The Fed and the Stock Market

January 4, 1999

On October 15, 1998, Federal Reserve Chairman Alan Greenspan fired the shot heard 'round the world. For on that day, with foreign and domestic equities markets in disarray, he announced that the Federal Reserve Board had voted unanimously to cut interest rates for the second time in three weeks. Investor reaction to the Fed's decision was nothing less than euphoric—the Dow Jones Industrials promptly shot up nearly 400 points on an intraday basis and proceeded to climb nearly 1500 points in the span of two months.

By this simple yet profound action, the Fed—unwittingly or not—provoked a nationwide debate among investors and economists over the role of central banks, monetary policy, and their influence on markets. Both critics and defendants of central banking wanted to know just how much of an influence these mysterious bodies exert over the course of one nation's economy? The Fed's "October Surprise" seems to have been forgotten but many questions remain unanswered. It is our endeavor to shed light on this issue and hopefully provide those answers.

Before we can provide solid answers to the question of how much control the Fed possesses, we must first understand the role this institution plays as a central bank. When we begin to examine the roles of central banks, we are immediately shocked to discover that the very nature of a centralized monetary authority is antithetical to the concept of the free enterprise system, as provided for us in a constitutional republic. Under this system, observed Reginald McKenna, former president of the Midlands Bank of England, "Those that create and issue the money and credit direct the policies of government and hold in their hands the destiny of the people." In other words, once the government is in debt to the central bankers, it is at their mercy, including the financial system of that government (i.e., the stock market).

Taking it a step further, Gary Allen, in his runaway best-selling book, None Dare Call It Conspiracy, observed: "All those who have sought dictatorial control over modern nations have understood the necessity of a central bank. When the League of Just Men hired a hack revolutionary named Karl Marx to write a blue-print for conquest called The Communist Manifesto, the fifth plank read: 'Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.' Lenin later said that the establishment of a central bank was ninety percent of communizing a country."

Allen continues: "How powerful is our 'central bank?' The Federal Reserve controls our money supply and interest rates, and thereby manipulates the entire economy—creating inflation or deflation, recession or boom, and sending the stock market up or down at whim. The Federal Reserve is so powerful that [former] Congressman Wright Patman, Chairman of the House Banking Committee, maintains: 'In the United States today we have in effect two governments…We have the duly constituted Government…Then we have an independent, uncontrolled and uncoordinated government in the Federal Reserve System, operating the money powers which are reserved to Congress by the Constitution.'"

Thus, we see the foundations lain for an all-powerful, all-controlling central bank over the financial affairs of the entire nation. But it doesn't stop there. Central bank control extends beyond merely national borders in an intricate web surrounding the entire globe. The U.S. Federal Reserve, in conjunction with international bodies such as the IMF and World Bank, are presently implementing their carefully crafted plans of global economic dominion. Alluding to this, market analyst Bert Dohmen, in the November 1998 edition of his highly respected Wellington Letter, wrote: "For more than twenty years colleagues in my business have talked about the long-term goal of certain groups to create a central bank of the world, which would eventually lead to one world government. Even those who have doubted that such a plan exists, or would ever be realized, must now have second thoughts. This year's financial turmoil, which may not have been all that accidental, has brought the major industrialized nations and emerging countries together in order to discuss these ideas in a more serious manner."

Indeed, as Bismarck once said, and as Dohmen pointed out, "Nothing happens by coincidence in the realm of politics." The same could easily be said for the financial and economic realms.

How then will this desired control be effected? Answer: the manner in which it is being pursued at this very moment—through monetary policy and market manipulation. By pursuing an easy credit policy and by rapidly expanding the available money supply, the Fed has manufactured a financial condition in which it is not worth having one's assets in a savings account or money market fund due to the low rate of interest, and in which it is too costly NOT to be invested in the stock market due to the extraordinary gains and profit potential (engendered entirely by an accommodative monetary policy). Thus, the Fed creates a situation in which, by default, everyone is in the stock market and therefore vulnerable to the possibility of financial collapse.

This further accounts for the unprecedented action of the Fed over the past few months in repeatedly lowering interest rates, an action which had the dual effect of boosting stock prices, thereby making them more attractive to the average investor, and of instilling a false sense of confidence that the Fed will always rescue the markets when they fall. Expounding on this phenomenon, The Economist wrote recently: "So what is wrong with America's cutting rates now just in case? Plenty. Every rate-cut pumps up an already inflated stock market. Investors piling in more money in the conviction that the Fed will bail them out if prices start to fall. Rising share prices, in turn, allow consumers to carry on spending, and companies to keep investing. But the more share prices become overvalued, the more they will eventually have to fall. And the more consumers have spent and companies have invested on the basis of these overvalued prices, the more painful the economies eventual adjustment will be." So in effect, the Fed is sowing the seeds of the Dow's eventual destruction.

Frank Veneroso (Veneroso Associates) told Forbes recently that he is "shocked" by the number of sophisticated money managers who are long equities because Fed-orchestrated bailouts inside and outside the U.S. have convinced them that the Fed will never let the stock market fail. Such faith in Alan Greenspan ignores history, as Veneroso pointed out. "The Fed has a tiger by the tail," he told Forbes.

