The Federal Reserve Plays a Dangerous Game

Be careful what you believe

by Dr. Chris Martenson | April 7, 2008

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A television ad for Morgan Stanley’s brokerage service flickers across the screen, showing a retired couple walking across a beach with a dog and their grandchildren. Smiles and ease and comfort drip off the screen. It is a happy, shiny future they are selling. Separately, a letter goes out from Morgan Stanley to their private clients warning of a “50% chance of a systemic crisis." Which do you believe? 

Executive Summary: 

• Keeping a wide-angle view on this developing crisis is the only way to avoid being whipsawed, and the stakes have never been higher (at least in our lifetime). 

• The US financial markets, and probably the world’s, peered over an abyss on the night of Sunday March 16th 2008, but were rescued by very unusual and concerted official actions.

• On the “happy, shiny” side of the equation, we have the fact that stocks mysteriously went up immediately on the open after the announcement of the collapse of Bear Stearns, and have continued up since.

• On the “Cold, Hard Facts” side of the ledger, indicating that a particularly nasty recession is already underway, the recent data is:

• The highly respected Economic Cycle Research Institute (ECRI) recently said, “Now the verdict is finally in. We have unambiguously turned onto the recession track.”

• Housing data was similarly unambiguous. Sales were down, mortgage rates were up, foreclosures up, construction down, and prices slid at a rate “not seen since the Great Depression.”

• Unemployment claims ratcheted higher.

• Consumer confidence hit a 35 year low.

• Global trade has decelerated to a standstill.

• Retail sales are in the cellar, plunging by more than expected, and auto sales are fading fast.

• The Empire state index clocked in at a record low.

• T-Bills gave a very strong recession reading by briefly trading at 0.21%.

• Tax receipts for the federal government are down by 12% over the past year.

You can choose to believe that the worst is behind us (stocks), or you can choose to believe the facts (everything else). But be sure to choose carefully, because the penalty for being wrong here will be particularly steep.

On Sunday, March 16th, deep in the night, the US financial system, and by extension the world financial system, peered over the edge of an abyss. If the Bear Stearns rescue (by the Fed & JPM together) had not happened, it is my firm conclusion that a systemic banking crisis would have ensued. While some commentators are now saying that “the bottom is in,” with one even going so far as saying the Dow 20,000 is now a lock, I would implore you to be careful in choosing your beliefs. 

Here’s why. In my economic seminars we spend about as much time on the economic context and data that define our current reality as we do examining beliefs and asking ourselves whether the ones we hold might be of the enhancing or limiting variety. This is important because what we believe shapes what we see, and what we see determines our actions and therefore our future. Holding the wrong beliefs at critical turning points can be extremely harmful. 

In the book The Mind of Wall Street by Eugene Levy, a wonderful example of both a limiting and an enhancing belief are simultaneously on display when he recounts his experience during the take-over of a struggling railroad back in the 1970’s. He made a bundle on the deal. Here he describes the situation: 

“Management executives looked to the past in their assessment of the railroad. They saw its wretched history of bankruptcy and losses, the thousands of miles of useless track, and the years of failed attempts at regulatory reform; from this they could only conclude that Milwaukee Road was a failed railroad that could never be profitable. We looked at the same railroad and instead saw vast assets in real estate and machinery that could be sold.” 

The railroad executive team held limiting beliefs about their company that prevented them from seeing the value of what they held. Because of this they saw the wrong things and therefore took the wrong actions and lost a ton of money as a result. Meanwhile Mr. Levy had an enhancing belief that allowed him to see things about the railroad that led him to a fortune. 

At this point, I’ll share a belief of mine with you: I believe the stock market is being propped up by the Fed and/or US government (PPT), who are desperately afraid of allowing the stock market to signal the true state of affairs. In some ways I can understand this; I think that the authorities who are stabilizing the markets right now are quite justifiably worried about what would happen if the stock market were “allowed” to send a correct signal to a wider audience. Because I believe that the stock market is being propped, I do not trust that it’s telegraphing useful or meaningful price signals and so I will take very different actions than someone who holds the opposite view. I might be wrong, or the person holding the opposite view might be wrong, but one of us is making a colossal mistake. 

And here’s a second belief: The market is bigger than the authorities, and they will ultimately fail in their attempts to prop the stock market because they are merely masking symptoms, not treating causes. If it were possible for an elevated stock market alone to cure what ails our economy, I might think differently, but those efforts are surely misdirected. 

The consumer-retrenchment genie is already out of the bottle and intervention will only serve to exacerbate what is already a terrifying gap between the ‘official story’ (as told by the stock market), the daily lives of ordinary people, and the cold, hard facts. 

Even as a possibly illegal and certainly ill-advised rescue of Bear Stearns is being revised and revisited, and the stock market keeps climbing or at least holding steady, we find that the current spate of fundamental economic news is especially worrisome, if not downright scary. The question before you, then, is, which will you believe? 

A happy, shiny stock market, or the cold, hard facts? 

Copyright © 2008 Dr. Chris Martenson
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Dr. Chris Martenson | Bernardston, MA USA | Email | Website

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