Elaine Meinel Supkis
There is no easy nostrum for preventing wild misspending. The only way to prevent financial messes is for the humans and various gnomes to refrain from wild spending and wild debt accumulations. This means resisting temptations and especially the temptation to wage fruitless wars. Once again, we get to see speeches from very long ago, when I was only a child. It is crystal clear that war inflation troubled our ruling elites. Yet at no time did they want to stop this, they just had to find some means of preventing workers and savers from avoiding eating inflation!
Statement of Wm, McC. Martin, Jr. Chairman, Board of Governors of the Federal Reserve System, at hearings on the study of the stock market before the Senate Committee on Banking and Currency,
Monday, March 14, 1955.
Mr. Chairman and Members of the Committee, as you are aware the Federal Reserve System has responsibility for regulating the general flow of credit and money with the objective of contributing to a healthy growing economy. In the Securities Exchange Act of 1934, the Board of Governors of the Federal Reserve System was given special responsibilibility for preventing the excessive use of credit for the purchase or carrying of securities.
Let me say at the outset that this responsibility of the Board of Governors relates to stock market credit and not to the price of stocks. The Congress rightly, in my judgment, did not place on the Board responsibility for trying to determine the level at which stocks should sell. Even if all credit were eliminated from the stock market, cash purchases could bid up the prices of stocks to high levels. Regulation can restrain the use of credit for stock market purposes, but it cannot serve as a guarantee against all speculative excesses.
After the collapse in 1929, the President, Roosevelt, launched the Securities and Exchange Commission. They, in turn, set up all sorts of rules and regulations which the stock market jobbers and jabbers all worked insidiously to destroy. Back in 1955, memory of the great crash was still quite raw but fading fast. I have noticed that people erase bad memories. This is how Mother Nature keeps us optimistic in the face of our own impending deaths in the future. So people were rapidly 'forgetting' what happened 15 years earlier and were clamoring for the SEC and the Fed to loosen the regulations so a new bubble could be formed.
Let's not kid ourselves: we LOVE bubbles and LOVE inflation when it is in stocks or assets! This is a great deal of fun for everyone! This is why it is not just a hazard but a temptation. Since it is ludicrously easy to make bubbles happen, the government and bankers must have all sorts of dire laws, warning systems and punishments dealt to anyone who violates these restrictions. Restrictions work as barriers to the temptation to create bubbles!
I know that people who own houses were delighted to see them go up in value. Even as this causes rising taxes, the feeling is one of 'I am richer' and thus, is a feel good sensation. I know people who hold stocks for a lifetime and never sell them. But they feel happy and rich if these stocks shoot up in value. Most people want assets like stocks and housing to shoot up in value because this creates a delightful situation whereby they can use this to gain credit which can be grabbed and turned into outright money. This, in turn, enters the financial markets as 'money' and inflation takes off based on inflating housing and stock prices.
But the barriers are kicked down by the government. When the government decides it is time to overspend the budget, they have to destroy these barriers to bubble making. So the regulator becomes the violator. Usually, they do this when launching wars. Taxing people directly for a war makes a war rapidly unpopular. But if all war costs are shoved into the future via the creation of new debts, all is well. Seeing this, all bankers then rush to also create more debt. Since all wars require LOW interest rates to run, the central bankers enable this by lowering rates to unrealistic levels and soon everything is a bubble. Even countries losing wars see this same thing. Prices rise, everyone feels rich at the beginning of a war, then the commodity inflation of necessities hits and all the bubble stuff loses value rapidly as people concentrate with increasing anger and hysteria on buying food and fuel.
Mr. McChesney Martin Jr. was handed the responsibility of stopping the war-driven bubbles from WWII, the Korean War, the Cold War and then the very hot Vietnam War. Eisenhower was always a very tightfisted man which is why we won WWII without going steeply into debt. He would not tolerate this. He immediately ended the hot Korean War and cooperated with the Fed in squelching inflation. The mid-1950's saw a recession that was pretty bad. Money was 'tight'. I remember Sputnik that happened at the end of this decade.
