Financial Crisis Deja-Vu: We’ve Been Here Before (Will This Time Be Different?)

In the current era of deepening social divisions, economic distress, distrust of government and financial chaos, there’s one thing that most Americans can still agree on: these are unprecedented times!

Right?

Actually, wrong! It’s fascinating (and liberating) to realize that despite the orgy of graft, corruption, wealth inequality, unprecedented government deficits, Wall Street malfesance, social unrest, welfare state and the potential for widespread economic collapse plaguing our society today, America has actually been here before. And lived through it. For those under about the age of 100 and who are concerned about the future, especially about America’s economic outlook and the potential state of their personal finances and retirement accounts, an examination of the history of American banking will help put things in perspective. If we feel that making an educated guess about the direction that society and the economy are headed and planning accordingly is a better way to manage our finances than leaving them to random luck or the advice of an advisor working off a “one size fits all” financial model developed decades ago, then understanding the nature of American banking and how it’s evolved since the 1920’s can be very helpful. 

Things are never quite the same as they were in the past, of course, but if we can see what has happened before, learn how the banking system responded to it, look for any predictable patterns in those responses, see what changes society has undergone between then and now, and apply some logic to uncover how those pieces of information influence each other, then we may have a more sound basis for rationally choosing the better among competing options of what to do with our money in the forseeable future.

Ready for a short guided tour of history, and a peek into the future? Then let’s start at the beginning, and take a look at what banks are, and what they do.

Banks: Financial “Black Holes”

For most of us, banks are kind of like black holes: mysterious, exotic entities that exist at the centers of the financial universe and pull in our life’s energy (as represented by the wealth we’ve worked to obtain), but give out very little energy or information about themselves in return. Although we can’t avoid banks and we interact with them either directly or indirectly every day, most of us actually know very little about them, or what they do, or even where they came from. How do banks function? And why, really, are they so important to the modern economy? Are banks our friends? Our enemies? Or perhaps a bit of both? Do banks control the economy, or are banks controlled by the economy? Should we trust the banking system to keep us safe during a time of unprecedented economic and social change, or are the banks actually co-creating many of today’s economic problems and using them to rip us off? There are many questions that need to be addressed, and plenty of simple opinions for answers. The realities, of course, are more complex. However, they’re not so complex that we shouldn’t be able to gain a much better understanding without too much brain drain. Given that banks will play an increasingly heavy handed, though often very veiled, role in our lives in the coming months and years, it’s probably wise to get to know more about them. If you’re a taxpayer, a retirement saver, a retiree living on a fixed income or an individual with any significant amount of wealth to protect, a basic understanding of how the banking system works and what the current developments in the banking industry may mean for the value of the dollar and the global economy will help you consider how to plan for a very uncertain future. Let’s start with a really basic, but fundamentally important, question.

What, Really, Do Banks Do?

Banks are, of course, businesses, and their products are financial services. Since the passage of the Glass-Steagal Banking Act in 1933, banks, or, more accurately, banking (the need for distinction between banks and banking will become clear shortly) have been divided into two types: commercial, and investment. Commercial is what most of us are familiar with. It includes holding deposits, managing checking accounts, and making loans. But banks also underwrite government bonds, participate in the stock market by buying and selling securities, operate hedge funds, facilitate corporate mergers and acquisitions, and organize the sales of initial stocks created by new companies (the process known as an Initial Public Offering, or IPO). Investment banks, or the investment branches of commercial banks, are the ones involved in these and other mostly exotic (to us), financial practices.

Within many large commercial and investment banks there is also a small but extremely important subdivision called bullion banks. (Bullion banks may also exist as their own banks, rather than as divisions within larger commercial banks.) Bullion banks are the most important banking creatures that you’ve probably never really heard of. They’re usually subdivisions of the commodities, foreign exchange or corporate finance divisions within the investment banks. Bullion banks trade, hold (vault), and distribute precious metals (PM’s) to buyers and sellers. They also finance precious metals mines and fabricators, conduct research on PM’s, serve as intermediaries between PM lenders and borrowers, and engage in other activities necessary (and profitable) to sustain a market for PM’s. Bullion banks play a crucial role in managing the modern economy, although much of their activity is clouded by secrecy and obfuscation. As we explore the role of banks in creating the economic landscape from the beginning of the industrial revolution until the current day, we’ll take a cursory look at the deeply crucial, but largely hidden, roles that bullion banks have been playing in supporting the U.S. dollar and shaping the contemporary domestic and global economies.

Why the Need For Three Types of Banking?

Why have commercial, investment and bullion banks, instead of, well, just one type of bank that can do everything?  Wouldn’t that be more efficient? Sure, from the point of view of the banks, it probably would be. But from the point of view of bank depositors and society at large, history shows that allowing banks to engage in both commercial and investment activities together is too financially and economically dangerous.

