“It is evident that the country cannot continue to advance prices and wages, to curtail production, to expand credits, and to attempt to enrich itself by nonproductive operations and transactions without fostering discontent and radicalism, and that such a course, if persisted in, will bring on a real crisis.”
– William P.G. Harding, Second Chairman of the Federal Reserve, 1916-1922(1)
The statement, or more accurately, warning issued by the Chairman of the Federal Reserve in 1920 could have been made last week by Jay Powell if one is to analyze what is happening in markets in this era.
What the markets today are not prepared for, is not much unlike what the Nixon Administration and newly selected Fed Chairman Arthur Burns had to deal with in the summer of 1970.
During the spring of that year, it became apparent that the merger of the New York Central and Pennsylvania Railroad to form PennCentral was realistically the act of taking two poorly run companies from an antiquated business model and attempting to make them too big to fail. It was at such a point that the Congress was looking at a possible bailout of the massive railroad as it was deemed crucial to the Defense Department and commerce in the Northeast region of the U.S.
Needless to say the fractured political leadership in the House and Senate failed which resulted in a not so shocking filing for bankruptcy by PennCentral on June 21, 1970. At that moment, it was the largest bankruptcy in the history of the United States.
The Federal Reserve under Burns realized that with this bankruptcy, a failure of this magnitude might freeze the commercial paper market in America. On Monday, June 22, 1970 the U.S. financial system teetered on a freezing, just like it did in 2008-2009, but Arthur Burns was ready to act:
As Burns said at the crucial Monday meeting, “a vast, new, unregulated banking system” had emerged in the 1960s. He had wondered when and how the system would be tested by crisis, and now he knew. Penn Central had borrowed heavily in the market for commercial paper (a term for short-term, unsecured corporate debt—essentially an IOU). When it ran into financial trouble, the railroad increasingly struggled to “roll over” its paper, meaning it found it challenging to access the credit lines crucial to its day-to-day business. When operational financing dried up, Penn Central was forced into bankruptcy.
The Fed worried that other lenders in the commercial paper market would refuse to renew credit to other companies teetering on the brink. Financial markets had been deeply stressed in the months before the bankruptcy, with the S&P 500 down by a third from its peak. If lenders panicked, short-term credit might dry up throughout the economy, preventing an unknown number of large companies from meeting their liabilities and throwing them into bankruptcy. If additional corporations were unable to roll over their commercial paper, the New York Fed staff predicted “dire consequences for the issuers, the commercial paper market, other financial markets and the banking system.”
On Monday and Tuesday of that fateful week, the Fed took a series of steps that set new precedents. In coordination with the Reserve Bank presidents, the board used its power of moral suasion to push banks to issue loans to wobbly firms. Most of these banks needed extra cash to extend this credit, and the Fed aggressively suggested they borrow directly from its discount window. Worried that this would not be enough to stabilize markets, the governors went further, suspending the ceilings on how much interest banks could pay on large certificates of deposit (a form of time deposit which had become essential to bank liquidity in the 1960s). This led large depositors to park more cash at banks, enabling those banks to lend more to the companies struggling to roll over their commercial paper.(2)
Thus the panic we are witnessing by some on FinTwit and other financial media outlets is nothing new. In the 1960’s the same speculative fervor of “American exceptionalism” and unbound economic expansion was touted as the future as technology evolved at lightning speed via innovations in computers, software, and hardware enabling the processing power to multiply exponentially.
Sound familiar?
Thus here we all gather again on a Sunday evening in February of 2025 where the concerns about a “vast, new, unregulated banking system” of private credit, private non-banks, and cryptocurrency are dismissed by the newly minted tech billionaire elites as the concerns of those who are within the uneducated masses.
Thus why the warning buried in Warren Buffett’s annual letter to Berkshire Hathaway’s annual shareholder letter struck this author as a warning for the current administration to actually follow through on the promises they have made and not submit to the whims of the corruption in the halls of Congress:
Paper money can see its value evaporate if fiscal folly prevails. In some countries, this reckless practice has become habitual, and, in our country’s short history, the U.S. has come close to the edge. Fixed-coupon bonds provide no protection against runaway currency.(3)
-(emphasis JohnGaltFLA)
With this as the backdrop, let’s review a quite stormy start to the year heading into an even more turbulent spring as the “real” economic data validates the reality of the two tiered U.S. economy.
The Week In Review and Ahead
Let’s dismiss the formalities with the weekly data first and foremost.
Dow Jones Industrial Average: Down 2.89%
S&P 500: Down 1.67%
Nasdaq 100: Down 1.93%
While these numbers might seem gaudy and dramatic, the close on Friday was on substantially lower volume than prior corrective declines in the past six months; even for an options expiration day.
Unfortunately for the equity markets there is not much from the earnings reports other than SMCI’s late night Friday masterpiece of gab and the upcoming report from Nvidia on Wednesday evening which could either trigger a false flag move up one more time for the AI bubble stocks or crater expectations heading into the second quarter if any investors actually take five minutes to actually read the report in detail.
Red Flags Everywhere
Despite this authors travails and travels the last two weeks, the focus on markets and the larger economy has not faded in the least if one follows this account on X.
The reason these pages have become skeptical, as predicted in the 2025 prediction thread, of any further rally in equities despite the dictates of our new Emperor, is that bull market is extremely long in the tooth and the risk to credit markets is indicating a massive, potentially devastating increase in the variability of the stagflationary outcome as warned in 2024.
The first red flag noted was from TD Cowen on Friday:
The email addresses and phone numbers of the parties above have been deleted so they are not harassed into oblivion by the bots and insane people which infect social media. The reality is that Microsoft has realized that the current infrastructure of the Artificial Intelligence capabilities has pretty much hit a wall, thus the need for rapid expansion of data centers should be delayed. Buckle up as this will have a larger, much more amplified impact in the quarters ahead.
The second massive red flag is our old friend Mr. Dow Theory. So just what is the old, crusty, and ignored Dow Theory? From Nasdaq.com:
Used in the context of general equities. Technical theory that a major trend in the stock market must be confirmed by simultaneous movement of the Dow Jones Industrial Average and the Dow Jones Transportation Average to new highs or lows.
The break in the Dow Transports from the post election euphoria is over. The reality is that the warning signs last August indicated a slow down in transportation demand and the news in the past week that Amazon was looking to expand it’s LTL reach and in house capabilities might cripple capacity even further for the already shaky trucking market.
At this moment, it would appear that the old Dow Theory is quite intact and the transports are going to lead the Dow further to the downside.
The last and probably largest red flag or flags, is founded in the idea the retail inflows are continuing to flow into speculative equities and investments while hedge funds are seeking the exits as this X posting from David Marlin of Marlin Capital:
With this level of de-grossing happening heading into the end of February while at the same time large institutions are seeking physical gold, buying US Treasuries heavily, especially at the shorter end of the curve, and the US Dollar not breaking below the 105 level on the USDX, everyone should be ready to jump into a foxhole on very, very short notice.
Otherwise one might get run over by an old, rusty bankrupt PennCentral railway car from 1970 that rolled downhill and smashed the current era’s myopic investing public without mercy.
Footnotes:
1. The Forgotten Depression by James Grant, p.96 (paperback edition) referencing a speech given by W.P.G. Harding to the twelve regional Federal Reserve banks.
2. Bigger than Penn Central:The Financial Crisis of 1970 and the Origins of the Federal Reserve’s Systemic Guarantee, by Tim Barker and Chris Hughes, Capitalism: A Journal of History and EconomicsVolume 5, Number 1, Winter 2024University of Pennsylvania Press
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