Background to this 5 part series.

I find it remarkable that Jerome Powell’s Federal Reserve (Fed) can ignore asset inflation to the extent it has.

Not my job! Let’s just focus on keeping interest rates low and overshooting inflation (even though we haven’t met the 2% target yet). Yup, that’ll get us through.

Welcome to the 2020 Fed. Oh, and by the way, the Fed says there is no asset bubble.

In contrast, the Fed of 1929 was a hugely different and multi-faceted animal. Not only was it a decentralised decision making system, it’s collective of divergent thinking reserve banks did eventually agree that the speculative use of credit in the money/securities markets was something that needed to be stopped. But by 1929 it was too late.

After 6 years of roaring growth and low interest rates, the accommodative (dovish) Fed turned contractionary (hawkish) and doubled interest rates from 3% in 1928 to 6% in 1929. It was this ‘too much, too late’ attempt to cool down the speculative use of credit that backfired and helped to precipitate the Great Depression.

We will see in later installments that it is a fear of not repeating this that caused Ben Bernanke in 2008, and Jerome Powell in 2020, to throw reality under the train and manipulate down interest rates with unlimited levels of bond buying (QE Infinity) - in order to give real economy demand enough breathing space to recover.

And, if in the meantime an issuer defaults - that’s OK, the Fed has said it will buy up those assets (Guarantee Infinity, or what I have called Powell’s Pandemic Put).

But running a steam train on space shuttle fuel gets passengers far too accustomed to a borrowed life, and that means the Fed sees no alternative to QE Infinity. Unlimited bond buying has become the modern monetary theorist’s high speed express to what will presumably be negative interest rates for the world’s reserve currency.

And today, with trillions of new bond issuance about to avalanche in order to pay for COVID welfare budget deficits ($3.1 trillion budget deficit in the U.S. alone) how will an attractive interest rate environment be created to soak up this new issuance?

So, the Fed manipulating interest rates down in the secondary market on one hand, plus the Treasury issuing new bonds and notes into the primary market on the other, represent a potential train wreck. Unless of course the Fed buys the new issuance under its Guarantee.

This post is the first in a five part series which will compare and contrast the views of the 1929 and 2020 Feds in an attempt to find out whether the low cost money punchbowl is again likely to be left out for too long, like it was in 1929.

The Fed’s 1929 Annual Report illustrates how the use of speculative credit in 1928 was similar to today, to an alarming extent.

The 2020 Fed says there is no evidence of asset inflation.

In contrast, the following are verbatim excerpts from the Fed’s 1929 Annual Report.

“The year 1929 opened with total reserve-bank credit outstanding in larger volume than in any year since the postwar crisis. Security loans of member banks and brokers' loans had attained new  peaks, Collateral indications derived principally from the intense activity of the securities markets and the unprecedented rise of security prices gave unmistakable evidence of an absorption of the country's credit in speculative security operations to an alarming extent. There was nothing in the position of commercial credit or of business to occasion concern. The dangerous element in the credit situation was the continued and rapid growth of the volume of speculative security credit.

The measures taken by the Federal reserve banks in the year 1928 to firm-money conditions by sales of open-market investments and by successive increases of discount rates from 3% per cent at the opening of the year to 5 per cent by midyear had not proved adequate. The second half of the year 1928 witnessed an aggravation of the conditions that had called forth the firm-money policy of the Federal reserve banks in the first half of the year.

The credit situation confronting the Federal reserve system at the opening of the year 1929, therefore, still stood in need of correction. The problem was to find suitable means by which the growing volume of security credit could be brought under orderly restraint without occasioning avoidable pressure on commercial credit and business.

With the system portfolio of Government securities practically exhausted by the sales made in the first half of the year 1928, the main reliance in a further firming of money conditions must have been further marking up of Federal reserve discount rates, unless some other expedient could be brought to bear in the situation.

The board was not disposed to regard favorably further increases of the discount rate as the appropriate method of dealing with the situation presented, and particularly as the Federal reserve system was related to it; the board, therefore, did not approve the discount rate advances voted by  some of the Federal reserve banks. It set forth its views of how the Federal reserve banks would best proceed in the circumstances in a letter to them under date of February 2, which was later supplemented by a statement further elaborating its position, issued to the public February 7 and  reading as follows:

"The United States has during the last six years experienced a most remarkable run of economic  activity and productivity. The production, distribution, and consumption of goods have been in un-precedented volume. The economic system of the country has functioned efficiently and smoothly. Among the factors which have contributed to this result, an important place must be assigned to the operation of our credit system and notably to the steadying influence and moderating policies of the Federal reserve system.

"During the last year or more, however, the functioning of the Federal reserve system has encountered interference by reason of the excessive amount of the country's credit absorbed in speculative security loans. The credit situation since the opening of the new year indicates that some of the factors which occasioned untoward developments during the year 1928 are still at work. The volume of speculative credit is still growing.

"Coming at a time when the country has lost some $500,000,000 of gold, the effect of the great and growing volume of speculative credit has already produced some strain which has reflected itself in advances of from 1 to 1% per cent in the cost of credit for commercial uses. The matter is one that concerns every section of the country and every business interest, as an aggravation of these conditions may be expected to have detrimental effects on business and may impair its future.”

Tightening in 1928 failed 9and should have been tackled earlier (but for political motivations). By 1929, at least 8 of the Fed’s 12 banks had acknowledged the problem!

But in 2020, the problem remains unacknowledged, and modern monetary theory (the idea that new money can be printed into infinity) has become a convenient yet unsustainable justification for some.

In the next installment (next Wednesday morning): The contrasting roles the 1929 and 2020 Feds felt they should play in arresting excessive speculative credit driven asset inflation.

Until then, keep it on the rails.

Mike.