Skip to content

How the Federal Reserve is Killing Capitalism…


…and why you and I will be caught in the crossfire

The 2020s are shaping up to be a dangerous decade.

Covid19 might appear to be a giant curve ball that we couldn’t have anticipated, but the response to it will accelerate trends that were already in place. The two major elements of our lifestyle at most risk are Western democracy and free market capitalism. I’ll leave the questions around liberty to a separate article, but today I want to focus on the system that has created the wealth and living standards so many take for granted.

Some would argue that the generation born after World War II, aka the Baby Boomers, are the luckiest people ever to roam God’s earth. Three quarters of a century without another global conflict. Institutions from the UN to the NHS and the welfare state established in the aftermath as part of a new determination to create a better world. Powerful trades unions to fight for better wages for working people. Defined benefit pensions to take care of you when your working days are over. And rising property prices to give you the impression of wealth accumulation to a level unthinkable for those born in the inter-war years.

It’s easy to argue that we won the war and lost the peace. While our parents coped with rationing and painfully slow economic recovery for a decade, it was the vanquished Germany and Japan who were able to leapfrog us with technology and become the powerhouses of manufacturing growth. We finally experienced a growth spurt in the late 1950s, including social mobility on an unprecedented scale. My parents were poster children for this era, moving in five years from a council flat in Aberdeen to a 3 bed semi in the posh end of Whitley Bay with two cars on the drive.

Both parents had a career, we acquired washing machines, fridge freezers and unit trusts and my dad seemed to get a promotion every year until he became technical director of a Tyneside engineering firm. I, of course, took all this for granted and assumed life had always been like this since all the friends I hung around with lived a similar lifestyle.

Things changed drastically in the 1970s. In 1971 Nixon took the dollar off the gold standard, then we experienced inflation so strong that my parents bought a house in 1971 for £5000 and sold it in 1973 for £10,000. 50% annual house price inflation in a sleepy Tyneside suburb? Don’t let a decade of emergency interest rates inure you to the risks of this silent destroyer of wealth.

With the benefit of hindsight, the 1970s were the high water mark of the post war boom. Real wages for the majority of people haven’t improved since. In the 1980s another silent revolution happened when most weren’t looking – the shift to defined contribution pensions. Suddenly, our employers were off the hook. If we wanted a prosperous retirement, it was down to us to fund it by being disciplined enough to save and gifted enough to choose the right investments. Given almost universal financial illiteracy, what could possibly go wrong?

These trends can take decades to become clear, and perhaps the most damaging of all has been the rise in influence of central banks, led by America’s Federal Reserve. Created after a secret conference just before Christmas back in 1913, the origins of the Fed remain shrouded in mystery. We can only guess at the banking families who might be its major shareholders, though we know they award themselves a 6% annual dividend. Wait a minute, a central bank that is really a privately owned company? Surely the scope for conflicts of interest bordering on corruption must be immense? Welcome to America…

The balance sheet of the Fed remained fairly flat and irrelevant for most of the first century of its existence. That all changed in 2008, when it began buying up government bonds to fund the bail out of the banks brought to the brink by the Global Financial Crisis. As with many things, once the QE genie was let out of the bottle there was no going back. The Fed went through three big rounds of money printing, inspiring the Japanese and even the Bank Of England to follow suit. Later Mario Draghi made his infamous ‘whatever it takes’ speech when rolling Europe’s presses to rescue its corporate lepers.

Politicians realised that they could use printed money to shore up financial markets and keep the economy looking vaguely healthy as elections approached. Which brings us to2020. The medical response to the pandemic will be debated for a long time, but the political and financial policy has been unequivocal – whatever it takes, and then a bit more. The Federal Reserve’s balance sheet is increasing in a vertical line headed for $7 trillion, whatever that number means. 

The question you may well ask is, where does all that newly minted cash go? The answer is usually that it goes to a handful of selected big banks who then buy government treasury bonds, effectively providing the money for the bail out programmes. But, the words that bring back painful memories of my losses in the dotcom crash, ‘this time it’s different’. The Fed has decided to broaden its remit into corporate bonds and Exchange Traded Funds. They’ve given hundreds of millions of dollars to their friends at Blackrock and told them to buy a range of instruments including Blackrock’s own high risk, high yield ETFs! If you want a definition of crony capitalism, look no further.

So the Fed is taking greater risks by buying bonds from companies like Toyota, Daimler, VW and Apple. Yes, they’re not all American companies. And no, I didn’t think Apple was in need of rescuing either. If these companies prosper and the higher interest rates on their bonds gets paid, the Fed will have even more profit to pay its 6% dividend to its secret owners. And if those companies fail? Why, of course it will be the American taxpayer who picks up the tab. It’s called privatising the profits and socialising the losses.

Meanwhile all that Fed liquidity arriving in financial assets causes the stock and bond markets to get back to record levels after the initial Covid19 induced crash. The 10% of the population who won these assets get richer and the rest continue to get poorer. Especially the millions losing their jobs due to the economic impact of the pandemic.

Do you think the riots and social unrest are entirely related to one man’s murder at the hands of the thuggish American cops? Or is it a symptom of a wider malaise? A realisation that there are ‘elites’ who are winners and the masses who are losers? There has to be someone or something to blame for this unfairness, right?

My bet is that the baying mob will blame capitalism and the elites for this unfairness and see the answer in socialism or Marxism. They won’t see the nuances of how the Fed has corrupted capitalism at the behest of leaders desperate only for re-election. There is no mainstream party in America or Britain that can now lay any claim to fiscal conservatism. Politicians of every stripe are shaking the Magic Money Tree with no idea of the long term consequences.

What is certain is that the 1% will be the prime target for ‘doing their share’ to compensate for the largesse of the central banks and their political masters.  Watch out for wealth taxes, pension relief changes and higher taxes on capital gains any time soon. 

And look back fondly on those post war decades of real growth before the politicians and central banks discovered the Magic Money Tree.