The Role of the Federal Reserve In Artificial Economics

By: Robert McHugh | Sun, Mar 19, 2006
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The chart below compares the Dow Industrials at the turn of this century versus the turn of the last century. In both cases, we saw major technological advances. Back then it was the birth of the industrial age. Now it is the birth of the information age. And, an amazing likeness occurred in the pattern of stock prices almost to the month from 1901 through 1906 versus 2000 through 2005 -- that is until the Fed went nuts pumping liquidity into the economy in late 2005 through early 2006. It shows that the investment psychology of both time periods were similar.

As we say goodbye to the best monetary measure out there, M-3, we pay tribute to the wonderful work the Fed has accomplished over the past six years and two months. First of all, the above chart from 2003 to 2006 shows outstanding lagged correlation between changes in M-3 and changes in the Dow Industrials. So from that perspective, M-3 is quite useful. Thus, we see why the Fed would want to hide M-3. They have hyper-inflated our monetary base, in direct violation of their Congressional mandate to "maintain a stable currency," and in fact have added more than half the money to the economy during the past six years that the Fed added the previous 87 years in total. Why? So Wall Street and Corporate America could show stable nominal stock values, and so Consumers could replace earnings with real estate inflated wealth to draw down money in the form of debt. However, key word here is nominal. In real terms stocks are worth far less now than they were six years ago. The Fed increased the money supply 56 percent in 6 years and 2 months so that the Dow Industrials could remain 470 points, or 4.0 percent, under its level 6 years plus ago. Was it worth it?

I'm not going to go through the precise mathematical calculation here, but in general we can say that if the Dow was at 11,700 on January 14th, 2006, and it is at 11,250 on March 17th, 2006, however there is now 56 percent more money floating around than there was back then, well, the Dow Industrials are really worth far less than 11,250 today. Why? Because with all that extra money in circulation, the cost of living has gone up substantially. A cavity could be filled at the dentist for about $50 six years ago. Today, it will cost you anywhere from $125 to $200. Six years ago, when you took your car in at 50,000 miles for repairs, you might have had a $300 bill to replace hoses, belts, and other normal repairs. Today? Closer to $1,000. Sure, you can buy some things at Wal-Mart as cheap today as six years ago, but at what cost to America? The exportation of our manufacturing base, and the loss of millions of jobs. Was it worth it? Artificial economics tells the story.

In a nutshell, here's what is happening. In a world where all currencies are fiat, where none are backed by gold or silver, the nation whose currency is blessed to be the world's reserve currency -- the currency that is accepted for all international and domestic transactions -- has the uncanny privilege to be able to print all the currency it wants to out of thin air and not have to worry too much about it dropping in value. That is because, as that nation increases its currency supply, world demand also increases, thus demand and supply remain in equilibrium at fairly stable currency exchange rates.

The key international commodity that stabilizes the Dollar -- today's world reserve currency -- is oil. Everyone needs it, are willing to pay what they have to get it, and need U.S. Dollars to acquire it. Because oil is a limited supply commodity, it is somewhat price inelastic. That means no matter what OPEC charges for oil, the nations of the world need to get their hands on U.S. Dollars to acquire it. To get their hands on U.S. Dollars for oil, they are willing to sell products to Americans at low prices so we will buy their products instead of products produced in the United States. They underbid U.S. companies, putting U.S. companies out of business, exporting U.S. jobs overseas.

The U.S. supplies the rest of the world with Dollars by inflating domestic asset prices. U.S. citizens replace earnings lost from jobs being exported overseas by drawing down the inflated newfound equity in assets and then buying foreign produced goods. Thus, foreigners obtain Dollars to buy oil. Americans get cheaper products and more debt to replace jobs and earnings. As long as oil is transacted strictly in U.S. Dollars, this evisceration of the past fundamental sound economic policy where Americans stayed out of debt, saved, and produced goods and services for income, continues.

Should an imbalance occur where foreigners are obtaining too many Dollars, more than they need for oil, so much that they pose a threat to buy up American assets, including U.S. companies, real estate, and securities, to rebalance, all that needs to happen is for the price of oil to be raised. In other words, under this incredible artificial economic scheme, in order for the U.S. to maintain some semblance of autonomy, from time to time the U.S. needs the price of oil to go up.

Only the nation with the greatest military might can enforce its world reserve currency status. Should any rogue nation attempt to sell oil in a currency other than the U.S. Dollar, that must be perceived as a clear and present threat to America's newfound Artificial Economic system. There is too much domestic debt, held by both individuals and by the government, and too much exported production to return to sound fundamental economics without causing the mother of all recessions. The Fed really has no choice. Artificial Economics has taken on a life of its own. It is now our master, and we are now its slaves.

M-3 was flat last week, but is up $83.7 billion over the past 3 weeks for an annualized rate of growth of 14.1 percent. Over the past 12 weeks it is up $221.1 billion, or 9.5 percent. Those are the massaged figures. The raw money supply was up $49.8 billion last week alone, for a 25.1 percent annualized rate of growth. For the past 4 weeks, unadjusted M-3 is up $130.6 billion, or 16.6 percent annualized. Atta boy, Ben.

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If you live in the greater Detroit area, or have access to CBS Newsradio WWJ 950 in Detroit over the internet, Dr. McHugh's latest interview by Anchor Jayne Bower will be aired Monday March 20th, between 5:00 a.m. and 10:00 a.m. They discuss the Iranian Oil Bourse, the Fed's hiding of M-3, the PPT, and the U.S. Treasury Debt Ceiling.

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Robert McHugh

Author: Robert McHugh

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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