Why Fed Chair is Almost Definitely Wrong?
During a conversation in London, the U.S. Federal Reserve Chair Janet Yellen said that the banks are “much stronger” and “another financial crisis is unlikely to happen in our lifetime”. While banks have continued to perform since 2008 and they passed the recent stress test, for the Fed chair to make such a bold claim, it is a sign of complacency and perhaps some ignorance. While she gave her stamp of confidence, my opinion is that the financial system is at very elevated levels now, and the next financial crisis may be more severe than the Global Financial Crisis in 2008 based on the current valuation.
With US stock market at all time high and the US national mounting close to $20 trillion. This begs the question of “Can the U.S. economy go on like this forever?”
To predict the future, we often just have to look to the past. And this time round, we set our eyes on France in 1700s and on an interesting character named John Law.
Those curls!
John Law’s background was colourful to say the least. Born in Scotland, he was known for this mental prowess in calculation and he has a brief success in gambling. However, in a twist of fate, he was jailed when he killed a man in a duel over a women. Miraculously, he managed to escape England and flee to Europe. He was later educated on finance and banking in Amsterdam.
He came up with his own economic and monetary theories which he tried to convince governments to adopt but to no avail. But a major economic event is developing in Europe which will alter his fate forever.
In 1715, France was facing an economic crisis. In short, it was almost bankrupt from all the debt of the expensive wars that it waged. The downtrodden French economy provided the suitable test-bed for Law’s economic theory.
Seizing the opportunity, Law presented his idea to the king of France. In order to rescue France from the economic crisis, he proposed that France set up a central bank that is able to issue large amounts of legal tender. It is essentially the modern day paper currency.
His main idea is to create a bank for all national monetary matters and establish a monopoly against the private banks. He believed that by increasing the amount of paper money in circulation, it will produce a greater GDP and its profits will help to pay off the national debt.
The king was delighted and granted Law the license to establish a national bank. Law was also granted exclusive trading rights to the French territories in Mississippi, and he soon set up the Mississippi Company to monopolise the trade in Mississippi.
But his genius stroke was when he issued 50,000 shares of the Mississippi Company. Each share is issued at $500, but investors just need to pay $75 down to purchase the stock with the remaining paid in instalments. With such a high leverage ability, the share price shot to $1,000 and even ordinary people who knew nothing about the stock started to participate in the investment.
In order to pay off the national debt of $1.5bn, Law issued even more shares. By 1719, more than 600,000 shares were issued and the share price sky-rocketed to $15,000 at its highest. This is also the first time the word “Millionaire” was used to describe a person of great wealth.
However, in 1720, some investors started to sell their shares for gold coins. To support the share price, Law asked the central bank to issue more money to buy back the shares. But this had a massive impact on the economy – inflation. Prices of daily produce and food started to rice and the investors rushed to convert the paper money into gold coins. Soon, the central bank was forced to shut down and the share price of Mississippi Company continue to fall.
The Rise and Fall of John Law
Law was sacked from his position as the Fed Chair equivalent and he went into exile.
Coming back to year 2017, although Janet Yellen’s action is from John Law, there is an eerie similarity between the current US economy and that of France in 1715. We still have the Fed Reserve, several rounds of QE (Quantitative Easing) and the interest rates are kept at all time low which encourage rampant borrowing (yes they did raise the rates a little recently). Most importantly, the S&P 500 is at an all time high since forever.
Source: Google
History does repeat itself but it sure rhymes.
While I’m not a betting person, but I am willing to bet my money that Yellen is definitively going to be proven wrong in time to come – “another financial crisis is unlikely to happen in our lifetime”…. unless her lifetime is coming to an end soon (sounds so morbid).
I don’t know when the crisis will come but the probability sure looks higher now than before. So invest carefully!
See you soon!
Investing Always,
Pete
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