I was thinking about a creative use of the Fed this morning. Not sure if I came up with this term–it seems too obvious not to have been thought of by someone–but I can’t consciously trace where I may have read it.
In the 20’s, Wall Street was largely unregulated. Groups of super-rich could and would, as a matter of historical record (I saw this on the History Channel, so it must be true), get together and pick a stock, any stock. They would buy up large amounts of it. The fundamentals didn’t really matter, although good lies are always more plausible than bad ones. They would literally pay someone at the New York Times or whatever other rags there were back then to start writing positive stories about that stock, such that excitement was generated. Other people would start buying it, so the price went up. At a certain point, they would send in their Sell notices, and pocket in some cases millions over the course of weeks. Obviously, you can’t do it weekly, or people wise up, but this was definitely something that happened more than once.
Now, let’s involve the Fed in this. I own a very nice top hat, gloves, tuxedo, have a chauffeur, a valet, and smoke expensive cigars. I instruct my bank to buy up a bunch of U.S. Treasury bonds at prevailing prices.
As it so happens, I also sit on the Board of Governors of the Federal Reserve Bank of New York. Frankly, this could be in the 20’s, or it could be today.
I decide that the economy–which is to say the same thing as “me”–would benefit from a healthy infusion of cash. So I vote for the Fed to buy up a bunch of my Treasury securities. This is new money. When I bought my Treasury Notes, that money went to the Federal government, and was promptly spent, entering the wider economy. That money is gone. So the money now coming from the Fed is money from that magical checkbook they have.
I now have a pile of cash with which to inflate things. I focus on a range of stocks, to make what is happening less obvious. But the net is that I buy up a lot of stock, and in so doing inflate the prices. This creates upward motion which, given human psychology, most notably a need to not miss out on a “sure” thing, feeds on itself, up to a point. Given enough money, you can “day trade” in a quite secure manner, by being the one who–by and large–dictates the value of the stocks. Again, there is no fundamental reason this could not be happening today.
At a certain point, you have made enough for now, so you put your Fed hat back on, and buy the Treasury stocks back. You take that cash out of the system, which is deflationary. To be clear, you pay the Fed cash for the Treasury notes it holds. That money is then extinguished.
Stock prices then fall to the extent to which they were inflated, but–again given human psychology–will tend to fall farther than equilibrium. What does this do? It creates sales. You have excess money left over from your stock speculation, so you use that to buy up banks and industries.
If you don’t get overly greedy, if you are sufficiently patient, you can do this over and over forever. I believe there may well be trillionaires out there.
I am still evaluating the situation, but it is hard not to believe this is basically what happened in the leadup to the Great Depression. Clearly there was inflation; clearly the Fed was ivolved; and clearly the main players got out before the Crash.