The Federal Reserve is just one part of our complex economic factors
Fed Chairman Jerome Powell’s January 26 statement following the last meeting of the Federal Reserve’s Open Market Committee signals an end to ultra-low interest rates and the huge amount of easy money injected into the economy.
According to Powell, the Fed “is okay” to raise interest rates in March. The central bank is already reducing its sustained purchases of Treasury bills and mortgage-backed bonds.
Stock markets have reacted with volatility, but not drastic declines, so far. A major drop could well occur, given the current extraordinary situation.
The financial collapse and recession of 2007-2008 provide a relatively recent basis for comparison. This crisis was the result of extreme speculation in mortgage-backed securities in the United States and quickly became global.
The Great Depression provides important historical context. The stock market crash of 1929 and extreme U.S. protectionism sparked a decade-long hardship.
Along with great human suffering, the Great Depression fueled the rise of Nazism in Germany. The fundamental lessons of this period remain profound.
The stock market crash of 1929 was sudden and steep. Since peaking at 381.17 on September 3, US stocks have lost 25% of their value in two days.
November brought a recovery, but it proved short-lived. Stocks drifted to an all-time low of 41.22 in July 1932. At the height of the selling frenzy, they traded in volumes not seen again until the late 1960s.
Stocks did not return to the 1929 peak until 1954, contrary to more recent experience. High levels of public distrust and hostility toward bankers have defined American political life for decades.
After the crash of 2007, banks went bankrupt and others only remained solvent thanks to emergency injections of federal funds. The Federal Deposit Insurance Corp., founded during the Great Depression, proved up to the task of protecting individual depositors.
The 2008 bankruptcy of investment bank Lehman Brothers underscored the depth of the crisis. Government intervention, including liquidity, was then crucial for the recovery.
Commercial banks have become more regulated again, with capital requirements raised as part of the bailout. In 2010, the Dodd-Frank Act came into effect, including Paul Volcker’s landmark initiative to separate trading funds from investment banking funds.
Volcker, as chairman of the Fed, defeated inflation in the early 1980s. Rising inflation is a major political concern today.
The US central bank conducted aggressive bond purchases. Traditionally, the money supply and interest rates have been the main financial tools. The Fed now controls a relatively small share of the total dollar. At the same time, the dollar’s global reserve role facilitates huge bond purchases.
Finance is only one component of our complex economy. Money is a universally accepted medium of exchange, but tangible value results from the work of a wide range of people.
Here’s what we the people should remember. First, take pride in your work. The United States has the most productive economy in the world. Our gross domestic product doubles approximately every two decades.
Second, as a citizen, be active. Government reforms reflect public pressure. There must be serious and sustained public scrutiny of financial activities.
Third, as an investor, do your homework, starting with the classic book by Dodd and Graham, Wall Street professor and genius respectively, first published in 1934, regularly revised. You can read this while listening to the media.
However, why not avoid this distraction? Non-stop electronic media is a bad investment.
Read more: Benjamin Graham and David Dodd, “Security Analysis”
Arthur I. Cyr is the author of “After the Cold War: American Foreign Policy, Europe and Asia” (NYU Press and Palgrave/Macmillan). Contact [email protected].