Demonstrating that history repeats (or, is soon about to repeat), Gary Allen writes concerning Fed manipulation: "Having built the Federal Reserve as a tool to consolidate and control wealth, the international bankers were now ready to make a major killing. Between 1923 and 1929, the Federal Reserve expanded (inflated) the money supply by sixty-two percent. Much of this new money was used to bid the stock market up to dizzying heights. [Ed note: Sound familiar?]

Allen continues: "At the same time that enormous amounts of credit money were being made available, the mass media began to ballyhoo tales of the instant riches to be made in the stock market…The House Hearings on Stabilization of the Purchasing Power of the Dollar disclosed evidence in 1928 that the Federal Reserve Board was working closely with the heads of European central banks. The Committee warned that a major crash had been planned in 1927. At a secret luncheon of the Federal Reserve Board and heads of the European central banks, the committee warned, the international bankers were tightening the noose" [i.e., were planning to raise interest rates].

Thus, the Federal Reserve created the stock market bubble of the 1920s by lowering interest rates, and then created its demise by raising them. Obviously, the exact same conditions that existed in the 1920s preceding the Great Crash are in place today. The overriding question then becomes: Will history repeat? Is the Fed presently conspiring to bring about a similar market panic through their control of monetary policy? The answer to that question has already been provided, at least in part. In July, we reported the following incident: "On 16 June 1998, the Navy and Marine Corps were conducting their annual strategy meeting entitled 'Current Strategy Forum.' This year's meeting was held at the U.S. Naval War College in Newport, Rhode Island. A source who was in attendance at the meeting reported that he was shocked by a sentence uttered by the Under Secretary of the Navy, if only for its remarkable candor. Our source reports, 'After speaking for about 30 minutes from his prepared notes, the U.S. Under Secretary of the Navy, the Honorable Jerry MacArthur, then began to answer questions. After answering several questions, Mr. MacArthur made this statement, apparently off the cuff: 'Senior Military Pentagon officials have been working closely with senior officials at Wall Street to perfect severe scenarios that could quickly be put into action once Wall Street crashes.' Notice the Under Secretary did not say 'could crash' or 'may possible crash.' He emphatically stated that the Pentagon is fully expecting it to crash." So very obviously, a blueprint for a Wall Street crash has already been drafted. We are merely awaiting its implementation. And if history is of further precedent, we may have already received another, more forceful, warning of an imminent collapse from Mr. Greenspan himself. In None Dare Call It Conspiracy, Allen mentions that then-Fed Chairman Paul Warburg provided a furtive warning to insiders who "knew the score" to sell all assets in anticipation of a crash. That signal came on March 9, 1929, when the Financial Chronicle quoted Warburg as giving this sound advice: "If orgies of unrestricted speculation are permitted to spread too far…the ultimate collapse is certain…to bring about a general depression involving the whole country." In a recent speech, Greenspan himself made a similar statement and even used the term "speculative orgy" as did Warburg. In recent Congressional testimony, Greenspan said: "I've never seen anything like this. What is occurring is a broad area of uncertainty and fear. When human beings are confronted with uncertainty, meaning they do not understand the terms of particular types of engagement they're having in the real word, they disengage. And in markets, disengagement of necessity, means that prices fall. In other words, fear itself is something to be frightened of. It harms markets in its own right." Interestingly, this statement is a complete inverse of Franklin Roosevelt's famous statement shortly after the Crash of '29, "We have nothing to fear but fear itself." To provide proof that a direct correlation exists between Fed monetary policy and stock price behavior, we have included a chart from a respected financial publication of many years ago.

In the chart shown here entitled, "Federal Reserve Monetary Policy and Dow Jones Industrial Average (1935-69), reprinted from the June 24, 1969 issue of Indicator Digest, we see clearly the impact that expansive and restrictive monetary measures have on the Dow's performance. As illustrated, the Dow fell whenever the Fed embraced a restrictive monetary policy and rose during expansive monetary policies. Further proof that a perfect relationship exists between Fed policy and the stock market is provided by a more recent chart comparing the performance of the S&P 500 price/earnings ratio and money supply (as measured by M2). Note the almost perfect correlation between periods of monetary restriction and expansion and the dips and rallies in the S&P. So what is the answer to this problem of central bank manipulation of markets and unilateral economic control? The answers are as complex as they are varied.

There is no one simple solution, certainly not one that can be easily implemented in view of the numerous obstacles in the path of true reform. However, one measure that MUST be undertaken before financial order and self-sovereignty can be restored to our nation's financial infrastructure is the return to a gold standard. Ironically, Greenspan himself made this very observation years ago before his entrenchment at the pinnacle of the Establishment. In an essay entitled "Gold and Economic Freedom," Greenspan wrote "The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit…In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value." Such a measure, however, will be a long time in coming, if ever. In the meantime, individual investors need to protect themselves from imminent financial chaos. And this can only be effected through the individual initiative of gold investment. For, as Greenspan so eloquently pointed out, it is gold alone that is immune from the monetary debasement policies of central bankers and others who would control the fate of nations.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.

10 karat gold is 41.7% pure gold.