My father always had trouble getting money from Congress for his projects. When he ran outside to see the first passage of Sputnik, he yelled, 'Finally we will get lots and lots of money!' Heh. And we did. The government programs for space, astronomy and computers suddenly gushed all over us and we moved to a very nice, much bigger house and lived much fancier lives. Thank you. Back to the 1955 speech:
[Referring the the Great Stock Market Crash of 1929] An important factor in that situation was that stock purchases were pyramided on the basis of credit extended on very thin nargins. As a result, a break in stock market prices, that in any event would have been severe, was magnified into a disastrous financial crash for the whole country.
The Securities Exchange Act was not formulated to restrict the natural operation of the stock market, but to rid the market of such evils as manipulative practices and inadequate disclosure of information vital to investors. Thus the market could better perform its basic investment functions. The margin requirement provision of the Act was not designed to deny the use of credit to the stock market; its explicit objective was to prevent the excessive use of credit. This legislation was designed to help create a healthier securities market as part of a strong, vigorous free enterprise economy.
Again and again the theme is sounded: the role, the main function of the central bankers and the government is to prevent EXCESSIVE USE OF CREDIT. Of course, the problem is, the government itself wants excessive credit. The fact that the Fed Chief has to lecture about the need for restrictions is clear: his audience hated this! They were hoping he would enable credit growth, not restrict it. Eisenhower wanted to restrict it. A true conservative. A man who saved pennies and wanted America, the world's new ruling empire, to not become the British Empire with palaces, a groaning lower class in slums while trotting around the planet ruling everyone brutally. Eisenhower was not very impressed by the British military, the ethos of the British rulers or anything British. He didn't want to imitate them.
Truman placed Martin Jr. in the Fed in the hopes he would enable war spending by creating credit. The new Fed chief tightened credit instead. But under Eisenhower, they were in concert. Nixon blamed his election loss to Kennedy on this matter. And Martin Jr, under first Kennedy and then LBJ, ended up loosening the purse strings and we had war and the degradation of our currency.
Organized stock exchanges are designed to function so as to encourage growth in equity ownership rather than debt, with resulting benefit to the economy. For business to raise equity capital through the issuance of common stock, it is important to have active and orderly markets for stocks.
The exchanges serve the economy by providing continuous, ready markets for securities that constitute an important proportion of the assets of many individuals and businesses. Individuals, to make purchases of goods or services, frequently have to sell or borrow on their securities to obtain the necessary cash. Furthermore, businessmen often sell their securities or pledge them as a basis for loans to meet payrolls or to obtain other capital. Sales or borrowing transactions of these kinds would be far more difficult without market centers where investors, traders, brokers, and dealers are brought together. Sales of new security issues by business corporations would also be more difficult if buyers did not know they could later dispose of such assets readily.
A major distinction between highly developed and industrialized economies and underdeveloped economies is the lack in the latter of effective markets for mobilizing the individual savings of their people.
The task of the Board, as I see it, is to formulate regulations with two principal objectives. One is to permit adequate access to credit facilities for security markets to perform their basic economic functions. The other is to prevent the use of stock market credit from becoming excessive. The latter helps to minimize the danger of pyramiding credit in a rising market and also reduces the danger of forced sales of securities from undermargined accounts in a falling market.
From the beginning, the Board has realized that regulations applicable to this intricate lending process ran the risk of leaving loop-holes through which bank credit might leak into stock market speculation. This was a calculated risk which was believed to be preferable to detailed rules that would impose a greater impediment to constructive financing than could be justified by avoidance of any leakage that could result from the existing regulation.
The Fed is a regulator. It is a governing system. Its job is to prevent excess credit from being granted. Note also that Martin Jr. talks about loopholes. These are the tiny glitches and graces in the system which as to have some looseness so that it doesn't seize up. But the questing minds of the gnomes is set on opening any loopholes or exploiting any systems weaknesses and use this as a means for opening a hole in the wall of the Cave of Wealth and Death and there, finding infinite credit which can be turned into Funny Money™ with which they can then rush out and buy the services of the haughty goddesses they so desire to own.
