Legal Market Rigging and the Panic of 1873
Is the stock market rigged? That is to say, are there shadowy hidden forces influencing market prices, in a manner that most investors don’t understand and often aren’t even aware of?
The answer to that question is yes. Absolutely and without question, the stock market is rigged. But perhaps not in the way one might think, and not for the reasons one might think.
To understand why the stock market is rigged — and what that means exactly — we have to look back to the Panic of 1873.
And by the way, this topic is more timely than ever now, thanks to the increasing involvement of the Federal Reserve, not just in the stock market, but in all manner of debt markets.
Groundbreaking and never-before-seen forms of Federal Reserve activity are accelerating, and possibly hyper-accelerating, because of the existential threat of deflation. That plays directly into the subject matter here.
The Panic of 1873, which ushered in the Depression of 1873-79, was comparable to the Great Depression of the 1930s — except it happened roughly six decades earlier, in the aftermath of the American Civil War.
The Panic of 1873 also had global impact. It hit Europe hard, and ushered in a worldwide deflationary period known as “the Long Depression.” The United States only had it rough for six years — until 1879 — but for some countries, the Long Depression stretched out until 1896.
It’s notable that the Panic of 1873 was brought about by the classic phenomenon of boom-and-bust.
The American Civil War ended in 1865, and shortly after, a railroad mania began. By 1873, the year that the railroad bubble burst, more than 33,000 miles of railroad track had been laid across the continent.
The railroad industry between 1865 and 1873 was like Silicon Valley in the 1990s. Railroads were the 19th-century version of “dot-com” stocks; the oversupply of 33,000 miles of new railroad track was comparable to the massive over-installation of fiber-optic cable in the late 1990s. Profit projections for the railroads reached absurd heights, just as they did for dot-coms 127 years later.
Then, too, the post-Civil War railroad mania was driven by speculators making huge bets with leverage and credit, as banks provided financing for companies and projects that would never be profitable — again just like the 1990s.
The difference, though, is that central banks weren’t yet a thing, which meant the U.S. economy had no means of protecting itself against the fallout from a speculative mania collapse.
In September 1873, Jay Cooke & Co., a major player in the U.S. banking industry, failed to sell a large allotment of Northern Pacific Railway Bonds.
Jay Cooke came very close to securing an emergency $300 million government loan, but his firm collapsed first, forcing Jay Cooke & Co. into bankruptcy.
The bankruptcy then set off a chain of bank failures that then set off a chain of business failures. The panic grew so intense, the New York Stock Exchange had to close for 10 days. Within a year, 115 of the country’s railroads were bankrupt.
After the Panic of 1873 came the Depression of 1873-79. Sharp wage cuts as a result of the ongoing depression, led to railroad worker strikes.
In 1877, a crash in the lumber market then bankrupted companies in Michigan and spread the pain to California.
What America learned from the Panic of 1873 — not all at once, but over time — was that, in the absence of intervention, a speculative mania collapse can be incredibly dangerous for a nation’s economy.
In the modern era, we are used to blaming central banks for booms and busts. But as America’s 19th-century history shows, you can get a mania — and a collapse — even with no central bank involvement at all.
That is because credit can be extended privately, and to the extent banks extend credit to speculators or financiers in the midst of a bubble, it is always possible for a boom to go bust.
After the Panic of 1873, the United States came to rely on one individual, John Pierpont (J.P.) Morgan, to help get itself out of tough economic jams.
In the 1890s the United States had the Panic of 1893, which was a kind of echo bust due to scars from the railroad mania. The Panic of 1893 created a two-year depression, which in turn fueled a new string of bank failures and a run on the country’s gold reserves.
Morgan’s firm, J.P. Morgan & Co., led a banking syndicate that repurchased gold from foreign investors. Morgan then made the gold available to the U.S. government, essentially saving it from ruin.
Fourteen years later, J.P. Morgan would save the system again, when he used connections, banking relationships, and sheer force of will to help resolve the Panic of 1907, a solvency and liquidity crisis similar to that of 2008.
As a result of these painful experiences, the powers that be realized that the United States needed a kind of permanent J.P. Morgan — an agency that could save the system in a crisis, as such that the U.S. financial system would not have to rely on a private individual.
This was the set of experiences that led to the Federal Reserve Act of 1913, which created the Federal Reserve System, also known as “The Fed.”
The Federal Reserve was literally born in secrecy. The famed Jekyll Island meeting, which took place in November 1910, sounds ripped from a conspiracy plot — in part because it really was a conspiracy at the time, in the sense of seeking to avoid huge controversy before the Federal Reserve Act was ready to present to Congress.
But if the Federal Reserve is a conspiracy, it is a legal one, born of perceived necessity.
The Federal Reserve was created as a result of painful experience as to what can happen when no policy manager is available to bail out the system in times of distress.
As a result, the stock market is rigged — and the whole financial system is, in a sense, rigged — to the extent the Federal Reserve can manipulate the contours of the financial system to directly impact market prices with its words and actions.
Stock prices have been driven by the Fed — more than fundamentals or earnings, more than economic outlooks — for a good while now. This is only going to become more true, in our view, because the opposite would mean the Fed losing all control — which could mean disaster.
Those who criticize the Fed would say that, as the most powerful central bank in the world, they have long abused their powers, which were too extraordinary in the first place, and that the Fed went completely off the rails long ago (courtesy of Federal Reserve Chairman Alan Greenspan).
Those who defend the Fed would point to events like the global financial crisis of 2008, or the pandemic-related collapse of February-March 2020, and argue that, without the Fed’s emergency actions, the global financial system would have died of a heart attack.
Like it or not, the Fed’s defenders would say, at some point you need a firefighter — and based on historic events, they have a point.
But whether one considers the Federal Reserve part of the problem or part of the solution — we are somewhere in the middle — their actions and abilities are unquestionably having a huge impact on markets now, perhaps the biggest net impact the world has ever seen.
And this isn’t just due to the initial round of crisis-related actions the Fed has already taken. It is also because the market is increasingly expecting Jay Powell, the intrepid leader of the Fed, to boldly go where no Fed Chairman has ever gone before.