used to force myriad Draconian schemes on us. Werner discussed the implications...

Critics of a central bank might suddenly find they are not allowed to pay for anything any longer... the way that protesting Canadian truckers were frozen out of their funds by the Canadian government in February 2022.

Additionally, central planners could theoretically restrict purchases to a limited geographical area, or to only the "right" items in the eyes of the authorities, or only in limited amounts – for example, until you have used up your "carbon credit" budget. The much discussed idea of a "universal basic income" could serve as the carrot for people to accept a central electronic currency that could enact a Chinese-style social credit system and even, in the future, exist in the form of an electronic implant.

In contrast, no such control is possible with old-fashioned cash – now recognised by many as a beacon of freedom.

Even if you don't buy the conspiracy angle, you can't deny what former President Barack Obama's adviser Rahm Emanuel once said...

'Never let a crisis go to waste'...

Power-mongers love to use crises to gain more power...

That's why the Founding Fathers famously warned us about the danger of giving up too much liberty in exchange for the illusion of greater security.

We ignored those warnings during the totally unnecessary and highly destructive pandemic lockdowns. In doing so, we taught power mongers everywhere that we're ripe for the plucking and that all they need to do is scare us enough and we'll fold up like lawn furniture at a sumo wrestlers' cookout.

Now, let's consider the alternative... Maybe the Fed isn't part of a conspiracy to force trackable, centralized digital money on us.

So maybe they're creating a crisis as a knee-jerk reaction to inflation, but whether it's a true tinfoil-hat wearer's worst nightmare or mere misguidedness... they're still creating a crisis on purpose... And crises are always followed by more clamoring for governments to do something... and that always means less liberty for you and me.

I don't know that I'll stay in this rabbit hole long enough to think about all the implications of that. But after reading Werner's article, I am now sitting here thinking maybe I should do more business in cash.

New 52-week highs (as of 3/23/23): Aehr Test Systems (AEHR), SPDR Bloomberg 1-3 Month T-Bill Fund (BIL), SPDR Gold Shares (GLD), inTEST (INTT), Novo Nordisk (NVO), iShares 0-3 Month Treasury Bond Fund (SGOV), and Torex Gold Resources (TORXF).

In today's mailbag, a different thought on what led to the bank crisis... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"You can look at say the Fed's policies, but I look at something else, which is the COVID shutdown. I don't know the facts for the U.S., but one of the British tabloids said that for each day of shutdown, the U.K. economy missed out on £500 million of transactions, which at today's exchange rate is $612 million.

"The U.K.'s population is some 60 million, the US is about 6x, so proportionately that would be $3.6 billion a day...

"That missing money will percolate around the economy. Most businesses were completely shuttered up, so those with loans and no liquid assets, to my comprehension, would transmute into a lot of loan defaults much further down the road...

"Where do loans occur? At banks! So guess what? The economy strangled for months and months via some COVID hysteria, and then banks suffocating months later, I WONDER WHY!

"If they guarantee deposits, that essentially is money printing, and for the U.K. they would have to basically print 500m PER DAY for however many months it was the country was shut down for in order to bridge the gap, and even then they would just be bridging the money, not the missing work!" – Anonymous paid-up subscriber

Good investing,

Dan Ferris
Eagle Point, Oregon
March 24, 2023