Martin Jr. doesn't want to close loopholes. But if they remain open and are detected by the alert minds and roving eyes of the gnome population, they end up becoming giant messes, bigger and bigger holes until all the force and fury of money creation are bent upon these loopholes! We see this all the time today. Now, no one is trying to regulate anything very much and money creation is roaring ahead like crazy. But always, when this happens, money destruction suddenly appears and it all crashes.
This is because when human regulators cease controlling the gnomic urge to create infinite credit, Libra opens Her Basilisk eyes and zaps all the new wealth and destroys it instantly. The Funny Money™ vanishes in thin air! Never to return! Suddenly, everyone is scrambling to avoid bankruptcy. This story has to be hammered into everyone's brains: too much credit=asset destruction. Which is what this speech in 1955 was trying to explain.
The loan values for the purchase or carrying of registered securities which have been imposed by this regulation have been consistently small by historical standards, i.e., margin requirements have been high.
Most of the time under the regulation margin requirements have ranged between 40 per cent and 75 per cent, with one brief period of 100 per cent. During the twenties, margin requirements imposed by individual brokers were customarily 25 per cent or less, with 10 per cent margins not uncommon.
Well, thanks to lax rules and the pirate islands that have taken over many of our banking and financial systems, we have gaping holes in the walls that separate the Cave of Wealth from the Cave of Death and the outside world. Credit has been created at insane levels. So much easy credit was offered by central bankers who ignoring inflation, the whole planet was soaked in red ink. Now, collecting the interest on all this as well as selling this to savers has collapsed. Most everyone is deep in debt. There are few savers left anywhere. There are sovereign wealth funds in the trade surplus nations. But a lot of the Funny Money™ is flowing to increasingly gigantic FOREX reserves. Which are now sailing into the multiple trillions. And then there is the Derivatives Beast that is swelling in size even faster!
It popped out of a tiny loophole in the regulations when the US ceased raising interest rates really high back in 1980. Interest rates plummeted but did government overspending? NO! That INCREASED and continued to increase until it went from the US owing only a trillion dollars to the US owning ten trillion dollars! Talk about wild credit creation.
As I have emphasized, the statute enjoins "excessive use of credit' in stock markets. It is difficult to define what constitutes "excessive use of credit" in stock markets, or for that matter in any field. It is largely a question of judgment and not merely a statistical computation. So far as stock markets are concerned, however, it seems to me that there are certain signs or symptoms of unhealthy tendencies when businessmen or the public generally become unduly preoccupied with stock markets and stock prices. An unsound speculative psychology may then develop that can have adverse effects throughout the economy.
Margin requirements are a comparatively new device in the arsenal of central banking. As I indicated at the outset, they are not and cannot be cure-alls for stock market excesses or abuses.
He is referring to 'The Madness of the Crowds' here. Manias sweep nations and everyone drops honest, hard working, productive labor and rush to the streets and begin to gamble and get hysterical over sudden price hikes of speculative things! Tulips are going up in value! Housing is shooting upwards! Stocks are soaring! This mania destroys commerce, wrecks cities and is totally non-productive in the capitalist sense. Speculation enables capitalist ventures to raise the funds needed to build value-added labor products that fuel commerce and trade. Speculation fever destroys all this. Bubbles are very bad. They encourage spending on frivolities and fopperies. Foolish, silly stuff. Note that the cities that grew the fastest and most during the last credit expansion bubble were mostly useless places of pleasure and gambling joys. The industrial cities foundered and died. Las Vegas and Miami Beach flourished.
The US came out of this wave of credit expansion with a far weaker industrial base, a weaker working class, a stressed out middle class and all we have to show for all this is a pile of useless SUVs, McMansions we can't heat or cool and are too far from work to live in, and huge debt bills to be paid for the foreseeable future. Not a good trade off! As the Fed knew perfectly well back in 1955.