Why Is The Stock Market Crashing?

Such an annoying question to ask, isn’t it? The correct answer is because people desire to hold stocks less and prefer to hold cash more than they did prior to the crash. The reasons for this are ultimately unknown but we can speculate.

The value of a stock to an investor is the present value of all future expected cash flows, discounted by the risk free rate. If you wanted to be 100% accurate you’d need to use the expected rate from now through the day of each individual cash flow, respectively, but I like to use the 20 year t-bond rate for simplicity’s sake.

Based on this there are two major reasons for stocks to crash: a drop in future expected earnings and/or a previously unexpected increase in the risk free rate.

Market action from Feb 1-8 has basically been marked by the following factors:

  • crashing stocks
  • slightly falling gold prices
  • falling/stable short term Treasury rates, rising long term Treasury rates, with a shift occurring around the 3-5 year duration (see graphic below)

Falling/stable gold prices indicate that investor expectations of future inflation haven’t fundamentally changed in recent days.

There’s no evidence that I’m aware of that indicates that corporate profit expectations are collapsing, in fact, the recent earnings season was upbeat, with positive news & expectations all over the place. But it’s also important to point that after the recent tax reform which is expected to expand deficits (a net positive on corporate profits, as I’ve explained before) one big factor towards rising corporate profits is now 100% priced in, whereas before it wasn’t.

Furthermore, there’s currently no evidence that the Fed is planning on accelerating the expected schedule of 3 rate hikes this year. In fact, at this very moment CME Fedwatch probabilities even slightly lean towards only 2 vs the widely expected 3 rate hikes!

In my opinion, this kind of action more than anything hints at a sudden change in investor expectations in the schedule of Federal Reserve interest rate increases over the coming years.

The one significant factor that I’ve been able to pinpoint is the seemingly subtle change in language in the most recent FOMC statement from January 1 2017. Minor shifts early on in the future schedule of expected rate hikes can have a huge impact on long term rates, since long term rates are basically just a bet on the average rate of short term rates inbetween.

If you do a text compare with previous FOMC statements, the following changes in verbiage stand out:

  • While most previous Fed statements said that “Market-based measures of inflation compensation remain low”, the most recent one states that “Market-based measures of inflation compensation have increased in recent months but remain low”.
  • Furthermore, most previous statements said that “Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term”, while the most recent one states that “Inflation on a 12‑month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term”.
  • And finally, another subtle difference is that statements recently always said “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate”, while the most recent one stated that “The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate”.

These changes could indicate that the Fed is beginning to prepare markets for an acceleration in the pace of raising interest rates, not immediately this year, but in the coming years.

This could explain why there hasn’t been a big shift in the rates on 3-5 year bonds, but after that the rates have increased substantially, with the 20 and 30 year Treasury rate (the one I like to use to discount future expected profits) rising by 13 basis points over just a few days. Such an adjustment in the medium to long term schedule of expected rate hikes, without corresponding changes in future profit expectations, can absolutely lead to significant adjustments in current stock market valuations, after which things should continue at the usual pace. For simplicity’a sake you could run a simplified model of present value at constant growth using different discount rates to get an idea of the possible magnitude of such adjustments.

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Discussion About Fed Rate Hikes & Modern Monetary Theory

I had another great conversation with my fellow BeingLibertarian.com contributor Brandon Kirby. We talked about the Fed hiking rates and Modern Monetary Theory.


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Is the Federal Reserve Bank Public or Private?

Private vs Public Ownership

Some people will say public ownership means something is owned by the government and private ownership means it’s owned by private individuals or corporations, but those are all nothing but fuzzy and imprecise ways of defining the concept at hand. When I lay out a definition I always want to make sure it’s as unambiguous and precise as possible.

That being said, here’s how I would suggest the terms be defined for the sake of a helpful and constructive discussion: Private ownership is the control over matter that has been achieved without the use or threat of theft. Public ownership, on the other hand, is control over matter that has been achieved via the use or threat of theft.

Theft in turn is the initiated occupation of something controlled by another person against that person’s will.

