The Discipline of Government


"What does the United States' lack of discipline mean to investors?"

As a general rule, the most successful man in life is the man who has the best information.

In my article The Politics of Personal Destruction I presented the case that the Federal Reserve was responsible for the Great Depression because of its extremely tight monetary policy.

In 1963 Friedman, and coauthor Anna J. Schwartz, published A Monetary History of the United States, 1867–1960. In it, the authors claimed that the Great Depression would have been a typical downturn had it not been for policy errors made by the Federal Reserve. U.S. Federal Reserve head Ben Bernanke also believes if the Fed had provided enough money to banks and bought U.S. securities the Great Depression would not of happened.

All the Fed had to do, back then, to turn the U.S. economy around was do what it was suppose to do—be a lender of last resort and add to bank’s reserves by purchasing government securities—this would have expanded the money supply.

But the Federal Reserve, on top of allowing the money supply to contract, deliberately contracted the money supply further by raising interest rates. Yesterdays Federal Reserve had no interest in increasing the money supply and saving banks because:
  • Fed officials subscribed to Treasury Secretary Andrew Mellon's liquidationist thesis

  • Most of the failing banks were small banks and not members of the Federal Reserve System

  • Large banks did not protect the smaller banks feeling the Fed should do it, and that the weeding out of small competitors was a good thing

"Mellon advocated weeding out 'weak' banks as a harsh but necessary prerequisite to the recovery of the banking system. This 'weeding out' was accomplished through refusing to lend cash to banks (taking loans and other investments as collateral), and by refusing to put more cash in circulation. He advocated spending cuts to keep the Federal budget balanced, and opposed fiscal stimulus measures." -Wikipedia

As an aside, Executive Order 6102 was signed on April 5, 1933, by U.S. President Franklin D. Roosevelt "forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates within the continental United States". Could an argument be made that Mellon's policies, adopted and followed by the Fed, and the subsequent results— turning a simple recession into the Great Depression—were the cause of the U.S. abandoning the gold standard?

Roosevelt's "New Deal" (a series of economic programs between 1933 and 1936 designed to bring; Relief to the poor and unemployed, Recovery of the economy, Reform of the financial system, the 3R's) meant the end of the Gold Standard. To accomplish his goals FDR needed the Federal Reserve to have complete control over the money supply.

FDR's "New Deal" was in direct response to economic conditions at the time—the Great Depression. Conditions that this author believes were brought about, or at least made much worse, by Treasury Secretary Andrew Mellon's advocacy of letting banks fail and a tight monetary policy.

Between 1929 and 1933 the U.S. money supply contracted by 31%.

Today, unlike in the late 1920's and early 1930's, the Federal Reserve is providing liquidity and increasing the money supply.

Bernanke is putting into practice what he believes to be the fix for our current economic woes:

  • Giving money to the banks

  • Cutting the prime interest rate the Fed charges commercial banks

  • Buying treasuries
  • Many economists believe the boom and bust effects of the business cycle can be largely smoothed over by government increasing or decreasing the money supply.

    If this is true, the questions we have to be asking ourselves are;

    Q: How did we get into this predicament in the first place?

    A: Our political masters have been printing our way to prosperity.

    "Government intervention begets government controls and regulations. When you replace the automatic workings of the gold standard with a government controlled fiat standard, you must regulate and control things like money supply and financial leverage, since the discipline of the market has been replaced with the discipline of the government." -Paul Nathan,

    All we need to know about politicians is 1. It isn't their money and 2. Nothing is more important to them then getting reelected. Asking for fiscal discipline from them is akin to asking John Dillinger to guard Fort Knox. In regards to Dillinger, congress and Ben Bernanke's actions we know what's going to happen—Dillinger would rob Ft. Knox and both congress and the Federal Reserve are going to create, give away and spent money in unbelievable amounts to keep the system afloat.

    As soon as the QE program, part's 1 & 2, ended in June of this year, the markets had to get by on a lot less money and liquidity. Today the dollar is up because the EU, and the world, has an acute shortage of dollars for the necessary bailouts and needed liquidity. These strange market conditions (the dollar up, markets down) are temporary and are providing a huge buying opportunity, here's why:

  • China will implement another stimulus program. China, even if growth slows, is still predicted to grow at nine percent and the urbanization of both China and India and the astounding prospects of Africa are far from over

  • The U.S. will soon start QE3 and initiate a massive stimulus program via an infrastructure maintenance and build program

  • Britain started QE2, British bank's exposure to continental Europe is equivalent to about 250% of their Tier 1 capital. The assets of British banks are equivalent to four times GDP, if the Eurozone were to collapse it's not likely Britain's banks would survive and the country would immediately go into recession

  • The European Union will vastly increase the size of their bailout fund, the European Financial Stability Facility (EFSF), to purchase bonds and recapitalize banks

  • A global coordinated bailout effort will begin

  • The U.S. 2012 budget projects that the deficits total $7.2 trillion over the next 10 years with the shortfalls never coming in below $607 billion.
  • Conclusion

    What does a U.S., that should read almost all governments, lack of discipline mean to investors?

    A soon back to falling, and much weaker dollar, will push up the price of commodities, rising commodity prices tend to push bond prices lower. A falling dollar is bearish for bonds and stocks because it is inflationary.

    Coming higher commodity prices should be on every investor's radar screen. Is how to gain the most leverage from investing in higher inflation and commodity prices on yours?

    If not, maybe it should be.

    Richard (Rick) Mills
    [email protected]

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    This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified; Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Richard Mills only and are subject to change without notice. Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, I, Richard Mills, assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this Report.

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