Community Assets, or Threats? How Banks Evolved From Being From One To Both

Most social entities, including businesses, have a limited shelf life. When entities stop serving their intended purpose, or no longer function properly, or find ways to game the system in which they operate, they’re often broken up into smaller, more manageable and – it’s hoped – less troublesome, units.  Such was the case with the banks when they grew so powerful and gamed the system so severely during the early 20th century that they eventually caused the Great Crash of 1929. And, when later, they escaped the bonds placed upon them as a result of that crash and caused our contemporary crashes of 2001, 2008, and, probably, 2021.¹

Banks were not always the huge, powerful creatures we’re currently accustomed to. Prior to the 1880’s, banks were mostly small, local entities that engaged in simple transactions and helped facilitate the growth and maintenance of their local communities. They were important institutions, to be sure, but of relatively limited and local influence. Then the industrial revolution came along and changed everything. With the “great leap forward” in technology came a simultaneous leap forward in the size, complexity, power and, ultimately, danger of banks. The relatively simple, local affairs that had served humanity since the invention of money couldn’t suffice to service the new and unprecedented financial needs of big technology. Nor could they effectively handle the increasingly complex financial needs of the increasingly complex society that industrial technology created. While new mechanical thinking was taking advantage of abundantly available raw resources to create an avalanche of novel material goods, new financial thinking was taking advantage of the increasingly abundant economic opportunities to create an avalanche of novel, and potentially dangerous, financial products. The result? Banks developed more ways than every before to multiply both profits for themselves, and risks to depositors and society. As banks grew hand in hand with industrialism, they set into motion a series of transformations that became the roots of the systems and problems we’re grappling with today.

The Early Years

Preindustrial banking regulations focused primarily on protecting depositors as opposed to promoting bank size and profitability. Controlling the avarice of banks was viewed by both the public and the legislators as a fundamental social good. This isn’t surprising as the limited mobility of the population in the pre-industrial era made the cultivation of upright and ethical character a prime social directive. Since honesty, fair dealing and responsibility were the elements of the social glue that held communities together, the complexion of financial laws naturally reflected those social ideals. Banks were supposed to be leaders in maintaining the social glue that kept their communities functioning. If they needed occasional help in sticking to their role, well, that’s what legislation was for.

Federal laws in the pre-industrial era restricted banks from lending large sums of money to individuals or businesses because enterprises that required big loans were inherently risky. Risk wasn’t the depositor’s friend. The freedom to make big loans also provided too much temptation to those bank managers who harbored a gambling mentality. If the bank lent and lost a huge sum, its deposits were raided to cover the debt. After all, somebody had to make the creditor whole. In the process, innocent depositors were often wiped out. Depositor-centric laws strove to protect depositors from this unfairness by effectively limiting the amount of trouble the banks could get into.

This arrangement worked reasonably well for both sides until the era of big industry got underway in earnest. Small banks could handle the small needs of local enterprises, but large businesses began requiring massive loans to fund their growth. Where would this cash come from? The banks couldn’t simply hand over sizeable chunks of wealth entrusted to them by depositors because of the depositor protection laws. The old depositor protection rules also prevented the banks from realizing the huge new profits to be had “if only” they could make the increasingly huge business loans that were in demand. This was unacceptable to the sensitivities of the banks. Unprecedented wealth and power were waiting to be claimed on the other side of the old rules, so of course the banks figured out how to get around them. Would it be surprising to anyone that the “solution” they seized upon may have gotten a bit out of hand? Indeed, the clever work-around the banks figured out to evade the letter of the old depositor protection laws created some of the worst unintended consequences in American history. Ultimately, they contributed to the Great Crash of October, 1929, and helped kick off the Great Depression and all of its sequelae.

Now, let’s be more specific so we can begin to see how the desire of banks to evade well-meaning restrictions during a time of great change, altered the course of financial history and set the stage for our current economic crisis and beyond.

The Setup for the Stock Market Crash of 1929, and Some Surprising Parallels With Today

During the era when depositor protection laws prevented commercial (savings, loan, and checking) banks from making large, risky loans, there was no deposit insurance. If the management of your bank made a bad investment with your money and they couldn’t cover the loss from other deposits or their own profits, you were on the hook. Fractional lending laws required banks to keep only 10% of your cash or gold in the bank itself, so the bank often didn’t have nearly enough on hand to pay up when big loans went bad. (Remember the family Christmas movie, “It’s a Wonderful Life”?) Because Federal rules prohibited commercial banks from making large loans as a source of income, or from trading in stocks, their income had to come primarily from three sources: fees, the payoffs from bond purchases (as bonds were considered a safe form of investing), and the difference between the interest rate at which they lent out money and the interest rate at which they paid depositors (the interest rate arbitrage rate, or arb).

