Wednesday, 19 January 2022 — Melbourne, Australia

By Callum Newman Editor, The Daily Reckoning Australia

[6 min read]

• The Fed is not the lender of last resort
• So who’s the real lender of last resort?

Dear Reader,

When he last wrote to you before the Christmas break, Jim Rickards explained how the Fed was created as a lender of last resort. But time and time again, it has failed to act as such.

This became abundantly clear throughout the 2020 economic crisis brought on by COVID. Instead of helping, it seems the Fed is pushing us closer and closer to a real financial crisis.

In today’s Daily Reckoning Australia, Jim Rickards answers the question, ‘Who is the real lender of last resort?’.

Read on to find out more!

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia

By Jim Rickards Strategist, The Daily Reckoning Australia

The 2020 economic crisis was not really a financial crisis. The economy closed down in March­–April 2020, then bounced back in July–August 2020. This was neither a normal business cycle recession nor a financial collapse. The banks were in much better shape in 2020 than 2008.

In 2020, the Fed went through the motions of cutting rates, buying assets, and flooding the zone with new money, but it had little impact. The new money went to the banks who gave it back to the Fed in the form of excess reserves. The money never made it to the real economy.

Output levels of December 2019 were not recovered until June 2021. Employment levels of 2019 still have not been recovered. Instead of stimulus and robust growth, the Fed gave us more of the same — slow growth, low labour force participation, and stagnant wages. After the pandemic interruption, the economy is returning to the same below trend weak growth of 2009–19. The Fed didn’t rescue anyone; we’re back in the long depression that began in 2007.

The Fed is not the lender of last resort

This financial history including Fed blunders (1929, 1937, 2007), Fed impotence (2009–21), and Fed irrelevance (1994, 1998, 2000, 2020) points to the least understood aspect of today’s global financial system: The Fed is not the lender of last resort. The Fed can put on a show of policy changes and announcements, but it doesn’t matter to markets.

The 2009 market bottom was reversed by a FASB ruling, not the Fed. The 2020 market bottom was reversed by congressional handouts, not the Fed. The Fed doesn’t matter.

Why is the Fed irrelevant? The reason is that the Fed doesn’t create the money that matters. Fed money (technically base money or M0) is sterile. Private banks are the entities that create real money as they have since the Middle Ages. This is done through the credit system. The interbank credit system depends on collateral, and the best form of collateral are US Treasury bills. When the Fed prints money, it buys Treasury bills from banks, thus depriving the system of valuable collateral.

Treasury bill collateral is moved around the financial system through repurchase agreements (repo) and involves chains of pledges and repledges (rehypothecation), which create leverage and new credit. Less collateral means less leverage, which means monetary tightening. Fed money printing is not a form of ease, it’s a form of tightening because it drains the system of good collateral. The Fed doesn’t understand this, which is why they are now blundering into a new financial crisis.

So who’s the real lender of last resort?

There isn’t one; unless you say the financial system is its own saviour through the repo markets. In 1907, Pierpont Morgan was the system personified. The founders of the Fed were right to create a substitute for Morgan, but they failed because the Fed’s mission has always been to save banks rather than save the economy. Morgan had the right idea in 1907 when he allowed the insolvent banks to fail while saving the rest.

The Fed is wandering in a wilderness of mirrors imposed by monetarists, especially Milton Friedman. The economy is not driven by money supply. It’s driven by credit, confidence, and behavioural psychology, which are reflected in the turnover of money (velocity).

The Fed can’t help confidence, but they can hurt it: they’re doing so now. There’s a worldwide shortage of dollar credit and collateral driven in part by the Fed draining the system of Treasury bills. The global economy is slowing dramatically as a result.

The demographic collapse in China will be so great that it may actually destroy the credibility of the Communist Party of China, something the Chinese themselves describe as losing the Mandate of Heaven. This could lead to internal turmoil or even breakaway provinces not unlike Taiwan today. The combination of geopolitical instability, excessive debt, reduced output, and weakening legitimacy will make China one of the least attractive destinations for capital over the coming decades.

This hidden credit crunch may come to a head as early as October 2021 as the banks struggle through 30 September quarter-end balance sheet window dressing. January 2022 could be another critical date because of the 31 December quarter-end. Precise timing is difficult to forecast; foreseeing a credit crisis is not.

Pierpont Morgan died the same year the Fed was created. There has been no real lender of last resort ever since. The financial system is on a high wire with no net. And the wire is going wobbly.

Where does this leave us now? In my next issue of The Daily Reckoning Australia, I’ll tell you more about the pandemic-fuelled economic crisis we are in now. Make sure you stay tuned for that one.

