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   Daily Blog - Tiger Software

                 February 3, 2008    

Aggressive FED Rate Cuts Like This Have One
     Precedent: 1957-1858. 

      Part II - Who Will Be Proven Right?
     The Monetarists or The Keynesians?

William Schmidt, - Tiger Software's Creator
      (C) 2007 William Schmidt, Ph. D.  - All Rights Reserved. 

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      wpe56.jpg (33448 bytes)

        Who Will Be Proven Right? 
              The Monetarists or The Keynesians?

        Part 2.  (See Part 1 - http://www.tigersoft.com/Tiger-Blogs/Jan-29-2008/index.html )
wpe4F.jpg (4271 bytes)            versus               wpe50.jpg (3042 bytes)
    Ben Bernacke                                          John M. Keynes

     Can A Severe Recession Be Avoided?

                         Bernacke's cuts of interest rates have been breath-taking.  We see very few times in history when
          rates were cut as fast.   People forget that it was the raising of rates by Fed Chairman Greenspan that
          started the awful 2000-2003 bear market.. He chose to fight stock market speculation in the same way the
          Fed had done in 1928 and 1929, raising interest rates rather than increasing margin requirements.  When the
          stock market did crash in 2001 and 2002, Greenspan dropped the Discount rates from 6.0% in small 1/2%
          and 1/4% steps from 2001 until November 7, 2002.  One has to ask if he had acted more forcefully, more
          quickly could the longest bear market since the Great Depression have been shortened and ameliorated.
          Greenspan was always cautious.   He instituted no Discount Rate cut after the 1987 Crash, though the Fed
           Funds' rate was dropped.. And he was late in reacting to the 20% decline in 1998 in the aftermath of
          of the collapse of the LT-Hedge Fund.  Bernacks clearly is more aggressive than Greenspan.  Bernacke's
          academic interest at Princeton was centered around the monetary mistakes of the Great Depression.

          wpe52.jpg (57921 bytes)

wpe51.jpg (4806 bytes)   DID GREENSPAN CAUSE
  THE CRASH OF 2001-2003?

11/19/98 to 08/24/99 4.50
08/25/99 to 11/17/99 4.75
11/18/99 to 02/02/00 5.00
02/03/00 to 03/20/00 5.25
03/21/00 to 05/17/00 5.50
05/18/00 to 01/03/01 6.00

                  Bernacke clearly is much more aggressive than Greenspan. We might want to study his
    wpe53.jpg (28382 bytes)       Essays on the Great Depression. 

wpe4D.jpg (29368 bytes)   Recent
Discount Rate
06/29/06 to 08/16/07 6.25 0
08/17/07 to 09/17/07 5.75 0
09/18/07 to 10/31/07 5.25 0
11/01/07 to 12/11/07 5.00 0
12/12/07 to 01/21/08 4.75 0
01/22/08 to 01/30/08 4.00 0
01/31/08 to present 3.50 0

    (Cartoon's source: http://politicalhumor.about.com/od/politicalcartoons/ig/Political-Cartoons/Bernanke-s-Brew.htm )

                         Ben Bernacke has followed in the foot-steps of Milton Friedman in believing that business
               cycles can be smoothed by timely raising and lower of interest rates.  When business conditions
               weaken it is the job of the Federal Reserve to increase the supply of money in the US economy.
               Both argue that the Great Depression was a direct result of mistaken monetary policies and that
               the inflation of the 1970s resulted because President Nixon wrongly tried to use wage and price
               controls to control inflation. 

                      Bernacke's lecture in March 2004 makes clear his concern that the Fed be a primary agent
                in the battle to avoid another great Depression.  He begins by contrasting the severity of the
                Great Depression and the deepest post World War II recession.  "During the major contraction phase
                of the Depression, between 1929 and 1933, real output in the United States fell nearly 30 percent.
                During the same period, according to retrospective studies, the unemployment rate rose from about
                3 percent to nearly 25 percent, and many of those lucky enough to have a job were able to work
                only part-time. For comparison, between 1973 and 1975, in what was perhaps the most severe U.S.
                recession of the World War II era, real output fell 3.4 percent and the unemployment rate rose from
                about 4 percent to about 9 percent."  Unlike in the 1970's, prices fell by 10% in the 1930s.  Money
                supply decreased by one-third between 1929 and 1933.  He praises the book by Friedman and
                Schwartz, A Monetary History of the United States, 1867-1960 (1963) for pointing out a series of
                mistakes by the Federal Reserve in the period 1929 to 1933.

