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1913 World of Change

Back in January we wrote how 2022 markets will behave like a two headed duck, one looking at interest rates and the other looking for growth opportunities. As interest rate cuts occurred and helicopter money fell from the sky to employers, families, and municipalities, we saw nearly ten years of normal market returns condensed into two years. As the Federal Reserve began to see inflation as less and less transient, I asked in June if the Fed prioritized fighting inflation or avoiding a recession.


Problematic Narratives:


Over the years the fed has not exactly stuck with the same story regarding the use of quantitative easing or tightening (QE or QT), rate reductions or increases and its effect on inflation. If you’d like to read more into it check out the Wolfstreet article from 2019 detailing the feds involvement in the repo and reverse repo markets prior to the pandemic. Now either the fed was incredibly insightful or completely ignorant of what they were doing. For starters they began to ease monetary policy well before it was necessary. The real inconsistency however is that in 2021 through March 2022 the Fed denied inflation as a real issue writing it off merely as “transitory,” ignoring the fact the trillions of dollars have either been handed out, borrowed at historically low rates or in some cases loans being forgiven and canceled. Now seven months after rate hikes began, inflation is still not declining month to month. If you’re wondering how that impacts the markets let's stop and look at some charts.


Going back to the 1980s rates have been in a bear market and inflation (perhaps surprisingly) has trended downward with rates! The chart below overlays year over year inflation with the federal funds rates.


Source: www.macrotrends.net On Left: Rate of inflation On Right: Fed Funds Interest Rates


So the question we should all be asking is: If inflation has been going down as rates have gone down why is the fed fighting inflation by raising rates?


One idea says they aren’t. The fed may not believe that rates can curb inflation directly but may believe that banks will lend out less money to collect the fed funds rates on their own books. If that is the fed’s goal, they could be making a mistake. As banks line up for the guaranteed interest rates by the fed, the fed runs the risk of not being able to cover its own debts. Now might be a good time to mention all the repos and high yield bonds they purchased during (and prior to…) the pandemic. As Feds raise rates these assets decrease in value and the fed could get stuck with a loss on their books or not having enough revenue to pay the rates they have set.


If you have an interest in history, you may ask has this ever happened before? The answer is yes. Over a century ago the United States had break throughs in car engines, airplanes, vaccines, global travel and finance. It was the greatest period of economic prosperity ever seen in the world up to that point, famously dubbed The Gilded Age. Then after a series of financial panics the 1913 Federal Reserve Act created what is now known as the Federal Reserve.


As globalization came to an end in 1914 and the assassination of the Archduke Franz Ferdinand kicked off World War I, the freshly formed US Central Bank was about to face its first major challenge. “How shall US monetary value be protected?” By 1915 World War I rapidly expanded across Europe and the United States began providing munitions, supplies and loans to European governments to help sustain their fight until ultimately sending its greatest resource “its own citizens” in 1917.


Readers of Mark Twain should feel a certain rhyme to current events. The invasion of Ukraine kicked off western condemnation of Russia. In return Russia kicked off a European energy Crisis. The United States in return sent billions of dollars’ worth of munitions to Ukraine while amping up fiscal, industrial, and energy support for Europe. Russia, who was once an ally to the United States, France, and Britain in World War I, faces a crucial question, “Will they follow the same path as the Central Powers?” Or “Will they fold their hand?”


Geopolitical Speculations aside, the actions of the federal reserve and outcome of the two wars from 1915 to 1947 resulted with the United States taking over as the worlds reserve currency and the dissolution of the British Empire. If Europe continues to fight for heating this winter and war efforts escalate in Ukraine, we don’t need to walk blindly into what happens next nor do we need to walk randomly down wall street. The intelligent investor can ask what happened last time and prepare their investment portfolios accordingly. If you or your advisor is not familiar with this history, we’d be honored to consult your portfolio and discover how to work together over the next season of financial markets. Blacor Investments has provided Private Investment Advice since 1959, we offer investors investment advice and financial strategies that stem from three generations of investment professionals.


References:



Securities offered through International Assets Advisory, LLC (“IAA”) – Member FINRA/SIPC.

Advisory services offered through International Assets Investment Management, LLC (“IAIM”) –SEC RIA.

Blacor Investments is unaffiliated with IAA and IAIM.


The information provided in this newsletter is based on carefully selected sources, believed to be reliable, but whose accuracy or completeness cannot be guaranteed. All information and expressions of opinions are subject to change without notice and are those of Blacor Investments. Past performance may not be indicative of future results. Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied on for the purpose of avoiding any tax penalties. You should discuss any tax or legal matters with the appropriate professional.

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