Interest rate arbitration was usually the best, and largest, steady source of income for commercial banks until the recent era of super low interest rates. The profits to be had through arb on thousands or millions of deposits when interest rates far higher than today, was huge. This is a primary reason why banks were so eager to attract depositors. When the bank could turn around and lend out 9 of every 10 dollars you entrusted them with, and keep the difference between the interest the borrower paid them for those nine dollars and the lesser amount they had to pay you in interest for your ten dollars, the difference added up. And while this interest arb has been very profitable for the banks, the concept of ‘fractional banking’ has it’s drawbacks for society. Let’s look quickly at the most egregious case of harming society through fractional lending, below.

Like Beer, Fractional Lending By the Bullion Banks Is Both The Cause Of, and the Solution To, All of the World’s Problems

As we look at the role of fractional banking in driving bank growth, it’s worth noting that bullion banks are also fractional banks, even though they deal in precious metal instead of paper. Like commercials, bullion banks are required to keep only 10% of the metals deposits they take in, on hand to return to depositors at the depositors’ request. This is deeply important in today’s economy because, unlike commercial banks that can substitute dollars only with….. other dollars, bullion banks are able to substitute paper claims of ownership for physical gold (or silver) when depositors come to claim their metals. Of course, depositors can demand that their actual metals and not paper claims be returned to them at any time of their choosing, and the bullion banks must cough the metal up to them. Usually, however, the owners of the metals don’t really want the bullion itself. They just want a deed of ownership to the metal so that they can trade the metal on one of the metals markets and (hopefully) make a profit. Why lug around gold or silver bars when one can leave them where they are and simply hand over a document of ownership, in order to complete a trade?

Such a practice would be fine, except that there is huge circumstantial evidence that, unlike the other fractional banks, the bullion banks have somehow been allowed (quite probably at the behest of the U. S. Government) to hand out far more certificates of ownership for bullion under their control than they actually have under their control.² This would be like commercial banks being allowed to loan out more than 100 percent (instead of “only” 90 percent) of the deposits they take in. The result? If the banks have indeed produced far more claims to precious bullion floating around than the banks actually have in bullion, and they’re creating more claims every day, that makes each claim less valuable. After all, who’s going to pay good money for something that’s becoming ever less scarce, ever more common, and being held in ever greater numbers of hands? And since each bullion claim is supposedly the representation of a fixed quantity of physical silver or gold, each new claim created deflates the value of each and every ounce of silver and gold in the world. (Does this sound like what’s happening with paper currency as the Fed “stimulates us to prosperity?) Now why would any government want gold and silver to appear to be losing value? Here’s the dirty little secret: as the price of gold drops, meaning that gold is worth fewer paper dollars, that makes the dollars each seem worth more than they really are and keeps up confidence in the value of the dollar! Can you see how fractional banking can be fraudulently used to keep up the confidence and appearance in the value of the dollar, and how that is necessary for propping up our economy and maintaining our global economic supremacy when we produce so few real goods and services? This, in a nutshell, seems to be why bullion banks are so important, and why their activities are so jealously guarded from public scrutiny. The evidence strongly suggests that bullion banks are today, in many ways, the banking lynchpin that prevents the entire global financial system from collapsing. If the free market were allowed to discover the true, unmanipulated value of gold and silver, the value of the paper dollar (and virtually every other world currency) would crash and the greatest financial crisis in history – which the Fed is trying desperately to stave off, as I’ll be discussing at the end of this paper – would commence immediately.

(For an exhaustively detailed and documented analysis of the attempts to bring the activities of the bullion banks and the American government’s involvement with bullion manipulation to light, please refer to the extensive archives and continuing investigations by the Gold Anti-Trust Action Committee (GATA) at www.gata.org)

Small is Beautiful, and Less Is More, Until More Is More

Going back to the topic of commercial banks, keeping them safe, and therefore small, was an arrangement that served both the banks and the public reasonably well until around the 1880’s. That was when the industrial revolution really began to pick up speed and the needs for capital consequently began to change dramatically. As the industrial revolution progressed, the world witnessed the emergence of social and technological innovation second probably only to the emergence of highly organized societies in ancient Egypt. Among the most fundamental and important innovations were continuous process technologies, (ex. – assembly lines), and modern management techniques that created efficient worker coordination. Products could now be produced quickly, in mass quantities, and with little waste of materials or manpower. As a result, commercial and industrial enterprises could develop on a genuinely huge scale. Such growth, in turn, allowed these enterprises to take increasing advantage of economies of scale and scope, to fuel even further growth. When conventional growth led to too much physical and management “sprawl”, efficiency was regained via vertical integration . This unprecedented, massive commercial growth created a new- to- the- banking- world need to make equally massive business loans. Big new plants, large equipment and raw materials were hugely expensive.  Since commercial banks were restricted by law from servicing the new, massive loan demands, and probably also hampered by size in most cases – as banks at the time were encouraged to be small and local – corporations began financing their growth via reinvesting their earnings, and issuing public stocks and bonds³.

