The Three-Year Lag the Fed Always Forgets

An essay from Porter Stansberry... This wasn't even the Great Depression... Delayed crises are the rule... Federal Reserve tightening ends with an 'event'... This time will not be different... The end game... [Stansberry Research Logo] Delivering World-Class Financial Research Since 1999 [Stansberry Digest] An essay from Porter Stansberry... This wasn't even the Great Depression... Delayed crises are the rule... Federal Reserve tightening ends with an 'event'... This time will not be different... The end game... --------------------------------------------------------------- Editor's note: Today, we are pleased to bring you a guest essay from Stansberry Research founder Porter Stansberry. As longtime subscribers know, Porter wrote Friday Digests for years, and today we're sharing a piece from him to end the week again. It was originally published last month at Porter & Co., the boutique investing research firm he started in 2022 where you can exclusively find Porter's new work today. In this essay, Porter shares his unique take on a familiar topic in these pages: the Federal Reserve. As he explains, when the central bank aggressively hikes interest rates, as it did in 2022 and early 2023, it often ends up triggering a crisis of the very kind it hopes to prevent. And seemingly, the Fed hasn't learned its lesson this time, either... We also want you to know that Porter recently sat down to record a brand-new interview with longtime friend and Stansberry Research partner Dr. David "Doc" Eifrig – and it will debut on Tuesday. This is a wide-ranging discussion that will be presented to Stansberry Research readers only. The broadcast includes everything from Porter's four big predictions for 2024 to the full details about where Porter has been the last three years – and why – and what he's doing now both at Porter & Co. and as the chairman and CEO of our parent company, MarketWise. Doc asks all the questions we believe any Stansberry Research subscribers who have known Porter over the years might be curious about, and Porter delivers frank answers – on what has really happened behind the scenes the last few years, how to prepare for a chaotic year ahead, and why exciting new developments could transform your financial future. To keep it private, the broadcast will only air for 48 hours next week. If you're interested, [click here to sign up to watch]( to make sure you don't miss anything. And in the meantime, enjoy today's essay... --------------------------------------------------------------- Harry probably shouldn't have left his friend Eddie alone to mind the store... The two buddies split duties at their Missouri haberdashery "equally" – which in practice meant that Eddie stayed behind the counter and hawked shirts and "no wilt" collars, while Harry gallivanted around town under the guise of business lunches. Then the Depression hit – and Harry likely wished he'd paid a little more attention to what went on behind the counter. "A flourishing business was carried on for about a year and a half," he wrote later, "and then came the squeeze... [Eddie] Jacobson and I went to bed one night with a $35,000 inventory and awoke the next day with a $25,000 shrinkage... This brought bills payable and bank notes due at such a rapid rate we went out of business." Harry and Eddie had to liquidate and file for bankruptcy – and they weren't alone. The stock market crashed, business failures tripled, and company profits on average fell by around 75%. As prices plunged, employment ticked up toward 12% and more than a thousand banks closed their doors. Oh, and here's the kicker – this wasn't even the Great Depression... This was a severe, 18-month economic contraction – from January 1920 to July 1921 – that's largely ignored in history books. When it's mentioned (rarely), it's called the "Forgotten Depression." It all started during the post–World War I boom. At that time, the U.S. was still on the gold standard – each U.S. dollar was backed by a corresponding amount of the precious metal. There was a post-war surge in spending to rebuild the neglected country after so much had been spent overseas to support the troops. The resultant increase in money supply and consumer prices caused a massive drain on the country's gold reserves. To cool down the economy and slow the loss of gold, the Federal Reserve began to raise interest rates aggressively. It hiked rates from a low of 3.5% in 1917 to a then-record-high 7% by early 1920. The Fed's first big rate-hike cycle (the central bank had only been founded in 1913) took several months to weigh on the economy. But once it did, the consequences were dramatic. The Dow Jones Industrial Average fell by nearly 50%, and the U.S. suffered its sharpest drop in wholesale prices in history (worse than even the Great Depression that followed a decade later). The adolescent Fed didn't immediately cut