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The Fiscal Cliff and 1937



January 16, 2013 – Comments (0)

Board: Macro Economics

Author: WendyBG

Steve wrote, "The government doesn't create wealth, it redistributes it."

I replied, "To a certain extent that is true. However, nowadays, you should modify that by saying, "The government collects and redistributes wealth and also borrows money from the Federal Reserve which is created out of thin air and was never wealth to start with.""

Then I thought...remember 1937? Few of us were alive then, but my beloved Grandma was so I think of this as "extended experience" (in a sense).

After struggling up from the nadir of the Great Depression, the stock market recovered nicely until 1937. There was a serious recession and stock market drawdown in 1937. Keynesian economists assign blame to cuts in federal spending and increases in taxes at the insistence of the US Treasury, while monetarists, such as Milton Friedman, assign blame to the Federal Reserve's tightening of the money supply in 1936 and 1937.

Date                  DJIA

1937-08-16 189.34

1938-03-31 98.95 (drawdown of 48%)

How much of today's government spending is tax collections, how much is direct borrowing (sales of Treasury debt to individuals, institutions and nations) and how much is created by the Federal Reserve?
Net Government Saving [This is the 3Q2012 current net deficit.]
2012:Q3: -1,229.3 Billions of Dollars, Quarterly, Seasonally Adjusted Annual Rate
Federal Government Current Receipts [Taxes collected] 2012:Q3: 2,671.3 Billions of Dollars Quarterly, Seasonally Adjusted Annual Rate
Federal Debt: Total Public Debt (GFDEBTN)
2012:Q3: 16,066,241 Millions of Dollars, Quarterly, End of Period, Not Seasonally Adjusted
Federal Reserve Assets - Securities Held Outright - U.S. Treasury Securities, 2013-01-09: 1,676,307 Millions of Dollars [This is stable and not increasing.]
Federal Reserve Assets - Securities Held Outright - Federal Agency Debt Securities, 2013-01-09: 76,361 Millions of Dollars [This is declining.]
Federal Reserve Assets - Securities Held Outright - Securities Held Outright, 2013-01-09: 2,679,380 Millions of Dollars [This is increasing.]

Of the Total Public Debt, roughly 10% is held by the Federal Reserve and is money created out of thin air by the Federal Reserve to buy Treasury securities in order to increase the money supply and manipulate interest rates.

The exploding deficit over the past 5 years (since 2007) was caused by the recession, which reduced receipts as expenditures increased (e.g. unemployment insurance, wars).

I think that both fiscal and monetary actions impact the real economy. The Federal Reserve has taken unprecedented actions to increase the money supply and has announced its intention to keep real interest rates negative until the unemployment rate drops to 6.5% (which may be forever depending upon increasing job loss due to automation).

The fiscal cliff negotiations that "succeeded" at New Year were a drop in the bucket and essentially meaningless in the larger picture.

Major declines in the government deficit or the money supply could cause a repeat of 1937. I am not recommending a policy here -- just saying that METARs should keep a close watch on the changes because a dramatic change in government and/or Fed spending and borrowing could cause a massive change in the markets. It's happened before.



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