(If this all sounds somewhat familiar, that’s because it’s not too dissimilar from our current tech revolution, especially going from the early years of the internet and all the dot.com startups, to the massive FAANG companies of today. Later, we’ll examine both their similarities and differences, with an eye on the changes in the banking system since 1929, to see if the comparison may suggest where the markets, and the US dollar, will be headed in both the short and longer time frames.)

Meanwhile, at around the turn of the 20^th century, commercial banks were understandably unhappy that they were permitted to partake of the industrial boom only by purchasing bonds from growing enterprises. The income they were missing out on from collecting interest on loans, and the profits they could have from trading stocks, were off limits. Industry, too, was somewhat penalized and slowed down from lacking easy access to loans of the sizes required. The banks, not surprisingly, decided that the situation needed to change, and the easiest way to create that change was to skirt the law. They realized that they could capture the huge but elusive profits potentially available to them, and grow their customer base, by simply setting up wholly-owned securities affiliates through which they engaged in all the activities the law forbade them to. Thus while the banks themselves to continued operating within the limits of their restrictions, their affiliates participated (and profited) freely in all aspects of investment banking and even the brokerage business. The plan worked. The affiliates grew in number and popularity, eventually handling such a volume of stocks and bonds that they were able to become underwriters, as well. The banks were now happy, industry was happy, and the more wealthy, educated members of the public who participated in the stock boom, were likewise happy. (ibid.)

Enter the Extras

To make sure everybody had the opportunity to participate in the stock market (and to soak up every possible pool of potential profit), the commercial bank securities affiliates created investment trusts, which allowed people of lesser means and education to buy affordable, diversified portfolios of stocks and thereby spread their risks. These trusts served the same purpose as mutual funds do today. Opening the doors of investment to all proved both successful and unsuccessful for the commercial banks On the one hand, many groups of people who had never before purchased stocks, especially women, became buyers. Indeed, women’s magazines began pitching articles on how to buy stocks, and brokers catered to them with special programs and dedicated rooms where the ladies could gather to watch the ticker tape (ibid.)

On the other hand, the increasing demands of industrial finance, plus the restrictions of regulation, kept diminishing the lending roles of the commercial banks proper. The result was the need for both the affiliates and the corporations themselves to sell ever more stock to the general public to keep the money flowing in. This need, and the evidence that the public was meeting it, suggests that one of the conditions for the formation of a bubble (whether a rational or irrational bubble is not clear), was present. Another factor suggesting, but not proving, that the stock market may have entered a bubble between about 1920 and 1929, was that the number and variety of seismic technological changes occurring over the decade made evaluating the future profitability of many companies, particularly those on the leading edges of the technologies of the day, virtually impossible. Investors lacked the means to easily analyze the future trajectories of dividends and profitability of many companies because novel technologies with unknown potential kept rapidly replacing older technologies. To increase the uncertainty, newer, more innovative companies were constantly coming onto the market, giving investors little concrete data to stand on when assessing how much to pay for the stock. Absence of such knowledge not only increased the odds that optimistic investors would make wildly high guesses on valuation, but also promoted speculation on companies that could have brilliant futures but did not have histories of dividends by which to judge their actual performance. (ibid.)

Are you hearing shades of 2000, 2008 and today, perhaps?

The Bubble Finds Its Pin? Or A Soufflé Simply Collapses? Either Way, the Deflation Fuels the Long March Towards Socialism

The common explanation for the crash of 1929 is that the market was in a massive bubble that suddenly burst. Actually, despite a reasonable amount of circumstantial evidence that yes, there really may have been a bubble in the 1929 stock market, hard evidence isn’t entirely definitive on that point. Many analysts disagree about it, but possibly the most thorough and objective analysis comes from Eugene N. White’s study  entitled The Stock Market Boom and Crash or 1929 Revisited .( J. Econ Perspectives 4(2), Spring 1990)³. In his paper, Mr. White  examines all the available theories of why the market crashed and carefully correlates them with the available evidence. His conclusion? That the rise in the stock market during the 1920’s was probably ‘legitimate’ in the sense that the era ushered in a wave of goods, services and general prosperity probably never before seen in human history. Companies rose strongly in value, but they probably had a right to. (Whether or not we can realistically say the same for many companies today, especially many tech companies, is a debatable point and a possible difference between then and now.) Combined with a very low unemployment rate and an annual growth in GNP of about 4.7 percent (compare that with barely 2% for the last eight years or so), and, even in the face of tight monetary policy instituted by the Fed, there was probably enough real, labor-created – as opposed to Fed printed – money in the public’s pockets to fuel the economic growth of investment in industry. In a sort of feedback loop, as the stock market rose, companies found it attractive to issue even more stock, which the public purchased. Was is possible that this feedback loop got a bit out of control, and the issuance of new stock overwhelmed the existing supply to cause the crash in 1929? The evidence suggests not. The amount of new stock issued was large, but, in context, seems to have been not nearly large enough to crash the market.

