Cabals, Conspiracies, Manipulations and other Market Machinations
By James J Puplava CFP, April 8, 2003
Diversity in the Markets & Opinion Chances are if you ask two different investment advisors or analysts on the markets, you'll get two completely different opinions. Obviously, in the daily buying and selling of stocks, investors take actions based on two completely different views. A buyer may come into the market and buy stocks because he or she is bullish on the markets or bullish on a particular issue. At the same time the buyer is making a purchase, a seller enters into the market with the desire to sell for opposite reasons. The seller may be bearish the market or bearish on a particular stock. The financial pages are filled each day with the various opinions of analysts, economists, and financial journalists as to where the market is positioned, where it is headed, and whether it is over or undervalued. Without this diversity, we wouldn't have liquid and functioning financial markets. In order for an investor to buy a stock, somebody has to be willing to sell and vice versa.
In addition to the plethora of views on the stock market, there are plenty of inexplicable reasons as to why the markets behave in the way they do. People want to have answers and we have a news business that is only too willing to supply the answers. Some days there are simply no answers that provide a compelling enough reason as to why the markets did what they did. Human psychology and the psychology of the crowd is a complex matter. Why human beings do one thing as an individual and quite another as part of a crowd is a complex matter in itself. Suffice to say various individuals and institutions have various reasons of self-interest for doing things that may not on the surface be explainable.
Given all of the diversity in today's markets you will find many opinions on why the markets are behaving in the way they do. It should come as no surprise that market manipulations are as equally diverse as the array of opinions. Some believe that our markets are free and open; while others believe they are at times manipulated to suit the purposes or self-interests of particular companies, institutions, individuals and even governments. Individual investors have recently discovered through the accounting scandals and corporate malfeasance scandals of last year that earnings were manipulated to achieve earnings objectives in an effort to influence stock prices. While this may have come as a surprise to many investors, it certainly wasn't a surprise to many in the profession who knew better. Certainly the history of the financial markets are filled with attempts to manipulate stock prices for the benefit of certain insiders or groups that were either trying to corner the market, a particular stock, or concoct schemes to defraud investors in an attempt to profit. Attempts at market manipulation are certainly nothing new in the annals of stock market history. It is only during such times when a particular market is in a mania phase, that the incredulity of investors expands. Schemes and attempts to manipulate the markets are as old as the markets themselves. With human nature being what it is, there will always be some one, some institution, some government or some politician who will try to influence or take advantage of the markets. Many refer to this action as a cabal when it involves a group; others call it a conspiracy, while still others simply refer to it as market manipulation. I call it enlightened self-interest, the act, or actions taken by either an individual or an institution either to protect one's own interest or to influence the outcome of the markets to one's benefit.
The Federal Reserve -- Designed to Intervene
Recently a statement was made that the existence of the PPT or any other entity that would try to influence the markets is an "urban fiction." The statement was made emphatically. I would disagree with this assumption. There are plenty of specific examples throughout the 20th century and the century that preceded it where government intervened in one form or another to influence economic policy or the markets in order to pay for war, forestall a depression, or directly influence the outcome of the economy. The best example is the creation of the Federal Reserve. The Fed was created under the guise of preventing a banking crisis by having the ability to inject liquidity into the banking system and forestall a banking crisis. The very nature of the Federal Reserve is an institution designed to intervene in the financial markets and the economy in an effort to affect economic policy.
Throughout much of its existence, the power of the Fed has increased substantially to where it is today. An economic history of the 20th century is filled with numerous examples of Fed intervention into the financial markets, the currency markets, the gold markets, and I believe the stock markets to direct the outcome of the markets, affect economic changes or alter the direction of the dollar. Most investors are familiar with central bank interventions into the currency markets either to prop up a currency or to bring the value of a currency down. We all follow with great interest the actions of the FOMC and the Fed's actions to either raise or lower interest rates. When the Fed, through its own action, expands the money supply and credit, or when it lowers interest rates artificially from where they would be if left to the supply and demand of capital in the markets, it is intervening in the markets to affect policy change. If this isn't intervention, then what else would it be called? The same applies to the currency markets where the Fed or the Treasury have moved to prop up the dollar when it is under attack or at other times when it is too high and policymakers want to use a lower dollar to stimulate exports.
Plain and simple, intervention into the markets, whether it’s currency or any other type, is a normal practice of government. Pick up any of today's economic textbooks and you will find the virtues according to today's Keynesian or monetary school of thought throughout the entire economic textbook. The government is always intervening in the economy or the markets every year in an effort to affect economic and financial outcomes or influence the behavior of businesses or individuals. This is simply how our economy and financial markets work. Each year depending on where the economy rests, various policy initiatives are proposed in order to influence economic outcomes. During times of recession, the Fed lowers interest rates and expands credit in order to stimulate the economy. When the Fed intervenes into the financial markets and lowers interest rates, they influence the financial markets in both stocks and bonds. Lower interest rates make it more economical to borrow. Lower interest rates affect bond prices, the rates on commercial paper and the discounting mechanism used to measure and evaluate future earnings. To say the government does not intervene in the financial markets to affect financial and economic outcomes is strewn with error. There are too many examples on a regular basis that indicate otherwise.