                  1. The first mistake was the Fed's raising the Discount Rate in 1928 to curb excessive stock
               speculation.   The Fed should have dealt with stock speculation differently (Raising the margin
               requirements would have been a better policy choice.) since the economy itself was slowing down
               in 1928. The Fed had lowered rates from 7.0%, starting on 5/10/21, in steps to 3.5% on 9/13/1927.
               It then raised the rates until 2/28/30, four months after the Crash. It sat on its hands after 9/12/30,
               when the DJI was at 241.20
                                    Date       Discount Rate  DJI
                                    9/13/27  3.5%                   194.70
                                    2/27/28  4.0%                   192.10
                                    4/25/28  4.5%                   208.90
                                    5/14/29   5.0%
                                    9/13/29                              381.20                             
                                    2/8/30    4.5%                   271.10
                                    4/15/30   4.0%                   293.30
                                    9/12/30   3.5%                  
                                    Fed did nothing for the next 3 1/2 years!
--------------------- DJI 1931 -----------------------------------------------------------------------------------------------------
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---------------------------- DJI 1932 -----------------------------------------------------------------------------
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                                   2/27/33                               50.20
                                    3/16/34   3.0%                   102.70
                                    1/8/35     2.5%                   105.00
                                     5/14/35   2.0%                  114.20
                                     8/24/37   1.5%                  182.40
11/23/37                         115.80
                                     9/12/39                             155.90
                                     3/28/42   1.0%                 
                                     (Source: http://minneapolisfed.org/research/data/us/disc.cfm
                 2. In 1931 and 1932, the Fed chose to protect the Dollar against foreign exchange speculators
               by rising interest rates, instead of doing all they could to take steps to prevent the growing number of
               bank failures in the US.  There was no Depositors' Insurance. That would have helped a lot to stem
               the tide of runs on banks. "The Federal Reserve had the power at least to ameliorate the problems
               of the banks. For example, the Fed could have been more aggressive in lending cash to banks (taking
               their loans and other investments as collateral), or it could have simply put more cash in circulation.
               Either action would have made it easier for banks to obtain the cash necessary to pay off depositors,
               which might have stopped bank runs before they resulted in bank closings and failures.
                  3. Many of the Fed Governors viewed the "Depression as the inevitable and necessary purging
               of financial excesses built up during the 1920's". 
                   4. Some Governors did not understand that "even though nominal interest rates were very low,
               the ongoing deflation meant that the real cost of borrowing was very high because any loans would have
               to be repaid in dollars of much greater value."

          The Closest Historical Parallel to 2008 Is 1958
         if We Are Considering Rapid Cuts in Interest Rates.
         This Produced A 52% Gain from Its Lows in 21 Months.

                      Background:   The DJI had run up strongly, nearly 100%,  from 255.50 on September 1954 to
             521.10 in April 1956.  In 1956, a Presidential Election year, ir then went sidewise with two steep
            drops in the Presidential Election year of 1956. But from mid-July 2007, with the DJI at 520, the market
            started turning down.   On October 4th, 1957, the Soviet Union successfully launched Sputnik, the
            world's first artificial satellite.  The USSR was seen as ahead of the US in the Space Race.   The US
            had announced its own plan to put up a space satellite in July 1955, but did not succeed until January
            31, 1958.
---------------------------------- DJI 1957 -------------------------------------------------------------

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                          On   11/22/57 the Discount Rate was dropped from 3.5% to 3.0% It was then lowered
             in three steps to 1.75% by 4/18/58.  On 11/22/57 the DJI was at 442.70.  On 4/18/58,
             it was at 449.30.    It peaked on 8/3/59 at 678.10, a rise of 50.9%.    This was a 50% reduction
             in the FED DISCOUNT rate cut in 4 months.

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Source: http://trendocracy.blogspot.com/2008/01/ben-bunyon-bernanke.html
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   I see no physical resemblance.  But it does increasingly appear
   that the Fed Chairman will do whatever necessary to prevent
   a bear market. .Imagine playing Monopoly with free access to
   the bank's money.

           Next - The Limits of the FED's Power:
                                 Criticisms of A Monetarism.....




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