Likewise, the evidence that the much discussed Smoot-Hawley Tariff killed the market doesn’t stand up to examination. If the tariff were having an effect on the market, if would have selectively hurt America’s export industry. In reality, the stocks of America’s export, import and non-tradeable industries all suffered similar declines together when Smoot-Hawley was passed. (ibid.)

(Consider the similarity to today, when we have a steeply rising stock market and a president who has imposed tariffs on Chinese goods. While not taking sides on the issue, I submit that the data suggests that while the tariff may do a bit of damage across the board, it’s not likely to be a big pin in the today’s stock bubble.)

The actual force that halted the market’s ascendancy may have come not in any particular pernicious guise, but in the form of an ordinary, periodic recession of the type that occurs regularly in the business cycle. According to Eugene White, the Federal Reserve’s index of industrial production first dropped in July, 1929. Then some of the Fed’s other indices began to fall. (Sound similar to our current crash in industrial output?) The mixed economic picture, combined with a rise in real interest rates both in America and abroad, suggested that a recession was coming on. Just like today (absent deliberate backstopping of the market by the Fed), news of an incipient recession was enough to cause stockholders to change their minds about the prospects for the future and turn from buyers to sellers.

What started out as a walk out the door by investors in early October, 1929, turned into a mad dash for the exits as everyone wanted to get their money out before it was gone. When brokerage firms became overwhelmed, the stock ticker began to lag. When investors could no longer find out the current prices of their stocks, they began panic selling. Vertical price drops prompted sudden margin calls, and many investors responded to the panic by simply liquidated their entire holdings. To make the chaos even worse, out-of-town banks and other lenders suddenly withdrew their loans to brokers – loans which were now seen as too risky. In a move echoed in 1987, 2000 and 2008, the New York banks stepped in and covered the losses. The Federal Reserve Bank of New York made open market purchases and let it be known that its members could borrow freely from its discount window without the usual stigma attached. To its credit, the New York Fed’s quick response insured that there were no panic-driven rises in money market rates and no threats to the banks from defaults on loans for securities (ibid.)  Thus, they confined the stock market collapse to the stock market itself, and spared its spread to the wider economy, a move praised by then President Herbert Hoover himself.  Again, sound familiar? Later we’ll discuss how that compares to the responses to the crashed of 2000 and 2008, and what the similarities and differences in bank and Fed actions today might suggest about what will happen when the current bubble finally finds its pin.

When the stock market crashed in 1929, panicked depositors across the nation suddenly withdrew $1.78 billion from their bank savings accounts in just four weeks. As a result, over 4,000 banks failed and any claims on deposits over and above the 10% reserves the banks were required to hold, were simply wiped out. Banks and depositors both suffered.

The Great Depression Kills Sound Money

A poorly understood consequence of the panic of 1929, and one that ushered nearly a century of America’s false prosperity and laid the groundwork for the chaos we’re seeing now, is that, because so many deposit holders demanded their money back in the form of gold (the U.S. was still on a gold monetary standard at the time), America’s central bank, the Federal Reserve, ran low on its gold supply. For four years, until Congress passed the Emergency Banking Act (discussed below), citizens understandably shunned the unstable banks in favor of hiding their cash under their mattresses.

Throughout the early part of the Depression, President Herbert Hoover, as well as most economists and business leaders, believed the downturn would be of a temporary nature. Hoover supported mainly voluntary efforts led at the state level to raise the capital needed to invest in industry and jobs (see, for example, Hoover’s letter to Illinois Governor Louis L. Emerson dated July 10, 1931 https://www.gilderlehrman.org/history-resources/spotlight-primary-source/herbert-hoover-great-depression-and-new-deal-1931%E2%80%931933.) Three years on, however, he realized that citizen and state initiatives weren’t enough to resurrect the economy, and gave in to cries that “the government should do more!”. (Have we been hearing that socialist refrain ourselves, lately?) In 1932, Hoover began reluctantly to get the Federal government involved in managing the American economy.

Hoover’s interventions included creating new banking institutions and new lending practices. One of Hoover’s early, and very significant, acts was to push legislation through congress for the creation of Federal Home Loan Banks. These banks were funded for the purpose of providing loans to local banks based upon those banks’ mortgage portfolios – something the Federal Reserve Act forbade the Fed from doing. The American ethic of the day encouraged banks to be small and local, and therefore they often lacked substantial reserves. Many were saved from going under by the liquidity provided by the FHL banks. (Later we’ll be comparing that to the effects of the bailouts of Freddy Mac and Fannie Mae.)  

Hoover’s administration also allotted $500 billion – a whopping one quarter of the Federal government’s total revenues in 1932 – to form a quasi-governmental entity called the Reconstruction Finance Administration (RCA). The RCA was a government-sponsored financial institution designed to shore up and ultimately restore proper functioning and public confidence in the banking system.