In addition to intervention in the financial markets, most notably with interest rates and in the currency markets, the government has also been known to intervene in the gold markets as well as the bond markets. Most readers are aware of the attempt by the U.S. government to intervene in the gold markets between 1964-68 with the London Gold Pool. Other lesser-known examples were attempts by this government and the Bank of England to intervene in the gold market in the 1920s, which in some way may have contributed to the Great Depression. For more information on this subject, I would suggest reading The Creature from Jekyll Island by G. Edward Griffin and the Gold Wars by Ferdinand Lips. Besides intervention in the gold and currency markets, the Fed has especially intervened in the bond markets to peg interest rates. There are numerous examples of this throughout the last century. In a speech given by Fed Governor Ben Bernanke on November 21, 2003 titled "Deflation: Making Sure It Doesn't Happen Here," Bernanke makes reference to past interventions.
Several pertinent points from Gov. Bernanke's speech regarding intervention and pegging the rate of interest are listed below:
"Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.
However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero." (Page 3)
"And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks." (Page 4)
"There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields.
"Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.11 For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt." (Page 6)
As the above speech indicates, there are times and various reasons why the Fed has and will continue to intervene directly in the financial markets in order to affect policy changes in the economy or the financial markets. It doesn't matter what the reasons are, whether it is to stimulate the economy, bring down inflation rates or to rescue a troubled bank or hedge fund, they do intervene in the markets. The above quotes refer to how they were able to peg interest rates in the past and how they can do so in the future. Even on a day like today the Associated Press refers to the Fed refining an emergency rescue plan for an economy faced again with recession. The article says how the Fed is now prepared to move beyond its traditional measures to pump more money into the economy.
The issue of what the Fed does when faced with nominal low interest rates or zero interest rates has been addressed in past working papers, most notably The International Finance Discussion Papers, Number 641 of July 1999. In this paper the Fed study group addresses what other measures may be taken when in effect the Fed is out of interest rate bullets or when they face zero bound on nominal interest rates. Discussion of relevant points is listed below.
4. The Zero Bound on Nominal Interest Rates
The zero bound on nominal interest rates is a feature of any economy in which cash holdings are a medium of exchange, are not taxed, are costless to hold (and insure), and do not pay interest.15 Phelps (1972), Summers (1991) and Fischer (1996) have argued that the zero bound poses a potentially serious problem for monetary policy. If economic activity is weak or contracting and interest rates hit the zero bound, a dangerous dynamic can be set in motion. Falling inflation, or even escalating deflation, would increase real rates of interest. As this depresses aggregate demand further, downward pressures on prices would raise real interest rates further: The economy would potentially face a downward deflationary spiral. These authors have conjectured that the likelihood of encountering this problem could be significantly lessened if long-term inflation is not allowed to decline to zero but is kept in a range of one to three percentage points. With a rate of expected inflation of this magnitude built into nominal interest rates, the economy would be entering any potential recession with nominal interest rates that much higher than they would be if long-term inflation was zero providing more scope for monetary policy to ease by lowering nominal interest rates." (Page 22)
"Indeed, recent experience in Japan suggests that should an economy become mired at the zero bound, central banks will consider creative new ways to make their policy tools more effective." (Page 23)
Alternative Policy Tools
In light of these possible limitations to continued open market purchases of T-bills after the interest rate has hit zero, a central bank may wish to either replace or reinforce these purchases with other policy actions. Several of these alternatives (purchasing treasury bonds, writing options on interest rates, and purchasing foreign exchange) can be viewed as extensions of conventional open market operations, while others (purchasing private sector securities, discount window lending to the non-bank sector, and direct cash transfers to the public) represent potentially new directions for U.S. monetary policy." (Page 25-26)
Purchasing Private-Sector Securities