Regards,

Jim Rickards,
Strategist, The Daily Reckoning Australia

PS: This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

By Bill Bonner Editor, The Daily Reckoning Australia

‘And as for fortune, and as for fame
‘I never invited them in
‘Though it seemed to the world they were all I desired
‘They are illusions
‘They’re not the solutions they promised to be’

Don’t Cry for Me Argentina by Andrew Lloyd Webber

20 years ago we predicted the US’s long trajectory ahead: ‘Tokyo… then Buenos Aires.’

We might have been holding the map upside down. But today, we return to our travel planning. Where are we headed? How should we pack? 

In 1999, we figured that the dotcom bubble was bound to pop, and that the US economy would likely turn into a Japan-like slump. Stocks would go down, we thought. The economy would sink. It would take many years to ‘fix’ the problem…we imagined. And it would only be done in the worst possible way — by inflating, a la Argentina.

In the event, the dotcom bubble did pop, and the economy did sink. In the first two decades of the 21^st century, per capita GDP growth rates were only half of those of the previous century.  

And stocks did try to follow in Japan’s footsteps. Not once, but three times — the dotcom crash itself in 2000…then again, in the mortgage finance crisis of 2008–09…and finally, in the COVID Crisis of 2020.  

Each time the feds came to Wall Street’s rescue with more money — so much so that two decades into the 21^st century the Fed has added US$8 trillion to its balance sheet (a rough measure of money supply footings) and the US ‘national’ debt has increased by US$23 trillion.

Wall Street’s gamblers and high rollers rejoice. The Dow rose from 11,000 in 1999 to 36,000 in 2021. And the rich — the top 10% who own more than 80% of the US’s stocks and bonds — got much richer. They gratefully returned the favor, generously providing funds for political campaigns and lobbying outfits.   

But Main Street slumped…manufacturing, a main source of high-wage jobs, continued to move overseas…real investment per capita (essential for real economic growth) fell…and flyover America grew surly and restless.    

Thieving hordes

In 2008, a new president promised ‘Change’. But no change of direction was forthcoming. And then, in 2016, another new president promised to ‘Make America Great Again’. But he turned out to be more in the bogus Latin American strongman tradition than a genuine reformer.   

And now, the Japan visit, as imperfect as it was, is over. Buenos Aires, here we come!

A news item a few months ago caught our eye. A truck was carrying beef cattle through a poor neighbourhood in Buenos Aires, on its way to the abattoir. The local people stopped the truck, unloaded a cow…and slaughtered it right on the street.

Last week, from California, came news that hordes of thieves had broken into boxcars and stolen whatever they could find. From Bloomberg:

‘CBS footage shows lines of packages from carriers including UPS and Amazon.com Inc., many of which arrived from Asia through the nation’s largest ports of Los Angeles and Long Beach, stretching along the railways. The looters raided packages that contained all sorts of consumer goods, while abandoning those seen as not valuable enough, including Covid-19 tests and EpiPens, devices used in emergencies to treat severe allergic reactions.’

People are growing desperate, lawless, and dependent. They no longer count on decent jobs where they can earn money. Instead, they look for opportunities for larceny, grift, and welfare. ‘Transfer payments’…money that the government takes from the people who earn it in order to hand it over to the people who didn’t…were only 5% of GDP in 1970. Today, they’re more than 20%.  

And while the lower classes commit petty crimes, the upper classes go for grand larceny.  

Also in the news last week, Fed Governor Richard Clarida resigned. He is the third resignation in recent months, as it comes to light that Fed honchos have been front-running their own decisions for years.  

The Pampas playbook

But even their millions are small change compared to the trillions skimmed by the elite over the last 20 years. Were it not for the conniving and fiddling by the Fed, their stock market fortunes — now about US$48 trillion — would probably be worth less than half as much as they are today.

Along with the corruption — paying for things you don’t need with money you don’t have — has come inflation. At the official rate, US inflation is now at 7%...the largest 12-month increase since 1982. 

But wait, in the 1990s, the feds changed the way they calculate inflation. If it were toted up the way they did in 1982, today’s rate would be above 15%.  

Even at its peak in the 1970s, US inflation never got that high. To get today’s inflation you have to go back 96 years — to 1917 — when the rate rose over 17%.

And lies! In Argentina, inflation has always been blamed on big business, capitalism, the US…you name it. And now in the US, the Biden team, along with demagogues such as Elizabeth Warren, are following the Pampas playbook, trying to shift the blame away from their own malign policies.

As Lincoln put it, you can fool some of the people all of the time and all of the people some of the time — and, as the Argentine government has proven over the last 70 years, that’s plenty!  

To be continued, tomorrow...

Regards,

Bill Bonner,
For The Daily Reckoning Australia