Among other mandates, the RCA allowed member banks to borrow cash in exchange for collateral not considered acceptable by the Fed. (Does this sound something like the banks of today borrowing against items like commercial or residential-backed mortgage securities and the like?) The lending focused on institutions that still had assets that could be used to repay creditors on the long run, but that were difficult to liquidate quickly enough to pay off current obligations. In other words, the RCA kept banking institutions alive long enough to unwind their illiquid assets to pay off their creditors. (Remember this when I discuss the failure of Lehman Brothers in 2008, below.) The RCA also issued tax-exempt bonds to raise the capital to loan funds to Federal Land Banks, which financed farm mortgages, and Federal Intermediate Banks, which financed farm crops in production, insurance companies, and railroads^4,5.  

OK, but what does all this have to do with me?

If you’re wondering why this history is important, remember that, in the 1920’s and 30’s, most Americans still lived on farms, and railroads were the primary mode of transport of goods and people across the country. Farms formed the bulk of the housing market and railroads were the backbone of transportation, so supporting them to keep the economy going was as important then as keeping the residential housing market and the airlines going today. In other words, the RCA was the first major, organized government bailout of “too big to fail” industries (farming/housing and railroads)!

In an echo of criticism that could be raised today, Rep. Louis McFadden (R, Pa.), who was himself a bank president, called the RFC “a scheme for taking $500,000,000 of the people’s money produced by labor at a cost of toil and suffering and giving it to a supercorporation for the sinister purpose of helping a gang of financial looters to cover up their tracks.”6  In addition, Congress raised taxes on high income earners, and imposed new taxes on such things as movie tickets and telephone calls (considered somewhat of luxury items in their day). (ibid.) Sound familiar?

Despite responding to public and congressional pressure favoring expansion of Federal intervention in the economy, Hoover starkly understood the dangerous long-term changes his policies posed to the American economy and national character. After being soundly defeated by Franklin Roosevelt who promised Americans a “New Deal” for prosperity (which was actually Hoover’s deal plus massive additional deficit spending, Hoover assessed, correctly, that deficit spending would ruin the moral character of America and our economy. I a letter written to Bruce Barton several months after Hoover left office, Hoover predicted that once the middle class perceived its economic doom, the vast bulk of the population would swing so far left that America would support the rise of its own unique version of Hitler or Moussolini. This was a very prescient observation. For anyone who is a fan of historic film reels, I would encourage you to watch a couple of news broadcasts featuring Benito Moussolini, and then watch a stump speech made by Donald Trump. I, myself, am a FreeThinker so I’m not claiming any political side, but I’ll leave it up to the watcher to be the judge as to whether or not there may be some resemblance between the two.

Banking Corruption and Congressional Response – Then and Now

Between the crash in 1929 and 1932, Congress held hearings and investigations into the Wall Street banks, to determine if market rigging and self-dealing by the Wall Street banks had contributed to the crash. The public, understandably, was outraged by the possibility and pressured congress to act. Congress did, and in 1934 passed the Securities Exchange Act. The Act created a new Federal Agency, the Securities Exchange Commission, set up specifically to register, regulate and oversee the purveyors of securities. The Act covered brokerages, clearing agencies and stock exchanges.

The Act recognized that securities prices were susceptible to manipulation and control. The ability to manipulate prices could give way to speculation, which in turn would cause a host of ills including the rapid and unreasonable expansion and contraction of securities prices (unfair to investors), unreasonable expansion and contraction in the amount of credit available for business growth (harmful to the economy), and make it difficult to calculate the correct amount of taxes owed to the government based upon fair valuation of the underlying securities (oh, boy! Now THAT would be a problem from the government’s point of view.) An additional concern was that securities price manipulation could prevent the fair evaluation of collateral for bank loans and thereby obstruct the smooth functioning of the national banking and Federal Reserve systems. We saw on the night of Sept. 16, 2019, what happens when the interbank lending system breaks down, and the result was the launching QE4 and explosion of the Fed’s balance sheet, which the taxpayers will have to repay at some point. Last but not least, the Act recognized that manipulation of securities prices and subsequent speculation could prolong and intensify national emergencies that create widespread unemployment, dislocate commerce and industry, and affect the general welfare.  Does this sound like something we should be concerned about today? Interestingly, in an example of how badly good legislation can be perverted by those it was meant to control, on May 5, 2020, the Securities and Exchange Commission granted several mega-banks, hedge funds and even a high frequency trading firm the right to jointly open their own stock exchange (ticker symbol MEMX)⁷. It went fully live on Sept. 29, 2020. Founders of MEMX include JP Morgan Bank, Goldman Sachs and UBS, as well as hedge funds Citadel Securities and Black Rock, which now handles all investments for the Fed. What’s so sadly remarkable is that each of the banks involved have been repeatedly investigated, charged and sometimes convicted of felony financial wrongdoing by the U.S. Department of Justice (ibid.) If you recall, I wrote earlier about how the banks created stock and bond programs to get around regulations preventing them from making big, and potentially risky, loans to growing industrial enterprises at the beginning of the industrial revolution. The result was the Great Depression. Are we seeing déjà vu all over again?