While using a credible rule to set short-term interest rates, purchasing government bonds, and using options may all help to lower and flatten the Treasury yield curve, the yield curves for private sector securities could remain somewhat elevated. In particular, if short-term Treasury rates are at zero and the economy is floundering, credit risk premiums could be quite high. If these risk premiums are holding back an economic recovery, the central bank could potentially unlock credit flows and jump start the economy by taking this credit risk onto its balance sheet, for example, through purchases of private sector securities. The key issue for a central bank contemplating such actions, however, is whether it is authorized to and whether it wants to take such private-sector credit risk onto its balance sheet. The Federal Reserve, for example, faces some important restrictions regarding the type of private-sector securities that it is authorized to purchase. The current statutory authority for open market operations is still strongly influenced by the intent of the original framers of the Federal Reserve Act. One intent of the Federal Reserve Act was to spur the development of the bankers' acceptance market. It was thought that if the Federal Reserve could purchase and sell bankers' acceptances and similar types of securities, this would stimulate the development of private markets for these types of credit instrument. Accordingly, even today, while the Federal Reserve can purchase virtually all types of Treasury and agency securities, it can purchase only certain types of private sector securities---bankers' acceptances and bills of exchange. Accordingly, the Federal Reserve is not authorized to purchase notes, such as corporate bonds and mortgages; nor can it purchase equities or real property such as land or buildings.22 Even within the class of bankers' acceptances and bills of exchange, Federal Reserve purchases are limited to those instruments that arise out of transactions in real commerce.23 By tying Federal Reserve purchases to instruments financing real commerce, it was thought that the money stock would expand and contract in line with real business activity. By this means, there would be enough money and credit to provide for real business needs, but excessive money growth and its inflationary consequences would be avoided." (Page 28-29)
As shown in this paper and referenced on numerous occasions, including today's AP story about emergency measures being considered by the Fed, the Federal Reserve will intervene in the financial markets and use whatever measures necessary when faced with a major financial or economic crisis.
In addition to intervention, the ease in which transactions could be facilitated in the stock market would be far easier than with transactions or measures taken to influence the bond or currency markets. The stock market is dwarfed by the size of the currency markets. In the stock market transactions are in the billions. In the currency markets, they are in the trillions. Intervention in the stock market could be facilitated through offshore accounts transacted through a small select group of key brokerage firms. Because the U.S. financial markets are so highly geared through the use of derivatives, affecting a desirable change would be much easier. A few select key purchases in the futures markets would be enough to produce or alter the markets. The PPT (Plunge Protection Team) or ESF (Exchange Stabilization Fund), which is accountable to no one, could buy a 20-30 contracts to produce an effective change in the markets direction. Short covering would then come in and do the rest. Please see past Observations on my four-step rally process.
Suffice to say there is ample evidence that the Fed, Treasury Department and other government entities have intervened in the economy and the markets periodically to alter the outcome of the markets, affect economic change, or alter the behavior of investors or consumers. To say that the government or any other entity or group within government would not do so is not based on facts. The moral hazard this creates, the harmful effects that it produces, and the eventual fallout caused by these interventions will be addressed in more detail. For the moment I would suggest the reader spend a few moments perusing the speeches, studies and article listed on our Fed Watch page on our web site. I would also suggest reading Lips and Griffin's books for more knowledge on this subject. This topic will be expounded upon in greater detail in the days ahead.
The markets ended the day on a negative note after a choppy session of trading. Poor earnings reports coming out of RF Micro Devices and Microchip Technology raises suspicion over tech valuations and earnings assumptions. Wall Street has been touting the sector but it looks like it is bound to disappoint investors again with lower earnings, and sales growth. The major indexes moved on both earnings and ware news. The markets rallied briefly on news that coalition forces may have killed Saddam Hussein and hasten the end of the war. Companies across a wide range of sectors have been warning that profits and sales would come in far below expectations this quarter.
Volume hit 1.2 billion on the NYSE and 1.3 billion on the Nasdaq. Declining issue outdistanced advancing issue on the Big Board by an 18-14 margin and by a similar margin on the Nasdaq. The VIX fell 2.14 to 29.59 and the VXN dropped .52 to 40.92. They are now both approaching levels of widespread complacency, a point at which markets turn.
European stocks slid, snapping a five-day rally that pushed the Dow Jones Stoxx 50 and Stoxx 600 indexes to their highest in 10 weeks, on concern an end to the war in Iraq won't revive economic growth. Bayerische Motoren Werke AG, the world's second-biggest luxury carmaker, fell following a report that showed German industrial production dropped in February. Marks & Spencer Group Plc declined after saying revenue growth last quarter stalled because of lower consumer spending. The Stoxx 50 shed 1.6 percent to 2307.86. The Stoxx 600 lost 1.6 percent to 191.68, with all 18 industry groups declining. All of Western Europe's 17 benchmark indexes dropped except for Luxembourg and Italy, which rose for a sixth straight day.
Japanese stocks fell on concern U.S. economic and earnings reports will damp some investors' expectations for a recovery in the world's biggest economy. Exporters such as Toyota Motor Corp. and Sony Corp. led the drop. The Nikkei 225 Stock Average fell 1.4 percent to 8131.41.
© 2003 James Puplava