interest rates in response to this crisis. Following the guidance of Benjamin Strong – head of the Federal Reserve Bank of New York – the Fed instead held rates at these high levels for the better part of a year as the crisis played out. Strong believed in the self-correcting nature of markets (that is, in the Invisible Hand). He figured that the only lasting solution to the post-war boom was a commensurate bust – and he was convinced the crisis would resolve most quickly without government interference. As he predicted in an early 1919 letter to his friend, economist Edwin W. Kemmerer... I believe that this period will be accompanied by a considerable degree of unemployment, but not for very long, and that after a year or two of discomfort, some losses, some disorders caused by unemployment, we will emerge with an almost invincible banking position, with prices more nearly at competitive levels with other nations, and be able to exercise a wide and important influence in restoring the world to normal and livable conditions. Strong was uncannily correct... right down to the "year or two of discomfort." The Forgotten Depression ran its course in less than two years. And by 1922, the economy had fully recovered. As legendary financial newsletter writer Jim Grant – author of the definitive book on this crisis – noted in the Wall Street Journal in 2015: In the absence of anything resembling government stimulus, a modern economist may wonder how the depression of 1920-21 ever ended. Oddly enough, deflation turned out to be a tonic. Of course, the year-and-a-half depression must have seemed interminable for all who were jobless or destitute. It was, however, a great deal shorter than the 43 months of the Great Depression of 1929-33. Then too, the 1922 recovery would bring tears of envy to today's central bankers and policymakers: Passenger-car production shot up by 63%, for instance, and the Dow jumped by 21.5%. "From practically all angles," this newspaper judged in a New Year's Day 1923 retrospective, "1922 can be recorded as the renaissance of prosperity." Prosperity returned a bit too late for young Harry, who lost his haberdashery in the bust. But, as his cousin Mary acknowledged, no one who knew him was surprised he went bankrupt. "Well, we of course were sorry that he didn't make a go of it," she said years later in an article about her cousin, "but we couldn't feel that that was Harry's life work any more than farming had been, and I think we just took it without too much concern, because we all felt that he hadn't gotten into the thing that would bring out the best that was in him." Not to worry, though – Harry eventually found his niche. A couple of decades after the Truman & Jacobson men's clothing store closed its doors, Harry S. Truman became the 33rd president of the United States. Selective amnesia... The Forgotten Depression carried several critical lessons for central bankers. It illustrated that busts are a natural and necessary consequence of booms – while painful, they're essential for liquidating bad debts and malinvestment and for "resetting" the system. It showed that these crises can resolve themselves quickly without government interference. And it highlighted that monetary policy acts with a significant lag. Specifically, the effects of rising interest rates don't begin to show up in the economy until two to three years after tightening begins, regardless of how aggressively central bankers act. The lag likely has to do with the term structure of debt – most borrowers typically don't have to refinance at higher rates immediately. Plus, even the weakest borrowers often have some amount of equity or savings they can rely on initially. But regardless of the reasons, these delayed effects have proven to be remarkably consistent over time. Unfortunately, like the Depression of 1920-21 itself, these lessons were quickly forgotten, if they were ever learned at all. (It doesn't help that the University of Chicago's Center for Research in Security Prices database – the source for most historical stock market and financial information today – only goes back to December 1925.) In virtually every boom since, the Fed has sought to avoid busts at all costs. It has typically intervened aggressively to stop them at the first signs of significant trouble in the markets or the economy. And though Fed officials often give lip service to Milton Friedman's 1959 insight about the "long and variable lag of monetary policy," their dogged impatience over the past 100 years suggests they've yet to take this enduring lesson to heart. Delayed crises are the rule... almost without exception... A look at financial history since the 1920s shows this lag between rising rates and their inevitable economic and financial consequences is not just remarkably consistent, it's also typically longer than just about anyone – including those controlling the levers at the Fed – expects in real time. This unfortunate reality has led to a predictable yet recurring problem. As you can see in the chart below, when the Fed aggressively hikes rates, it often ends up triggering a crisis of the very kind that it hopes to prevent. This dismal pattern began a few years after the Forgotten Depression. As a new speculative boom took hold during the second half of the decade, the Fed started raising rates sharply in early 1928, ultimately reaching a peak of 6% in 1929. But it wasn't until October 1929 – roughly two years from the start of that tightening cycle – that the stock market began its historic plunge (the Dow would go on to drop 89% before bottoming in 1932). And it was still another year after that before the Great Depression went global in early 1931. That's when Austrian bank Creditanstalt – one of the largest and most important banks in Europe – collapsed, setting off a deflationary crisis that quickly spread across the continent. The 1960s and '70s saw this cycle repeat several times. In mid-1967, in an effort to fight inflation, Fed Chair William Martin began an aggressive tightening cycle. In just over two years, he more than doubled the federal-funds rate from 3.75% to nearly 10%. Yet, it still took another 10 months – and three years in total – before trouble began. Economic shockwaves followed the failure of railroad giant Penn Central, at the time the largest corporate bankruptcy in history. Since the railroad controlled a third of the nation's passenger trains and a majority of freight traffic in the Northeast, its collapse created significant economic and financial market fallout. In addition to the obvious disruption of interstate trade and significant losses among the company's many pensioners, the collapse triggered a liquidity crisis in the short-term corporate-debt market that nearly bankrupted renowned investment bank Goldman Sachs. And still no lesson learned... Martin's successor – the much-maligned Arthur Burns – presided over a similar tightening cycle a few years later. Despite his legacy of being "soft" on inflation, the Burns Fed aggressively raised rates from less than 4% in early 1972 to a whopping 13% in July 1974. And it was not until October 1974 – nearly three years into the tightening cycle – that his Fed finally relented. In that cycle, the central bankers feared the recent collapse of Franklin National Bank, the largest bank failure in U.S. history at that time, could trigger a financial crisis (much like the failure of Lehman Brothers several decades later). Regulators quickly stepped in – orchestrating the first federal wind down of a major financial institution in history – and Burns cut rates back down to 5% to ease financial conditions, even as inflation remained high. Even famed inflation fighter Paul Volcker was a victim of this lag. As many recall, Volcker held rates as high and as long as necessary to defeat inflation – rapidly pumping up the fed-funds rate above 20% by 1981. But when Volcker finally gave up his fight in 1984 – again, roughly three years after his final tightening cycle began – it was not because inflation had been defeated. Consumer prices would continue to rise between 4% and 6% annually – well above the Fed's target – for much of the next decade. Rather, Volcker began cutting rates following the near-failure of Continental Illinois National Bank – the country's largest commercial and industrial lender and arguably the first "too big to fail" bank – that threatened to trigger a financial crisis that spring. Most notably, Volcker's successor, Alan Greenspan, played a role in multiple such cycles in the following decades. Those lags culminated in the "Black Monday" stock market crash in October 1987, the savings-and-loan crisis in the early 1990s, the dot-com boom and bust in the late 1990s, and ultimately, the 2000s housing bubble and the great financial crisis that followed. And despite all that history could have taught him, former Fed Chair Ben Bernanke – who took over the reins from Greenspan in 2006 – was most famously fooled by the lag. In a speech in March 2007 – almost three years after the start of the Fed's most recent rate-hike cycle – Bernanke assured Congress that the growing problems in the subprime mortgage market were "contained" and unlikely to impact the "broader economy and financial markets." Of course, we now know that the worst financial crisis since the Great Depression was already brewing, and the Fed would begin cutting rates in a panic just a few months later. Bernanke's misplaced confidence is among the biggest blunders in modern financial market history. But as we've seen, virtually every Fed chair – along with most investors and market pundits – has made similar mistakes in every tightening cycle in U.S. history. The 'end game' is clear... That brings us to where we are now. You've likely read or heard commentary about the "surprising" resilience of the U.S. economy in recent months. Over the past year and a half, the Jerome Powell-led Fed has raised short-term rates from near 0% to 5.5% – representing the most aggressive tightening cycle in history on a percentage basis. Yet, despite total U.S. debt levels – including federal, corporate, and consumer debt – being roughly double what they were in 2007, these recent rate increases haven't created any severe problems in the U.S. to date (outside of a handful of regional bank failures). The lack of any significant fallout from the Fed's aggressive hikes – so far – has led many investors to assume that "this time" really is different... that these moves will somehow successfully tame inflation without causing a financial crisis. Unfortunately, today's cheerleaders are likely to be disappointed, like countless others before them. Despite growing optimism that the Fed will achieve a "soft landing," more than 100 years of history suggests a crisis is unavoidable. And we're now approaching the period in the cycle – roughly two years after the first rate hike – when it is most likely to begin. We've already witnessed significant stress in the banking system – though there will likely be more disruptions ahead. And we're just beginning to see signs that the economy is teetering, including a slowdown in housing, manufacturing, and corporate profits, rising consumer delinquencies, and weakness in commercial real estate. It's likely just a matter of time before another crisis begins. But the delayed consequences of Fed policy aren't the only predictable aspect of these cycles. In each of these prior scenarios since the Great Depression, the Fed also aggressively reversed its policy as panic set in. And as these crises have become increasingly more severe under the growing pile of bad debts and malinvestment over the years, the Fed's responses have also grown larger and more dramatic – flooding the economy with more liquidity and stimulus each time. This trend suggests the next crisis – the "End of America," as we've called it – will be one for the record books... And the Fed's response to it will be among the biggest and most inflationary in history. Unfathomable amounts of money-printing are assured. Here at Porter & Co., we believe the surest way for investors to protect – and even build – wealth in the years ahead is to own hard assets (particularly gold and Bitcoin) and the world's most dominant, capital-efficient businesses. However, it's also important to understand that the Fed historically acts only after a crisis is already underway. In the meantime, we could experience severe economic and market turmoil, including soaring unemployment and unprecedented market volatility. Investors who take on too much risk – even in the highest-quality equities – may be unable to weather the storm. This is why we continue to urge investors to remain patient and conservative. The coming crisis will present a once-in-a-generation wealth-building opportunity to buy the best companies at bargain-basement prices – but only for investors who have the capital available to take advantage. --------------------------------------------------------------- Editor's note: As we mentioned, Doc Eifrig recently sat down with Porter for an honest discussion on his journey over the past few years. If you've read any of Porter's work over the years, or even if you haven't, we urge you to watch this brand-new free video. In this special broadcast, Porter and Doc discuss why Porter hasn't written to Stansberry Research subscribers in so long... why he felt compelled to start Porter & Co... and what his plans are for our business today and in the future. Plus, Porter details how he's looking at the markets right now, including how he's finding buying opportunities today while acknowledging the risks in the economy and the major financial crisis and chaos he believes we're due for in 2024. The next crisis, Porter says, will allow prepared investors to buy world-class businesses at fire-sale prices and create many other buying opportunities most individual investors will simply overlook or not know about. You can get all the details in Doc's interview with Porter. [Click here to sign up to watch it]( when it goes live on Tuesday. As we said, it will only be available for 48 hours. --------------------------------------------------------------- Recommended Links: # ['This Tuesday, I'm Pulling Back the Curtain']( Our founder, Porter Stansberry, is finally going to tell you where he has been the past three years... the real reason he left the company... why he's back... and, most importantly, how it benefits your financial future. [To hear Porter's full story, check this out](. --------------------------------------------------------------- # [WARNING: Wall Street Fraud Hits 40-Year Highs]( Twenty years ago, one of the BIGGEST accounting-fraud indicators triggered for Enron – before the company imploded. Now this same indicator has flashed bright red again... with corporate manipulation soaring to 40-year highs. One of Wall Street's whistleblowers is stepping forward to give baffled investors some straight answers on what's happening and [where they should be putting their money in 2024](. --------------------------------------------------------------- Our office is closed today to celebrate the holiday season, so we're taking a day off from sharing yesterday's 52-week high list and the mailbag. But, as always, let us know your thoughts with an e-mail to feedback@stansberryresearch.com. Following this weekend's Masters Series, we'll pick things back up on Monday. Regards, Porter Stansberry Stevenson, Maryland December 15, 2023 --------------------------------------------------------------- Stansberry Research Top 10 Open Recommendations Top 10 highest-returning open positions across all Stansberry Research portfolios Stock Buy Date Return Publication Analyst MSFT Microsoft 11/11/10 1,284.6% Retirement Millionaire Doc MSFT Microsoft 02/10/12 1,183.7% Stansberry's Investment Advisory Porter ADP Automatic Data Processing 10/09/08 866.0% Extreme Value Ferris wstETH Wrapped Staked Ethereum 02/21/20 771.1% Stansberry Innovations Report Wade WRB W.R. Berkley 03/16/12 654.8% Stansberry's Investment Advisory Porter BRK.B Berkshire Hathaway 04/01/09 541.9% Retirement Millionaire Doc HSY Hershey 12/07/07 460.0% Stansberry's Investment Advisory Porter AFG American Financial 10/12/12 415.0% Stansberry's Investment Advisory Porter BTC/USD Bitcoin 01/16/20 379.0% Stansberry Innovations Report Engel PANW Palo Alto Networks 04/16/20 339.2% Stansberry Innovations Report Wade Please note: Securities appearing in the Top 10 are not necessarily recommended buys at current prices. The list reflects the best-performing positions currently in the model portfolio of any Stansberry Research publication. The buy date reflects when the editor recommended the investment in the listed publication, and the return shows its performance since that date. To learn if a security is still a recommended buy today, you must be a subscriber to that publication and refer to the most recent portfolio. --------------------------------------------------------------- Top 10 Totals 4 Stansberry's Investment Advisory Porter 3 Stansberry Innovations Report Engel/Wade 2 Retirement Millionaire Doc 1 Extreme Value Ferris --------------------------------------------------------------- Top 5 Crypto Capital Open Recommendations Top 5 highest-returning open positions in the Crypto Capital model portfolio Stock Buy Date Return Publication Analyst wstETH Wrapped Staked Ethereum 12/07/18 1,701.2% Crypto Capital Wade ONE/USD Harmony 12/16/19 1,111.4% Crypto Capital Wade POLYX/USD Polymesh 05/19/20 1,059.7% Crypto Capital Wade BTC/USD Bitcoin 11/27/18 1,045.3% Crypto Capital Wade MATIC/USD Polygon 02/25/21 860.3% Crypto Capital Wade Please note: Securities appearing in the Top 5 are not necessarily recommended buys at current prices. The list reflects the best-performing positions currently in the Crypto Capital model portfolio. The buy date reflects when the recommendation was made, and the return shows its performance since that date. To learn if it's still a recommended buy today, you must be a subscriber and refer to the most recent portfolio. --------------------------------------------------------------- Stansberry Research Hall of Fame Top 10 all-time, highest-returning closed positions across all Stansberry portfolios Investment Symbol Duration Gain Publication Analyst Nvidia^* NVDA 5.96 years 1,466% Venture Tech. Lashmet Microsoft^ MSFT 12.74 years 1,185% Retirement Millionaire Doc Band Protocol crypto 0.32 years 1,169% Crypto Capital Wade Terra crypto 0.41 years 1,164% Crypto Capital Wade Inovio Pharma.^ INO 1.01 years 1,139% Venture Tech. Lashmet Seabridge Gold^ SA 4.20 years 995% Sjug Conf. Sjuggerud Frontier crypto 0.08 years 978% Crypto Capital Wade Binance Coin crypto 1.78 years 963% Crypto Capital Wade Nvidia^* NVDA 4.12 years 777% Venture Tech. Lashmet Intellia Therapeutics NTLA 1.95 years 775% Amer. Moonshots Root ^ These gains occurred with a partial position in the respective stocks. * The two partial positions in Nvidia were part of a single recommendation. Editor Dave Lashmet closed the first leg of the position in November 2016 for a gain of about 108%. Then, he closed the second leg in July 2020 for a 777% return. And finally, in May 2022, he booked a 1,466% return on the final leg. Subscribers who followed his advice on Nvidia could've recorded a total weighted average gain of more than 600%. You have received this e-mail as part of your subscription to Stansberry Digest. If you no longer want to receive e-mails from Stansberry Digest [click here](. Published by Stansberry Research. You’re receiving this e-mail at {EMAIL}. 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