Gekko - Federal Reserve may be manipulating financial markets - Column

National Review, August 12, 1996 by John Dizard

### DIZARD, JOHN

YOU may have heard about some, ahem, volatility in stock prices in the first part of July. It was sort of like riding a roller coaster that was running at double speed. The most educational day, of course, was Tuesday, July 16. For my sins, I happened to be spending the day at a brokerage house. The people weren't visibly panicked -- they just whispered to themselves as their whole lives passed before their eyes.

As you might recall, right around lunchtime, the free fall in the major averages, particularly the Dow and the S&P 500, suddenly turned into a violent updraft, as if the biggest checkbook in the world had just been handed to a drunken sailor. The "market," that is to say the Dow and the S&P, wound up just a little up for the day after a three-digit round trip.

For a couple of years now, I've been hearing tales of intervention by central banks, in particular, the Federal Reserve market, outside their traditional purview. Even, possibly, their legislated mission. Gold-market experts such as Frank Veneroso have been pointing to central banks, including the Fed, as likely suspects in the recent gold-market weakness. Now that has become a staple of world gold-market chatter.

Gold is a monetary metal, though, and it could be plausibly argued that central banks, including the Fed, have a legitimate function in "maintaining an orderly market." An orderly gold market from the Fed point of view, it would seem, is a declining one that maintains faith in major currencies.

But if the Fed or some instrumentality of the Fed were intervening to prop up equity markets, that would be an interesting use of taxpayers' money. Yes, I know the Fed is not directly owned by the taxpayers, but it is taxed by the government at a confiscatory rate, so there is a distinction without a difference.

What was interesting about the Tuesday reversal in the market was the suddenness with which the S&P futures index, which was "lock limit down" at the maximum possible loss for the day, went to a premium over the cash market, or the price of the actual basket of shares that is represented in the S&P 500 index.

Could that have been some Mississippi riverboat gambler of a professional trader? Not likely. The phrases one hears with tedious regularity from these people -- "Don't try to catch a falling piano," "The trend is your friend," etc. -- suggest that they are the sort of people who get on speeding trains rather than lie down in front of them. The talk -- I emphasize that for now it's just talk -- is that the Fed intervenes in the S&P futures market through a special account at Goldman Sachs.

Now if you were a typical Fedling, you might believe such intervention was justified "to maintain an orderly market." Just such a view was propounded by Robert Heller, a former Fed governor, in a speech in San Francisco in 1989. And it is true that stock-market crashes are not orderly. But they probably are necessary to wash out excesses. Let's say for the sake of argument that, many of the times that the S&P futures have hit their lock limit down, the Fed or a Fed instrumentality has bid up the market. Then lots of people, such as mutual-fund investors, might have gotten an unrealistic view of how risky the equity markets really are.

In other words, the Fed may have helped inflate the bubble of the last few years. With the best of intentions, of course. Government people always have the best of intentions.

My ambulance-chasing friends on the edge of the emerging markets are dusting off their Turkish card files even as they check to make sure their sell orders on Russian debt were executed. Few life-insurance salesmen are calling on Boris Yeltsin these days, of course. But there has been a spate of articles congratulating Western leaders for their foresight in backing Prime Minister Viktor Chernomyrdin, Yeltsin's supposed successor. Interestingly, informed people who have been betting their own money on Russia's future are taking it off the table. As one of them says, "I wouldn't be too sure that someone like General Lebed won't plant a bullet right between those bushy eyebrows of Chernomyrdin's. He's got a lot of friends in Washington. Not so many in Russia, outside the mafia and the oil and gas generals."

The new speculative playground may well be Turkey. It's a disaster. The Turkish state is spending over half its revenues on interest payments. An anti-"usury" Islamic party now has partial control over the previously secular government. And nobody knows what civilian nonsense will be tolerated by the large, irritable army. Turkey is big -- sixty million people -- and, Islamic government or not, cannot permanently walk away from Western credit markets. The price spreads among Turkish debt issues are bound to widen, depending on how the volatile politics work out. In other words, an iron-nerved speculator's paradise.

A couple of months ago, I suggested buying a basket of South African gold stocks and selling an offsetting basket or index of North American stocks. Well, it worked, and the South African golds did outperform. I'd unwind that trade now. I'm giving some thought to the next interesting gold-market trade.