The
conditions have now aligned for a repeat of the major stock market
crashes that have occurred since the founding of the US Federal Reserve
Bank (Fed) in 1913. Considering their vast experience and resources, the
Fed has to know that their plan to control inflation by raising
interest rates rapidly and significantly since 2022, and also tightening
credit this year, will likely result in another major crash. Although
the Fed has issued vague warnings about the impending pain on the stock market and economy, they have not explained how and why they will again wipe out trillions of dollars of wealth of unsuspecting investors.
As Marty Zweig, a successful Wall Street investment adviser known for data studies, warned,
“Don’t fight the Fed,” because the central bank largely controls the
direction of the stock markets. Generally, the major stock market booms
start with the Fed stimulating slow economic growth by lowering interest
rates, often while the government increases deficit spending. As
Austrian business cycle theory predicts,
this results in asset price inflation (e.g., stocks, houses, etc.), and
sometimes also consumer price inflation. The major busts result when
the Fed seeks to control the inflation by raising interest rates
significantly, while the government reduces deficit spending.
The following graphs demonstrate the strong inverse relationship
between the Dow stock market index and interest rates largely set by the
Fed (i.e., stocks values inflate when interest rates are lower and
deflate when higher). The top graph from Macrotrends
shows the Dow Jones stock market index on a logarithmic scale and
adjusted for today’s dollars over time. The bottom graph from the Fed
shows interest rates over the same time. These graphs can be used to
locate the major stock market cycles and analyze the effects of interest
rates along with deficit spending in causing booms and busts.
Figure 1: S&P 500 versus federal funds rate
Source: Stansberry Research.
The Dow Jones stock market can be considered to be in its sixth major
boom and bust cycle. The first cycle had a 1913–15 boom and 1915–20
bust. The second cycle had a 1920–29 boom and 1929–32 bust. Then, there
was a 1932–50 period that was effectively absent of major booms that
could go bust. The third cycle had a 1950–65 boom and 1965–82 bust. The
fourth cycle had a 1982–2000 boom and 2000–2002 bust. The fifth cycle
had a 2002–7 boom and 2007–9 bust. The sixth cycle had a 2009–22 boom
and a bust starting in 2022. The five major stock market crashes can be
considered to have started in 1915, 1929, 1965, 2000, and 2007, with
another likely in 2022.
1915—As the Fed started cutting interest rates in 1913, the Dow stock
market climbed and peaked in 1915. That year, the Fed started raising
rates and the stock market dropped in 1916. During 1917 and 1918,
deficit spending
for World War I, while interest rates were flat, caused rampant
inflation and a spike in stock prices. After the war, the Fed rapidly
raised interest rates in 1920 to cause a stock market crash and the
depression of 1920–21.
1929—After the Fed cut interest rates from 1921 to 1925, the so-called roaring ’20s
brought a booming Dow stock market from 1921 to 1929. After the Fed
started raising interest rates in 1927, the stock market crashed in 1929
and the economy tanked. During the 1930s, the Fed cut interest rates,
but President Franklin D. Roosevelt
resisted deficit spending after 1932. The Fed even raised, before
lowering, interest rates in 1935 to cause stock market losses and the
recession of 1937–38. These policies prolonged the Great Depression
until World War II, if not longer.
1965—Deficit spending during World War II, along with low interest rates during and after the war, helped bring a postwar boom
with economic recovery, consumer price inflation, and stock market
gains. During the late 1960s and 1970s, the government accommodated
inflation by raising interest rates slowly over a relatively long time
period. This caused a long, flat stock market with sharply declining
real values (due to inflation) from 1965 to 1982. Finally, the Fed raised interest rates rapidly and high around 1978 to cause a severe recession in the early 1980s.
2000—After 1981, the Fed started cutting interest rates and the government increased deficit spending, especially on defense.
The stock market boomed. The Fed raised interest rates starting in 1993
and even higher in 1999 to stop what was claimed to be the “irrational exuberance”
of the booming stock market, while the US government ran budget
surpluses from 1997 to 2001. The stock market, especially tech, crashed
in 2000, and the economy receded during the recession of 2001.
2007—In 2001, the Fed started cutting interest rates and loosening credit on home loans
while the government increased deficit spending. The stock market
boomed back to its prior peak (in 2000) and home prices inflated. From
2005 to 2008, the Fed raised interest rates and the government decreased
deficit spending. In 2007, the stock market and home prices crashed.
The economy suffered through the Great Recession until 2009.
2022—Since the start of the Great Recession
in 2007 and until 2022, the Fed has lowered interest rates to near zero
while the government increased deficit spending. This has accommodated
asset and consumer price inflation. Since March of 2022, the Fed has
quickly raised interest rates by about five percentage points.
Today, the Fed is clearly still concerned about the inflation. However, higher interest rates have already led to a financial crisis
among the banks. Experiences with past markets indicate that, if the
Fed continues to fight inflation, the stock markets will likely crash,
like they did twice in both the early 1900s and early 2000s. If the Fed
gives up their inflation fight, the stock market will likely gradually
fall in value over many years if not decades, like they did after 1965.
There have been some other large, but less significant, stock market declines.
The crashes in 1917, 1941, and 2020 were caused by fears of wars and a
pandemic but were soon reversed by lower interest rates and massive
deficit spending used to meet the aggression. The crashes of 1937 and
1946 and subsequent recessions were preceded by rising interest rates
and limited deficit spending, but 1937 was part of the recovery from the
Great Depression while 1946 was soon reversed by the exceptional
postwar boom. The crashes in 1968 and 1972 were preceded by rising
interest rates and limited deficit spending but occurred within a major
crash. The crash of 1987 was preceded by rising interest rates and
reduced deficit spending but was a brief and steep up-and-down blip
within a major boom.
The graphs indicate the major stock market crashes have always
resulted when, and only when, the Fed has responded to inflation by
raising interest rates by three percentage points or more, while the
government reduces, or at least doesn’t significantly increase, deficit
spending. There has never been a so-called soft landing,
and the graphs indicate a so-called Fed pivot, which has usually
arrived after the crash. The graphs also indicate the 1915, 1929, 1965,
2000, and 2007 crashes caused Dow stock market index losses of 59, 85,
71, 35, and 49 percent. The losses were not recovered until eleven,
thirty, twenty-nine, eight, and six years after the start of the
crashes, respectively.
The government has responded to the major stock market crashes, with
the exception of 1929, by lowering interest rates and increasing deficit
spending to gradually pump stock prices back up and eventually even
higher than before. There is no guarantee that this will happen again,
especially with the political far right threatening to repeat the policies that prolonged the Great Depression by restricting deficit spending.
Stock markets are unfair to uninformed and amateur investors since
they are rigged by the Fed and government without transparency. Informed
stock traders and insiders can earn far greater returns by selling
stocks high before the stock market crashes. They can also profit by
buying low later if they are assured that the government will bail out
the market with low interest rates and deficit spending. Moreover, the
stock markets will be unsustainable as soon as most investors realize
that they are rigged.
Monetary and fiscal manipulations, currently needed to stimulate
stock markets and pull economies out of recessions, should be replaced
by something else, like effective deregulation of free markets.