All property origination is of course private. For anything that is supplied by nature and not yet being made use of by anybody can be taken initial ownership of without anybody else exerting control over it at that time, and the occupation occurs without affecting any current owner’s will.

Note that control can be direct physical control but could also mean indirect control, such as instructing other people to do the physical controlling, etc.

For all practical purposes, the main entities engaging in such threats and acts of aggression and theft that characterize public ownership as outlined above, are what people commonly refer to as governments.

The Federal Reserve System

Under our currently prevailing system of societal organization, namely interventionism, where it’s certainly hard to find even just one industry where the state does not heavily interfere in one way or another, it can be argued that no ownership is ever 100% public or private. The real question then becomes is something owned in a rather private or rather public fashion.

For example, if 20% of activity within a business occur under the threat of theft or aggression, while the remaining activities occur without it, one could argue that the organization in question is by and large private.

So let’s examine some facts a little more closely to determine whether the Fed should be considered rather public or rather private:

On the creation of the Federal Reserve System (Fed):

The Federal Reserve Act (ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. ch.3) is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes (now commonly known as the U.S. Dollar) and Federal Reserve Bank Notes as legal tender.

So in other words, an Act of Congress established the Fed first and foremost and laid out the rules that would apply to how it would be implemented and run.

It’s also important to point out that as per this Act

… all nationally chartered banks were required to become members of the Federal Reserve System. It required them to purchase specified non-transferable stock in their regional Federal reserve bank and to set aside a stipulated amount of non-interest bearing reserves with their respective reserve bank. (Since 1980 all depository institutions have been required to set aside reserves with the Federal Reserve and be entitled to certain Federal Reserve services – Sections 2 and 19.) State chartered banks were given the option of becoming members of the Federal Reserve System and thus to be supervised, in part, by the Federal Reserve (Section 9). Member banks became entitled to have access to discounted loans at the discount window in their respective reserve bank, to a 6% annual dividend in their Federal Reserve stock and to other services (Sections 13 and 7).

In other words, any organization that wants to operate as a National Bank, a concept that results out of government legislation, is required by government law to join the Federal Reserve system and purchase non-fungible ownership shares in their regional Fed branch.

The Fed’s main governing body, the Board of Governors, is a Federal government agency:

The seven-member Board of Governors is the main governing body of the Federal Reserve System. It is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy. Governors are appointed by the President of the United States and confirmed by the Senate for staggered, 14-year terms.

The Federal Open Market Committee, arguably the most influential organization within the Fed, is under majority control by the members of the aforementioned Board of Governors:

The Federal Open Market Committee (FOMC) created under 12 U.S.C. § 263 comprises the seven members of the board of governors and five representatives selected from the regional Federal Reserve Banks. The FOMC is charged under law with overseeing open market operations, the principal tool of national monetary policy.

A graphic illustrates the control exercised via these two organizational bodies:

Structure of the Federal Reserve System

The Fed obviously earns money from interest payments on the assets it holds on its balance sheet. The profit generated is is transferred over to the U.S. Government every year:

The U.S. Government receives all of the system’s annual profits, after a statutory dividend of 6% on member banks’ capital investment is paid, and an account surplus is maintained.

The most recent annual report shows that the Fed made a total profit of $77.3 billion in 2011. Of that a total of $1.5 billion was paid in dividends to member banks while $75.4 was paid to the U.S. Treasury. In other words, the U.S. Government receives around 98% of all Fed profits.

The Fed’s main physical product, the so called Federal Reserve Notes, which all deposits are ultimately convertible into in last resort, is produced by the U.S. Department of the Treasury and sold to member banks of the Federal Reserve System for about 4 cents per note:

Federal Reserve Notes are printed by the Bureau of Engraving and Printing (BEP), a bureau of the Department of the Treasury. When Federal Reserve Banks require additional notes for circulation, they must post collateral in the form direct federal obligations, private bank obligations, or assets purchased through open market operations.[8] If the notes are newly printed, they also pay the BEP for the cost of printing (about 4¢ per note). This differs from the issue of coins, which are purchased for their face value.