Franklin D. Roosevelt Sets Out To “Progressively” Improve the World – And We’re Still Living With the Fallout

In 1933, while congress was still debating the Securities and Exchange Act, newly elected President Franklin Roosevelt set out to improve on the emergency measures enacted by Herbert Hoover in 1932 and restore full confidence in the banks. Soon, cash began flowing into the banking system again. Roosevelt shut the banks, including the Federal Reserve, for four days (the infamous “banking holiday”) while calling a special session of congress to deal with the ongoing crisis. One of the little known, but deeply important, parts of the Emergency Banking Act legislation they passed was Section IV, which gave the Fed the flexibility to issue emergency currency, known as Federal Reserve Bank Notes (what we know today as dollar bills, or cash), to be backed by any assets of a commercial bank. In this one move, Congress effectively took America off the gold standard, and gave the Greenback all the security of, well, whatever collateral the banks happened to have on hand. It’s quite a sobering thought to realize that the United States is still operating on ‘emergency money’, and, by extension, so is the rest of the world when we consider the pre-eminence of the dollar in global trade and finance.

Interestingly, a debate within the Federal Reserve in 1932 over how to deal with the deepening depression, foreshadowed the circumstances of today. The leaders of two Federal Reserve member banks, as well as several Federal Reserve Board members and many in Congress and the public, wanted to Fed to vigorously fight the Depression by extending more credit to member banks, expanding the monetary base, and providing liquidity to all financial markets. Sound familiar? Many business leaders, financial executives, academic economists and policy makers at the time, however, warned that such a response would either prolong the contraction or create inflation that would lead to future cycles of great booms and busts. Can you start to see how the foundations were laid for the problems our economy has been experiencing since the late 1990’s?

The Rise of Red and Black Crises

As we’ll see shortly, the prediction that the economy would devolve into an unending series of massive booms and busts if the Fed tried to “stabilize” it by unleashing huge quantities of credit and liquidity, ostensibly to stimulate growth, turned out to be a prescient observation. There were two details, however, about the social and economic effects of loose liquidity that couldn’t be forseen when the original policies were being crafted. The first, was how “accommodative” policy would affect a nation that would eventually become dramatically different in terms of demographics, technological innovation, job types, and culture.  Second, was how the Fed itself would increase the complexity, sophistication and simple blunt force of its responses to the problems created by its own loose policy.  Such complexity, which evolved largely in response to the desperate desires of the Fed, the banks and the political class to keep banks and markets afloat in increasingly challenging scenarios – regardless of the social or economic fallout – has led to what one financial analyst has construed as a series of up and down waves of potential financial crises and opportunities created by the Fed’s attempts to eliminate economic downturns. The phases of the cycle in which the Fed attempts to contain or mitigate oncoming “hot Red” crashes, are called “black containment crises” by the developer of the theory, Daniel R. Amerman, CFA. “Black crises” owe their existence to the Fed using whatever policy tools and levers they have (and maybe ones they don’t really have, but managed to appropriate when congress was busy not looking), to stave off the normal periodic slide into full-on, “red” crises (crashes). If the black containment attempt fails, then the financial system slides into a traditional, full on, hot “red” crisis/crash. The cyclical drift between cold, “black” attempts to contain financial crisis and the “hot red” failure of such attempts, gives rise to a predictable series of risks and opportunities which savvy investors can play to increase their wealth. Understanding the history of financial depressions and the Fed’s responses to them, allows individuals to effectively use the Fed’s containment and crisis mitigation strategies to create personal wealth. For more information and deeper insight into Mr. Amerman’s Red and Black “Crisis and Containment of Crisis” Matrix and how to use it to build security in times of financial turmoil, please visit his web site at www.danielamerman.com.

Just When You Thought It Couldn’t Get More Screwed Up, The Fed Goes Even Further!

If loosening the money spigots to fight the onset of a full-blown, hot “red” financial crisis hasn’t proven to be deadly enough to the economy overall, today the Fed has increased the sophistication and range of its interventions beyond the dreams of avarice to re-animate our increasingly moribund economy. Interventions now include such things as removing the stigma of using its “discount window” (which is sort of like a Catholic confessional, only where banks that have gotten into trouble can ask the Fed for forgiveness – and loans to alleviate their sins when nobody else will talk to them). The Fed is also propping up failing businesses by  purchasing toxic assets, including corporate junk bonds. Well, maybe it purchased only a relative few junk bonds, but purchasing even one goes well beyond the Fed’s legal purview and demonstrates just how far out on a limb it’s now going to shore up a clearly sinking economic ship. Interestingly, some of the exercises the Fed is currently engaging in may be more about giving the markets a series of ‘head fakes’ to get the desired market response without committing the Fed to actually doing much. (The practice of getting the markets to move just by saying that the Fed will or won’t be doing something is called “jawboning”, and it’s a policy tool that the Fed has come to rely upon more and more over the past several years.)

