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Back in 1966, the most esteemed Alan
Greenspan himself wrote the following in an essay entitled “Gold
and Economic Freedom”:
“When
business in the United States underwent a mild contraction in 1927,
the Federal Reserve created more paper reserves in the
hope of forestalling any possible bank reserve shortage. More
disastrous, however, was the Federal Reserve's attempt to assist Great
Britain who had been losing gold to us because the Bank of England
refused to allow interest rates to rise when market forces dictated (it
was politically unpalatable). The reasoning of the authorities involved
was as follows: if the Federal Reserve pumped excessive paper reserves
into American banks, interest rates in the United States would fall to a
level comparable with those in Great Britain; this would act to stop
Britain's gold loss and avoid the political embarrassment of having to
raise interest rates.
The
"Fed" succeeded; it stopped the gold loss, but it
nearly destroyed the economies of the world, in the process.
The excess credit which the Fed pumped into the economy spilled over
into the stock market-triggering a fantastic speculative boom.
Belatedly, Federal Reserve officials attempted to sop up the excess
reserves and finally succeeded in braking the boom. But it was too late:
by 1929 the speculative imbalances had become so overwhelming that the
attempt precipitated a sharp retrenching and a consequent demoralizing
of business confidence. As a result, the American economy collapsed.
Great Britain fared even worse, and rather than absorb the full
consequences of her previous folly, she abandoned the gold standard
completely in 1931, tearing asunder what remained of the fabric of
confidence and inducing a world-wide series of bank failures. The world
economies plunged into the Great Depression of the 1930's.” (end,
emphasis added)
Do we see any parallels here?
The two major players in the world
financial system at that time were the United States and Great Britain.
The United States was the emerging industrial power, whereas Great
Britain was the mature and stagnating industrial power. The central bank
of the emerging industrial power (the US) printed money in an effort to
prop up the economy of the mature industrial power (Great Britain). The
inflation of the money supply resulted in the overheating of the economy
and the stock market of the emerging industrial power. It was the crash
in the stock market of the emerging industrial power (the US) that
brought about the crash in all the world’s stock markets and the Great
Depression followed later.
Now fast forward to today, and what you
see is China as the emerging industrial power and the United States as
the mature and stagnating industrial power. China is printing money in
an effort to prop up the economy of the mature industrial power (the
US). The inflation of the money supply is resulting in the overheating
of the Chinese economy and stock market. Very interestingly, on February
27, 2007, it was the sharp 9% one-day drop in the Chinese stock market
that led to the sharp drop in stock markets worldwide, including the US.
People may be conditioned to think that economic events in developing
countries pale in significance to economic events in the US, and may
fail to see how what happens “way over there” in China would have
any significant impact on their economic well-being. But how different
the truth really is. I think most people even now after the February 27th
turn of events, fail to grasp why the US stock market sold off so
sharply after the Chinese stock market sell off
occurred first. The idea that a foreign stock market could dictate what
happens in the US stock market almost offends the American sense of
national pride (so the event is casually dismissed as “market
irrationality”). A word of advice: you better get used to it, as there
is much more of that to come. The crash is coming. |