Trying to compete with the Treasury Department or the Fed by producing the same product they deal in can get you kidnapped and thrown in a cage for up to 15 years:

Manufacturing counterfeit United States currency or altering genuine currency to increase its value is a violation of Title 18, Section 471 of the United States Code and is punishable by a fine of up to $5,000, or 15 years imprisonment, or both.

Legal tender treatment has ensured an ongoing demand for Federal Reserve Notes, in particular I always like to point to an excellent analysis called “Gold, Money and the U.S. Constitution” from constitutional lawyer Eugene C. Holloway, or my summary of it:

Some scoff at the statement that the legal tender laws are coercive. The answer to those skeptics appears in Andrew Dickson White’s monograph Fiat Money Inflation in France. In 1793, failure to accept the French paper money was made punishable by death and the punishment was actually imposed as demonstrated by the lists of those condemned to the guillotine. In contrast to the Draconian measures taken after the French revolution, the import of the U.S. legal tender laws has been merely to allow private and public debtors to legally discharge their debts by payment of legal tender currency. But this form of interference by the state in private transactions to appropriate the wealth of creditors is coercive nevertheless; and the French experience illustrates the direction that any kind of state coercion can take once the state’s authority to act is established.

Public or Private?

So to sum it up:

  • The Fed and all rules associated with it were created by the U.S. Congress
  • Membership is mandatory for national banks by government law
  • Ownership of Fed stocks is mandatory for national banks by government law
  • The Fed’s Board of Governors is appointed by the President and confirmed by the U.S. Senate
  • The Federal Open Market Committee (FOMC) is under majority control by the federally appointed Board of Governors
  • The products that the Fed deals in are produced and sold by the Department of the Treasury
  • The Fed is protected by the U.S. Government from competition in the products it deals in
  • The U.S. Government has, via a succession of different court rulings and laws, made the acceptance of Federal Reserve Notes required as a means to discharge all debts public and private
  • The U.S. Government receives around 98% of the Fed’s annual profit

I know there may be cases where the question of rather public or rather private may be difficult to decide, for example an oil company that competes with others in a market environment, yet receives government subsidies, or GSEs such as Fannie Mae and Freddie Mac before they were completely nationalized, etc.

But I don’t see how the US central bank could pose such a challenge by any stretch of the imagination – can there be any doubt that for all practical purposes the Federal Reserve System is a 100% public institution of the U.S. Government?

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The Fed’s Secret Loans, Europe’s Crisis, and the Boring Patterns of Statist Propaganda

In response to recently published information about the Fed’s emergency loans, Bloomberg’s Felix Salmon was promptly ready to perpetrate this piece of grade A scumbaggery:


Ladies and Gentlemen, this is what a lender of last resort looks like. What you’re looking at here are three lines. The black line is Morgan Stanley’s market capitalization, which tends to hover in the $40 billion range but which fell as low as $9.8 billion in November 2008. The orange line is the amount that Morgan Stanley owed to the Federal Reserve on any given day — an amount which peaked at $107 billion on September 29, 2008. And the red line is the ratio between the two: Morgan Stanley’s debt to the Federal Reserve, expressed as a percentage of its market value.That ratio, it turns out, peaked at some point in October, at somewhere north of 750%.

Many congratulations are due to Bloomberg, for extracting this information from the Fed after a long and arduous fight. It couldn’t have come at a timelier moment: if the ECB wants to avert a liquidity crisis, charts like this give a sobering indication of just how far it might have to go, and how quickly it might have to act.

The Euromess has everything to do with the fact that the ECB exists in the first place, and the fact that it enabled irresponsible bureaucrats to hide behind relatively responsible ones and borrow beyond their respective taxpayers’ means.

Almost 3 years ago I already said that if European government bureaucrats don’t quit the centralization of power which enables the above, things would only get worse and worse.

Then about 2 years ago I wrote:

The truth is very simple: The best that can be done for the people of Greece is to not provide one cent of assistance to its corrupt, bloated, and union-controlled government apparatus. A country’s bailout is like a corporate bailout, only many times worse! From this logically follows that the absolute worst Europe could do to the people of Greece would be to give their rulers any more means to continue their irresponsible policies.

