A Toast to the Lender of First Resort

By David Stockman  |  February 28, 2019

The people are naturally conservative. They are more conservative than the financiers. Those who believe that the people are so easily led that they would permit the printing presses to run off money like milk tickets do not understand them. It is the innate conservation of the people that has kept our money good in spite of the fantastic tricks which financiers play – and which they cover up with high technical terms.

The people are on the side of sound money. They are so unalterably on the side of sound money that it is a serious question how they would regard the system under which they live, if they once knew what the initiate can do with it.

– Henry Ford, My Life and Work (1925)

In a properly functioning free-market economy, central banks are “lenders of lastresort.” That means they do their work during financial crises, providing finance to worthy credits at times of high stress. And they do so at a penalty spread above the market rate of interest, no matter how high it goes.

Today, central banks are “lenders of first resort.” That means they’re expected to work round the clock to keep traders and speculators happy. And they go to extraordinary lengths to make the process as easy as possible.

The estimable David Rosenberg framed it well a couple weeks ago on Twitter:

We are on the precipice of an earnings recession and the market is soaring. Is there a chapter in the classic Security Analysis by Graham & Dodd that I missed on trade talks and border wall funding?

Well, yes, there is a missing chapter.

It’s the one on the theory held by a long line of academic scribblers, from Milton Friedman to Ben Bernanke, that the free market is a wonderful thing… except when it comes to Wall Street and matters of money and credit.

Their argument is that the money-market interest rate, the shape and level of the bond yield curve, and even capitalization rates for equities and risk assets are too important to be left to the market-clearing, price-discovery mechanisms of supply and demand.

For all these crucial financial prices, you need a monetary politburo. In America, we call it the Federal Open Market Committee (FOMC).

They gaze upon the complexities, cross-currents, and undulation of a $20 trillion economy.

And they divine the rates that will optimize growth at any point in time… that will always and everywhere ward off recession… that cushions the threat of underperformance arising from any untoward act of god and/or man.

Of course, Professor Milton Friedman and other forbears of modern central banking never put it so bluntly. Instead, they hid behind a quantity theory of money and an obsolete view of bank-based credit.

The giant problem with monetary central planning is that in targeting, pegging, and falsifying financial asset prices, the FOMC became Wall Street’s hostage.

It steadily lost sight of any limits at all on its efforts to “stimulate” gross domestic product (GDP) and its components. And it set aside all traditional notions of financial discipline and sound money.

As a practical matter, that meant interest rates could never be low enough. Also, prices of risk assets needed to climb indefinitely. And they should be propped up by the central bank if they should seriously falter. We saw it happen in 1987, 1998, 2000-01, and 2008-09.

It’s been happening continuously ever since Alan Greenspan took over the Eccles Building.

Our monetary central planners have tumbled deep into a rabbit hole. Indeed, they’ve lost all contact with the absurdity and danger of what they’re doing. They are massively and fraudulently monetizing the public debt. And they’re expanding the nature of their asset purchases.

The Bank of Japan, for example, owns 78% of Japanese exchange-traded funds. The Bank of Switzerland is one of the world’s largest equity hedge funds. And the European Central Bank is the proud owner of billions of euros in corporate and junk bonds.

In all, led by the Federal Reserve, monetary central planners have undertaken a collective money-printing spree with not even a remote historical precedent.

Their balance sheets have grown from $4 trillion to $25 trillion since 2003. And bit of that $21 trillion expansion was plucked from thin air.

But that’s the point of Keynesian central banking: It’s all about falsifying the price of credit and subsidizing the use of leverage.

That’s despite the obvious real-world proof that rising debt relative to income has caused GDP growth to slow relative to historical rates.

But that’s not really the point anymore. Monetary central planning no longer even pretends to be about Main Street.

It’s about the Acela Corridor and sustaining the American Empire.

Here’s Your Fail-Safe…

Desperate times call for common sense measures.

And these are desperate times… Markets are corrupted by monetary central planning. They’re confused. And the road back is going to be treacherous.

We’re looking at a major re-pricing for all financial assets. And thousand-point intraday or day-to-day swings are part of that equation. Those can be frightening… for “buy and hold” investors.

I have a different approach, one that combines strategy and tactics into a plan flexible enough for you to survive and thrive amid the coming chaos. It’s called “The Stockman Model.”

All we’re after is a little stability, perhaps a chance to pocket a windfall when opportunity presents…

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David Stockman

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR