The Fed's Stunning Admission Of What Happens Next

Tyler Durden's picture


Following an epic stock rout to start the year, one which has wiped out trillions in market capitalization, it has rapidly become a consensus view (even by staunch Fed supporters such as the Nikkei Times) that the Fed committed a gross policy mistake by hiking rates on December 16, so much so that this week none other than former Fed president Kocherlakota openly mocked the Fed's credibility when he pointed out the near record plunge in forward breakevens suggesting the market has called the Fed's bluff on rising inflation.

All of this happened before JPM cut its Q4 GDP estimate from 1.0% to 0.1% in the quarter in which Yellen hiked.

To be sure, the dramatic reaction and outcome following the Fed's "error" rate hike was predicted on this website on many occasions, most recently two weeks prior to the rate hike in "This Is What Happened The Last Time The Fed Hiked While The U.S. Was In Recession" when we demonstrated what would happen once the Fed unleashed the "Ghost of 1937."

As we pointed out in early December, conveniently we have a great historical primer of what happened the last time the Fed hiked at a time when it misread the US economy, which was also at or below stall speed, and the Fed incorrectly assumed it was growing.

We are talking of course, about the infamous RRR-hike of 1936-1937, which took place smack in the middle of the Great Recession.

Here is what happened then, as we described previously in June.

[No episode is more comparable to what is about to happen] than what happened in the US in 1937, smack in the middle of the Great Depression. This is the only time in US history which is analogous to what the Fed will attempt to do, and not only because short rates collapsed to zero between 1929-36 but because the Fed’s balance sheet jumped from 5% to 20% of GDP to offset the Great Depression.

Just like now.

Follows a detailed narrative of precisely what happened from a recent Bridgewater note:

The first tightening in August 1936 did not hurt stock prices or the economy, as is typical.


The tightening of monetary policy was intensified by currency devaluations by France and Switzerland, which chose not to move in lock-step with the US tightening. The demand for dollars increased. By late 1936, the President and other policy makers became increasingly concerned by gold inflows (which allowed faster money and credit growth).


The economy remained strong going into early 1937. The stock market was still rising, industrial production remained strong, and inflation had ticked up to around 5%. The second tightening came in March of 1937 and the third one came in May. While neither the Fed nor the Treasury anticipated that the increase in required reserves combined with the sterilization program would push rates higher, the tighter money and reduced liquidity led to a sell-off in bonds, a rise in the short rate, and a sell-off in stocks. Following the second increase in reserves in March 1937, both the short-term rate and the bond yield spiked.


Stocks also fell that month nearly 10%. They bottomed a year later, in March of 1938, declining more than 50%!

Or, as Bank of America summarizes it: "The Fed exit strategy completely failed as the money supply immediately contracted; Fed tightening in H1’37 was followed in H2’37 by a severe recession and a 49% collapse in the Dow Jones."

* * *

As it turns out, however, the Fed did not even have to read this blog, or Bank of America, or even Bridgewater, to know the result of its rate hike. All it had to do was to read... the Fed.

But first, as J Pierpont Morgan reminds us, it was Charles Kindleberger's "The World in Depression" which summarized succinctly just how 2015/2016 is a carbon copy of the 1936/1937 period. In explaining how and why both the markets and the economy imploded so spectacularly after the Fed's decision to tighten in 1936, Kindleberger says:

"For a considerable time there was no understanding of what had happened. Then it became clear. The spurt in activity from October 1936 had been dominated by inventory accumulation. This was especially the case in automobiles, where, because of fears of strikes, supplies of new cars had been built up. It was the same in steel and textiles - two other industries with strong CIO unions."

If all off this sounds oddly familiar, here's the reason why: as we showed just last week, while inventories remain at record levels, wholesale sales are crashing, and the result is that the nominal spread between inventories and sales is all time high.

The inventory liquidation cycle was previewed all the way back in June in "The Coming US Recession Charted" long before it bacame "conventional wisdom."

Kindleberger continues:

When it became evident after the spring of of 1937 that commodity prices were not going to continue upward, the basis for the inventory accumulation was undermined, and first in textiles, then in steel, the reverse procees took place.

Oil anyone?

And then this: "The steepest economic descent in the history of the United States, which lost half the ground gained for many indexes since 1932, proved that the economic recovery in the United States had been built on an illusion."

Which, of course, is what we have been saying since day 1, and which even such finance legends as Bill Gross now openly admit when they say that the zero-percent interest rates and quantitative easing created leverage that fueled a wealth effect and propped up markets in a way that now seems unsustainable, adding that "the wealth effect is created by leverage based on QE’s and 0% rates."

And not just Bill Gross. The Fed itself.

Yes, it was the Fed itself who, in its Federal Reserve Bulletin from June 1938 as transcribed in the 8th Annual General Meeting of the Bank of International Settlements, uttered the following prophetic words:

The events of 1929 taught us that the absence of any rise in prices did not prove that no crisis was pending. 1937 has taught us that an abundant supply of gold and a cheap money policy do not prevent prices from falling.

If only the Fed had listened to, well, the Fed.

What happened next? The chart below shows the stock market reaction in 1937 to the Fed's attempt to tighten smack in the middle pf the Great Depression.

If the Fed was right, the far more prophetic 1937 Fed that is not the current wealth effect-pandering iteration, then the market is about to see half its value wiped out.

h/t @pierpont_morgan

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Sun, 01/17/2016 - 12:33 | 7058047 Truther
Truther's picture

Fuck the Fed. All the way to Wall Street.

Sun, 01/17/2016 - 12:38 | 7058065 Perimetr
Perimetr's picture

Next chart, World War II

Sun, 01/17/2016 - 12:45 | 7058090 MrNosey
MrNosey's picture

This is what will happen next......

There will be no real recovery what so ever!

The elite will soon run and hide in the bunkers paid for with citizens taxes, after engineering a full economic collapse as well as starting WW3, plus they will make sure that there are enough Jihadi's in the West to start a race war.

That should be enough to cover up the failed fiat ponzi scheme and take care of the 'excessive' population......


Sun, 01/17/2016 - 13:01 | 7058153 skinwalker
skinwalker's picture

I downvoted you for spamming. 


That said, if you are right, I am not worried. I am prepared as well as my means and knowledge would allow. I think I have a pretty good chance of survival, and I have useful people willing to help me (family, nieghbors etc). I might be ok. 

Sun, 01/17/2016 - 15:46 | 7058822 BarkingCat
BarkingCat's picture

I don't even read what the spambot writes. I hit down vote and move on.

Mon, 01/18/2016 - 09:25 | 7061107 nscholten
nscholten's picture

That being said; the video is worth a look. (The Lion) has received somewhat of a parabolic viewing of late. 

Sun, 01/17/2016 - 13:16 | 7058203 MASTER OF UNIVERSE

Whatsoever is one word, MrNosey.

Sun, 01/17/2016 - 15:02 | 7058637 erkme73
erkme73's picture

Can you uplease give it a goddamn rest?

Mon, 01/18/2016 - 09:26 | 7061111 nscholten
nscholten's picture

Is it really that fucking hard to simply move past the post your not interested in??

Sun, 01/17/2016 - 16:57 | 7059038 The Squid
The Squid's picture

Sorcha Faal always seems to be bang on with their predictions. I don't even need to click the link to know what 'she' has to say...


Let me guess...


A top secret report has been leaked from the Russian ministry of defense, containing the outcome of a recent study comissioned by the Duma, which stated that world war 3 was imminent, thanks to the interception of an off world transmission, which originated from the iluminati homeworld, nubiru.

The source within the ministry stated that a Russian Typhoon class sub was perfoming a 'Crazy Ivan', whilst on a canyon run, when it intercepted the transmission on VLF channel 476. The transmission was intended for the Bush family, which has now fully relocated to the antarctic Nazi base and it gave the greenlight for operation 'Guidestone'.

Everyone should prepare now for imminent global nuclear war but should go forth with peace and love in their hearts, in the hope that the shadowy plaedian galactic council can somehow prevent the luciferian attack from taking place.

PS, you are a fucking moron.

Sun, 01/17/2016 - 17:56 | 7059279 KesselRunin12Parsecs
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But wait! Theres more! ~ lol

Sun, 01/17/2016 - 19:16 | 7059566 divingengineer
divingengineer's picture

That is perhaps the most lucid comment you have ever made.

Sun, 01/17/2016 - 13:02 | 7058156 SgtShaftoe
SgtShaftoe's picture

Fuck the fed in the ass until it dies.  - Mr. Garrison

Sun, 01/17/2016 - 13:08 | 7058176 Bangin7GramRocks
Bangin7GramRocks's picture

Don't see any soup kitchens, men with moth eaten clothing or babies dying in the streets. We may get to a depression era level destruction of society, but we aren't there yet. Ease up on the drama queen bee!

Sun, 01/17/2016 - 13:31 | 7058269 Buckaroo Banzai
Buckaroo Banzai's picture

You do understand what an EBT card is, right? It's the 21st century equivalent of a "soup kitchen". A few internet searches should yield a rather telling graph or two.

Sun, 01/17/2016 - 13:35 | 7058281 weburke
weburke's picture

we are all going to regret the days when ebt cards fail. what a mess that will be. 

Sun, 01/17/2016 - 14:06 | 7058412 Bangin7GramRocks
Bangin7GramRocks's picture

Only when the EBT cards stop working will it be an equivalent to the Great Depression. Where are the empty storefronts? It is bad, but not near the level of desperation of the 1930's.

Sun, 01/17/2016 - 14:39 | 7058536 Reverend Galileo
Reverend Galileo's picture

It may not be "bad" where you are, but other places, like where I live, it's been depression territory for at least a deacde now.

Sun, 01/17/2016 - 15:02 | 7058643 Harry Balzak
Sun, 01/17/2016 - 15:24 | 7058733 brucekeller
brucekeller's picture

Detroit? Gary, IN? Basically somewhere in the Midwest?

Sun, 01/17/2016 - 15:35 | 7058785 TheReplacement
TheReplacement's picture

Please check with mainstreet mom and pop shops - they've almost all gone away.  Check Radioshack, Sears, Kmart and never-made-a-profit Amazon.  Hell, check Walmart now that they are starting to close stores across the country and fire thousands.


Sun, 01/17/2016 - 15:57 | 7058859 HardlyZero
HardlyZero's picture

Walmart closings will concentrate EBT holders to fewer stores.

Transit will be farther and longer.

Camps nearby next ?

Sun, 01/17/2016 - 17:32 | 7059176 ZeroPoint
ZeroPoint's picture

It will make the Rodney King riots look like a garden party. And not just in the urban areas. Suburban supermarkets, gas stations, and warehouse clubs will burn.

Sun, 01/17/2016 - 20:59 | 7059954 In Ze No
In Ze No's picture

Have you seen Detroit pics lately?  Have you seen the rust belt cities of late?  Heck the homeless were in Hyannis MA in the pre 9/11 recession and there were empty store fronts before the newly emigrated Brazilians began to move into space.  Officials had to move the homeless out of the woods in people's backyards cause of the fear the poop and pee from the many people living there without facilities were causing health issues. Then if I remember correctly they were outlawed from hanging on the streets and removed from the woods. Just move them to another location and deny they exist. At least from the wealthy's perspective, problem solved.

Sun, 01/17/2016 - 21:28 | 7059955 In Ze No
In Ze No's picture


Sun, 01/17/2016 - 21:29 | 7059956 In Ze No
In Ze No's picture


Mon, 01/18/2016 - 03:23 | 7060811 Global Observer
Global Observer's picture

Only when the EBT cards stop working will it be an equivalent to the Great Depression. 

They won't fail.

It is bad, but not near the level of desperation of the 1930's.

It won't come to that. People will continue to get food and toilet paper as long as they follow the rules. Those breaking the rules, whatever they be, will be sent to the FEMA camps. Sterilisation may become mandatory for those on EBT cards and their children who entered or crossed puberty. Those put in FEMA camps will be sterlised before admission itself. What is in store is more government, not societal collapse.

Sun, 01/17/2016 - 15:04 | 7058651 erkme73
erkme73's picture

They did a dry run not that long ago where, IIRC, 9 states' EBT system shut down for a few hours.  The pavement apes just about looted Walmart...

Sun, 01/17/2016 - 21:24 | 7060049 In Ze No
In Ze No's picture

Actually it reminds me of my Skinner box rat when we got to the extinction part of the experiment. You train the rat that he gets a reward when he does a specific behavior. You continually reinforce until he no longer questions it will happen and the behavior/reward.  Then you change the box set up so that the behavior no longer produces the reward. Watch your rat go nuts and run around the box in a complete frenzy.

I gotta say I've witnessed Skinner Rat extinction behaviors in all levels on the socio-econic ladder. I've coached myself through the frustration reaction understanding it for exactly what it is. So I don't mean the analogy as a put down. Expectations are a bitch. 

Sun, 01/17/2016 - 13:36 | 7058284 daveO
daveO's picture

Subtract Fed. gov. deficit spending for millions on welfare. We're there and it's being hidden. Abortion kills the babies before they get to the streets. Go into Walmart at midnight on the 1st day of the month. Eliminate Fed. gov. deficit spending via FED counterfeiting and see what happens.

Sun, 01/17/2016 - 15:16 | 7058702 BullyBearish
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E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E   

F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D  

T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D

E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E   

F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D  

T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D

E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E   

F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D  

T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D   E N D   T H E    F E D


How Many Es in this chart?

Sun, 01/17/2016 - 15:37 | 7058797 KesselRunin12Parsecs
KesselRunin12Parsecs's picture

How Many Es in this chart?


If you strategically add a 'j' & a 'w'... well then, lots!

Sun, 01/17/2016 - 16:38 | 7058976 tempo
tempo's picture

only winning wwII and becoming an atomic power reversed the decline and lead to the70 years of prosperity that American's now enjoy.

Sun, 01/17/2016 - 20:43 | 7059888 AsinineBovineFeces
AsinineBovineFeces's picture

Someone called in a request for this on NPR this morning. It made the drive to work more enjoyable.     

"The country's in the very best of hands"

Sun, 01/17/2016 - 12:33 | 7058048 Larry Dallas
Larry Dallas's picture

War. That is what is certain. War.

Sun, 01/17/2016 - 12:42 | 7058077 WTFRLY
WTFRLY's picture

Joo World Order, that's what's next

Sun, 01/17/2016 - 12:57 | 7058139 tmosley
tmosley's picture

You are mistaken. That is the past. That system is crumbling now.

The next world order is the Eurasian Alliance between China, Russia, and Germany (along with most of the rest of the world).

Sun, 01/17/2016 - 12:59 | 7058147 Savyindallas
Savyindallas's picture

The Germans first have to surgically re-attach their balls. 

Sun, 01/17/2016 - 13:17 | 7058205 KesselRunin12Parsecs
KesselRunin12Parsecs's picture

"You are mistaken. That is the past. That system is crumbling now"


Perhaps... But in the event of THAT scenario unfolding, AmeriKa just gets split up into a fifedom collection of 'Districts' (vis-a-vis HUNGER GAMES), with jews controlling that turf.


FFS ~ it's already like that now.

Sun, 01/17/2016 - 13:58 | 7058373 A82EBA
A82EBA's picture

yep there are currently 12 fed districts

Sun, 01/17/2016 - 14:22 | 7058465 MopWater
MopWater's picture

I'd be 100% OK with that. State I'm in has solid Fortune 500 companies, highly regarded research hospital, ore deposits, neighbor to the west has oil, we have enough arable land That needs no irrigation to feed enough fresh water for an eon.

Sun, 01/17/2016 - 23:31 | 7060465 KesselRunin12Parsecs
KesselRunin12Parsecs's picture

Plus, you'd have a nice sporty pink hairdo to go along with it!

Mon, 01/18/2016 - 10:15 | 7061214 Calmyourself
Calmyourself's picture

If I guess right, your state is run by a drug addict and communists and the temp is about 20 below today..  The miracle that is MN wont last....

Mon, 01/18/2016 - 10:22 | 7061228 KesselRunin12Parsecs
KesselRunin12Parsecs's picture

Minnesota... Isn't that in Canada or sumpin'?

Sun, 01/17/2016 - 15:49 | 7058828 caesium
caesium's picture

With 50,000 allied troops still occupying the country to prevent German men from protecting their women that is not going to happen soon.

Sun, 01/17/2016 - 15:49 | 7058829 caesium
caesium's picture

With 50,000 allied troops still occupying the country to prevent German men from protecting their women that is not going to happen soon.

Sun, 01/17/2016 - 12:58 | 7058142 Savyindallas
Savyindallas's picture

Or revolution -ala 1930's germany style. 

Sun, 01/17/2016 - 13:00 | 7058151 o r c k
o r c k's picture

Every indicator points to massive global war. All it needs is the appropriate spark. And Obombyou will likely supply that soon.

Sun, 01/17/2016 - 13:12 | 7058189 Laplacian2003
Laplacian2003's picture

Obama will supply the spark, but only because of his lack of leadership, not because of something specifc he has done. His wishy-washy, pitifiul aproach has created a real leadership vacuum on the world stage and other countries know this.  Iran, Putin, ISIS, etc. keep pushing the envelope because they know Obama is too incompetent to respond properly...Eventually however, they will push to far...

Sun, 01/17/2016 - 14:34 | 7058517 Seer
Seer's picture

Leaders cannot lead if they don't have the resources.  PERIOD.

Putin is the success that he is because Russia isn't drowning in debt (Obama didn't create the debt-ridden system, though he's ramped it up).  Russia has REAL natural resources in the form of energy that it is able to realistically extract and sell: no scraping shale oil barrels.  Russia has a first-rate military (likely less corrupt than the US's, though that may not necessarily be saying a lot).  And Russia's people aren't heavily divided: the division in the US was underway decades ago, ramping up dramatically in the last two administrations (under the "uniter" and the "peacemaker").

People in the US WANT war, that's the bottom line.  They can say they do not but yet the politicians and their industries say otherwise.  There will be no introspection, it will be, as humans have been programmed for eons, "others" who have caused our despair- war it shall be.

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