So, What’s the Alternative?

OK, so far, I’ve talked about all the bad things that fractional banking and Fed crisis intervention have caused (or could cause) to happen to our economy. It would be entirely fair to ask at this point, “sure, but what would happen, or will happen, if the banks and the Fed start doing things differently?” The question might be rephrased as, “If all the banks (especially the bullion banks) were no longer allowed to practice fractional reserve banking and the Fed was no longer attempting to prevent the economy from sliding into a full financial depression, would we actually have a “Red” crisis/crash? And, if so, how long and how deep would it be under current circumstances? How long a recovery would take, absent Fed intervention?” This leads to a natural corollary question: “Which would be worse at this point: to voluntarily let the whole system experience the necessary cleansing process now, or to keep prolonging fake prosperity by increasing the size and variety of “black” interventions until the “red” crash simply cannot be postponed by any type of interference any more?”

The answer is: nobody knows. However, what can be said with certainty is that the more the Fed fights the onset of a full on “Red” crisis by pouring on more “Black” interventions (such as flooding the economy with paper, propping up non-performing businesses and loans, and even joining with congress on ill-conceived fiscal policy like Universal Basic Income), and the more the bullion banks join the effort by suppressing the free market prices of precious metals, the longer and deeper the eventual crash will be. Also, the weaker and more prolonged the recovery will be, especially in an age when much of our social, intellectual and industrial capital has decayed even before the crash has arrived. We are no longer a nation of young, hearty, ambitious citizens blessed with an almost limitless supply of belief in ourselves and raw materials with which to turn our visions into concrete reality. We are now a much more aged society afflicted with dep social and political divisions and diminishing natural resources. Our creative and intellectual capital has also been depleted by decades of “progressive” education. Out of what will we rebuild, after a devastating financial crisis that will actually be global in scope? The answer is anyone’s guess. Yes, we’ve been here before, and pulled through, but the changes from then until now must be taken into account when analyzing how similar circumstances will be handled this time. From what I’ve seen, the technology-based “solutions” being offered by the global financial elite (example – digital government currencies to replace paper currencies) are far from reassuring or just. But that will have to be the subject of another paper.

Back to the Future

With so many young people demanding that America transform into a socialist economy, it might be good to remember that the bow to socialism actually began with our grandparents demanding that President Hoover and the Fed artificially end the hardship of the Depression by printing money and starting “make work” programs by which to distribute it.  In this way, Hoover’s programs, which were aggressively expanded by Franklin D. Roosevelt under his “New Deal”, ushered in the current era of big government and the entitlement culture, a consequence of government management of the economy that Hoover himself was deeply afraid of⁶. The progressive era that our grandparents, and then parents, largely supported by electing Franklin D. Roosevelt to office an astonishing four times (proving that humans often don’t learn very well), paved the way for many of the excesses and resulting problems we’re grappling with today. So, perhaps we shouldn’t lay all of our fears and frustrations about economic and civil decline upon today’s generation. There is plenty of blame to go around. In a future paper I’ll be examining how Congress and Presidents during the Bush, Clinton and Obama eras colluded, in concert with progressive social leaders, to twist the concept of the American Dream into a nightmare that catalyzed the 2001 financial crisis, blocked the prospect of true recovery, and has kept the economy increasingly in need of life support and in the continual grip of ‘black crisis management’ to our collective long-term detriment. Stay tuned. In the meantime, I hope you’ve enjoyed and benefitted from my small attempt to place our current economic crisis in some historical perspective.

References:

1. https://www.ccn.com/us-dollar-will-crash-2021-senior-yale-economist-warns/
2. https://www.bullionstar.com/gold-university/bullion-banking-mechanics
3. White, Eugene, J. Economic Perspectives, 4(2), Spring, 1990
4. https://bankingjournal.aba.com/2020/07/a-short-history-of-economic-rescues/
5. (https://www.federalreservehistory.org/essays/banking_acts_of_1932https://www.federalreservehistory.org/essays/banking_acts_of_1932
6. https://fee.org/articles/the-first-government-bailouts-the-story-of-the-rfc/
7. Martens, Pam and Russ, “Wall Street’s Felons Go Live With Their Own Stock Exchange This Month” Wall Street on Parade, 9/2/20
8. https://www.gilderlehrman.org/history-resources/spotlight-primary-source/herbert-hoover-great-depression-and-new-deal-1931%E2%80%931933