The European Currency Union and the European Union itself are both such gigantic failures that it is already pre-ordained that the entire experiment will go down in flames sooner or later. Now is certainly not that time yet. What we are seeing are just a few more cracks emerging in the structure of the system. The European bureaucrats will come up with some sort of pseudo solution to paper over and patch the Greek problem for now.

Even if the Greek government were saved to the detriment of the people it tyrannizes, this won’t be the last time we’ll be having this discussion, and it sure as hell won’t get any better!

We’re having that discussion again now, and the time has run out for patchwork and pseudo solutions. The system is going down as predicted.

To say that the Euromess is caused by a lack of even more ECB intervention is to say that the heroin addict’s withdrawal pains are to be imputed upon a lack of an increase in his dosage.

I think that’s pretty lazy and irresponsible stuff to put out there and it genuinely hurts reading it.

Wouldn’t it make sense at some point to stop and think a little more carefully and precisely about the things we say in public discourse?

Bank of England governor King pointed out a few weeks ago: “This phrase ‘lender of last resort’ has been bandied around by people who, it seems to me, have no idea what lender of last resort actually means, to be perfectly honest. It is very clear from its origin that lender of last resort by a central bank is intended to be lending to individual banking institutions and to institutions that are clearly regarded as solvent. And it is done against good collateral, and at a penalty rate. That’s what lender of last resort means.”

And about the Fed having solved any problems in the US … are you going to say the same thing when the public debt burden, subsidized by QE1,2,3,4,5…, will have reached an amount where the government’s automatic spending cuts start to kick in and begin to impoverish more and more of the millions of people who have been made dependent upon government handouts?

Or better yet, are people going to be asking for the Fed and government to step in, grab more power, and regulate all these banks’ irresponsible speculation binges, because for some inexplicable, magical reason they don’t seem to have much of an incentive to conduct business prudently, to pay themselves reasonable salaries, or to lend responsibly, and not, say … invest in Greek bonds for example?

The pattern is simple and boring: Keynesian and other statist clowns out there will continue doing what they’re paid for. They will support one stupid ass government spending and expansion program after another, applaud one newly created government institution after another, be completely incapable of predicting the long term effects of those unsustainable policies, ignore or even ridicule those who are capable, and then when the inevitable crisis hits they will boldly “predict” that a tragic crisis is going to hit, should all those unsustainable programs not be sustained.

This is truly embarrassing to watch.

But at the same time it’s encouraging to see other people around the world wake up to the truth, and ditch the repetitive dronings and platitudes of entitled and state tenured ivory tower academics whose cumulative output will supply plenty of instructive and awe-inspiring entertainment for future generations.

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Arguments for Quantitative Easing?

For the sake of grasping the futility of spending time sifting through politicians’ arguments, I want to point out a prime example.

This is Ben Bernanke on Quantitative Easing:

“The best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States,”

OK, so this of course means absolutely nothing to any mortal person. Nor is it supposed to. It’s yet another innocuous, dumb, and boring front to pure and simple theft.

On November 4th, after announcing QE2, Bernanke certainly wasted no time to declare victory:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

OK, as you know I would argue that it is simply ridiculous so consider a coerced cheapening of interest rates when people are sick and tired of debt anyway, and a simultaneous increase in the cost of purchasing shares in companies’ profits a success by any means. Furthermore it is even more ridiculous to look at month to month movements to proclaim success or failure of any policy, while disregarding the long term effects that always inevitably ensue!

But let’s forget about that for a second. Let’s measure the immediately proclaimed success by Bernanke’s own standards. Surely if he says that all those measures moved into a desirable direction over the course of a month or so, it would most certainly be undesirable if they moved in the other direction by even more, right??

“Stock prices rose … “

What has happened since Nov 4th with stocks?


“… long-term interest rates fell …”

What has happened to long term rates since Nov 4th?



“… Lower corporate bond rates will encourage investment …”


OK, so now that all these figures have blown up right in Bernanke’s bearded face, he’s surely going to step up to the plate and admit failure immediately, right?

Just kidding … I’m just posting this as one example as to why you should not spend a second listening to bureaucrats’ arguments that are designed to defend their own policies.

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