The Stock Market is not a Free Market Because It Is Dependent On A Monopoly

Can there be a free market if there is a monopoly?

Is there a monopoly in the issuance of dollars?

The answer to the first question is, no.

The answer to the second question is, yes.

The conclusion then is: debt markets and the stock market are not free markets because they depend on the monopoly-creation of dollars.

The currency-creator (US Federal Government) is in full control of the issuance and, therefore, the value of the dollar. Congress has legislative control over spending (dollar creation) and taxation (dollar cancellation), and — like it or not — control over the Federal Reserve bank as well; when the Treasury tells the Federal Reserve bank to deposit dollars into accounts…it must do so.

The issuance of bonds to match the net-creation of dollars (deficit-spending) is a choice, not a mechanical requirement. A choice that serves to encourage the holding of dollars and, therefore, maintain the use and value of the dollar, but it is not a mechanical necessity; the dollars are created first (through spending), and only afterwords can they be used to buy the bonds.

When Congress enacts a “debt ceiling”, it is simply saying that the government cannot net-spend money into existence. It doesn’t have to do that. It just does not understand how the fiat money system works! Spending and “borrowing” by the Federal government is simply an issue of accounting principles — double entry accounting where a deposit on one side of a ledger, is a liability on the other side.

Before 1981, the Treasury could simply run a deficit (overdraft) on its cash account at the central bank (the Federal Reserve). The government would issue bonds that the Fed would “buy” directly from the Treasury as a way to register an overdraft on the Treasury account…simply an accounting formality. Because the Federal government is the monopoly issuer of dollars and can never be forced to default on any dollar-denominated accounting entry, the bonds are risk-free and cannot, therefore, be considered as normal household “borrowing”. The Federal government “debt” is simply the stock of Treasuries that accounts for the net-transfer of dollars from the Government to the private sector.

Government Assets vs Private Assets

Source: Cansim table 36100580. ‘Private sector’ aggregates data for ‘Households and non-profit institutions serving households’, ‘Corporations’ and ‘Non-residents.’ ‘Governments’ is ‘General governments.’ Note: Series is the year-over-year change in quarterly values.

Since 1981, however, Section 14(B) of the modern Federal Reserve Act includes a limitation where the Fed can buy and sell Treasury bonds and notes “only in the open market”, not directly from the Treasury. This, of course, was a major step in the financialization of the US economy which provides risk-free profits for the ‘primary dealer banks’ who exclusively are allowed to intermediate with the SOMA at the NY Federal Reserve. It is simply the privatization of the monopoly-issuance of dollars; whenever the Federal government wants to issue dollars (net-spend), it is forced to pay private banks to do so. Totally unnecessary, but a great risk-free business opportunity for the banks.

Congress, for its part, seems to not understand that it has a monopoly over the creation of dollars (Coinage Act of 1792). If they did understand this, they would not be asking the question “how do we pay for” the goods and services that the government needs to provision itself? They would instead be asking “how do we resource” what is needed. Since Congress is the currency-issuer, it can “pay for” anything at any price, but there might not be enough real resources available to produce the goods and services needed. Congress preventing itself from paying for the resources it needs — by not allowing the sale of new bonds — is tantamount to economic ‘self-harm’. It demonstrates a complete misunderstanding of the system they are in control of. Or more cynically, they understand it, but simply want to hurt the opposing political party even if it damages the American people who elected them.

Since the pandemic started, the Fed has been buying Treasuries and MBS (in the open market), but recently it has started to slow the pace of buying by $15B/month. The balance sheet of SOMA is still increasing, however, and it will continue to increase until Spring of 2022.

This reduction in the balance sheet expansion will not harm the stock market because the Fed will not raise rates until the balance sheet stops expanding , and, in any case, raising rates from the zero-bound by 0.25 or 0.50 basis points will have no negative effect on the stock market — although, Wall Street will react to the headline and provide us with a buy-the-dip opportunity. Keep in mind that no rate hike is likely before May, at the earliest.

The chart below shows that rising rates do not cause bear markets. ‘Too high’ rates are associated with bear markets. The stock market will continue to rise along with rates, just like it has done in the past (chart below).

The stock market is not a free market because as long as funds continue to flow into the private economy from the monopoly-creator of dollars, the US Treasury, corporate profits will grow and the stock market rises. And when deficit-spending (dollar creation) slows down, the stock market drops.

Markets cannot be free when dependent on a monopoly. As investors, it pays to understand that a rising stock market requires a government deficit. Investors can profit as the “debt” increases by holding broad-spectrum ETFs such as VOO, SPY, DIA, and IWM.

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Forty years of private equity trading, and still learning.

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