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THINK ABOUT IT!
The Rude Awakening
Submitted by Don Stacey
Nov. 3, 2005
Last week, James Grant, publisher of Grant's Interest Rate Observer, held a conference in New York. His comments are worth careful thought. Isn't it time to get rid of the Federal Reserve?
James Grant, the conference host and keynote speaker,
presented a talk entitled "Man's Inner Bubble," which, he
pointed out, had nothing to do with gastrointestinal
In the span of forty very entertaining and amusing minutes,
Grant argued that easy credit fuels EVERY U.S. asset
bubble, and that the Federal Reserve is the original source
of all easy credit. Therefore, the world might be much
better off without the Federal Reserve...or a Federal
Grant pointed out that before the creation of the Federal
Reserve in 1913, prices "sometimes sagged." Throughout the
19th century, therefore, prices tended to drift lower – as
productivity gains and innovation drove the cost of living
down. Post-1913, however, the Federal Reserve has presided
over the continuous depreciation of the U.S. dollar.
The appointment of Ben "Helicopter-drop" Bernanke as the
new Fed Chief will likely accelerate this trend. In fact,
any Fed Chief who thinks that the Federal Reserve is an
inflation-fighter ought to be lashed to a mast and forced
to stare at the following chart until his eyeballs burn
with memory of it.
The key difference between the pre-Federal Reserve American
economy of the 19th century and the post-1913 variety is
that the pre-fed dollar derived its value from a strict
connection to gold. Indeed, many dollars were actually
minted in gold itself. Such a tether limited the production
of new dollars and served to contain inflation...But the
last remaining tether to monetary responsibility snapped in
1971, when President Nixon eliminated any connection
whatsoever between dollars and gold.
To help the audience appreciate the dubious benefit of the
Federal Reserve's stewardship, Grant presented a snapshot
of life circa 1890, compared to today. First, there were
some stark differences. Inflation was a negative 1.2% in
1890. The population of the country was 62 million. The
Federal Government was in surplus. There were 25
professional baseball teams, spread over 3 leagues.
Railroad stocks dominated the Dow Jones Industrial Average
(with 10 of the 12 stocks).
But, there were also some remarkable, and ominous,
Interest rates were low. High-grade bonds yielded only
3.68% and the savings rate was 4%. Investors, groping for
yield, took bigger risks causing a boom in speculative
Grant shared some quotes from Hallie Farmer (published in
1924), in a report published in the Mississippi Valley
Historical Review. Credit was easy and lending standards
were loose. "Competition existed not between borrowers but
between lenders," Farmer notes.
This created a boon for debtors. An example from Farmer:
"All the rail roads offered lands at low prices and one
easy terms...The Union Pacific offered eleven years'
credit. One-tenth of the purchase price was to be paid at
the time of sale; deferred payments bore interest charges
at 6%, but for the first three years the purchaser was
required to pay interest only."
Sound familiar? It's not so far removed from the
unconventional mortgages we see in our mortgage bubble
today. There was a boom in housing then as well, with the
total mortgages outstanding nearly tripling from 1880 to
In the 1890s, too, they had their share of securities
fraud. Grant related how the bonds of Capitola township in
Dakota were sold to Eastern investors and changed hands
many times before it was discovered that no such township
Farmer's diagnosis of 1890 applies today. "The prosperity
of the period was a prosperity based upon credit," he
Today's prosperity is no different, says Grant. Easy credit
fueled the stock market bubble, the housing bubble and
every other bubble – great and small – that the Greenspan
Fed has nurtured. And presumably, as America's bubble
economy deflates, the dollar's value will suffer...despite
the very best efforts of the Federal Reserve and its new
But let's not forget that bad news for the buck is gold
news for the gold price and the oil price and for the price
of every other hard asset. Make way for the "new reserve
From The Rude Awakening, an investment advisory service
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