Inside today’s Daily Journal…

Kevin Warsh resigned from the Federal Reserve in 2011.

At the time, he was in open rebellion against the central bank’s decision to continue expanding its balance sheet. The Fed’s decision to proceed with quantitative easing (“QE”) would have profound impacts on our markets, our society, and the government’s role in our lives.

In three months, Kevin Warsh will return to the Fed – this time as its chairman. His mandate is to restore the market’s natural function. He is determined to bring back capitalism to America and to stop the never-ending encroachment of the government into every aspect of life.

Recently, in public remarks, Warsh stated clearly that we sit at a critical juncture, a “hinge point in history,” he calls it. He believes we must act to restrain the power of the government and restore the centrality of the free market in society.

Warsh inherits a Federal Reserve grappling with the long-term consequences of decades of expansive policies. For most of the past 30 years, at every turn, U.S. society has turned to the government – via the Federal Reserve – to solve its problems. The Fed’s mandate has expanded from protecting large commercial banks from acute liquidity crises to solving every conceivable social ill – including vast mortgage fraud, runaway and corrupt social programs, endless wars, and the annual flu (aka, COVID). The result has been a massive expansion of government debt, government power, a soaring wealth gap, and the risk of a global run on the dollar.

Warsh clearly plans to reverse this decades-long expansion of the Fed’s power and its balance sheet. And, in the short term, that makes the markets vastly more dangerous.

In the long term, however, Warsh may save us from socialism. It is no exaggeration that his mandate is to save the American way of life: a free people with free markets.

It’s worth taking a minute to review how we got here.

The monetization of everything began in September 1998.

Long-Term Capital Management (“LTCM”), an enormously leveraged hedge fund founded by Nobel laureates managing the fortunes of Wall Street’s titans, teetered on the brink of collapse. LTCM’s arcane strategies – mainly bond arbitrage – ended up exposing it to billions in emerging-market debt. When those markets blew up because of Russia’s August 1998 debt default, the fund’s $4.6 billion in equity evaporated, leaving over $125 billion in assets and $1 trillion in derivatives notional value spiraling lower. The losses were so large that they threatened the entire global financial system.

Rather than letting the huge credit pyramid collapse and allowing the market to find its own clearing level, The Federal Reserve, under Chairman Alan Greenspan and the “committee to save the world” as Time magazine called them, intervened by orchestrating a $3.6 billion rescue package from 14 private banks and brokerages, including Goldman Sachs and JPMorgan.

The Fed was willing to intervene in crises, even those stemming from private speculation.

This was an entirely new role for the Fed, which was supposed to help the government finance its debts and to support commercial banks. It was supposed to foster wise credit allocation across the U.S. economy. Its powers were never intended to back reckless speculation.

The LTCM episode normalized Fed involvement in private-sector rescues, paving the way for expansive policies in future crises and embedding expectations of government backstops in financial markets.

The Fed took the failure out of capitalism. Its powers were being used to eliminate the “destruction” that is inherent in the normal “creative destruction” of progress in free market economies. Capitalism without failure – and speculation without risk – is like Christianity without Hell. It doesn’t work. All discipline is abandoned.

Before the 2008 Global Financial Crisis, the Fed’s assets hovered around $900 billion. It exclusively owned U.S. Treasury securities, reflecting a conservative approach focused on short-term interest rate management.

That approach prevented any reckless expansion of credit, and it limited the scope of what could be considered a monetary asset to risk-free Treasury securities.

But all of that restraint ended with the mortgage crisis, which led to the Global Financial Crisis. In 2008, the enormous fraudulent underwriting and trading practices of the world’s largest financial institutions – including the government-run mortgage lenders Fannie Mae and Freddie Mac – collapsed. The resulting losses – around $10 trillion globally – once again threatened to completely wipe out most of the world’s financial institutions. Rather than taking this medicine and re-setting credit and price levels around the world, the Fed began to monetize the world’s credit markets.

The Fed launched three rounds of QE, purchasing longer-term Treasuries and mortgage-backed securities (“MBS”) to lower long-term rates and inject liquidity:

Soon, MBS (housing) comprised over 40% of the Fed’s assets. That’s a huge departure from owning only short-term, risk-free Treasuries.

This is now why most Americans can’t afford a house.

The 2020 COVID-19 pandemic triggered QE4: purchases surged to $120 billion monthly, inflating the balance sheet to $8.9 trillion by 2022, or 35% of GDP. This was the beginning of an unprecedented inflation and a radical expansion of the role of government in American society. Emergency facilities like the Paycheck Protection Program Liquidity Facility further expanded asset types and funded enormous amounts of fraud.

The U.S. currency – and the country – had completely lost its moorings.

Today the Fed’s balance sheet stands at $6.5 trillion – 7x pre-2008 levels.

These monetary expansions, while aimed at stabilizing the economy, have had profound real-world implications – through inflation and massive wealth inequality. Although initial QE rounds did not immediately spark broad inflation – largely because excess reserves remained parked at banks, failing to translate into widespread lending – the post-2020 QE contributed significantly to price pressures, particularly in housing, where Fed purchases of MBS fueled a 40% to 50% appreciation in home prices, adding $480 billion to $840 billion in stimulus via wealth effects and boosting aggregate demand.

Worse, because the Fed’s expansion of the money supply has dwarfed increases to productivity, wages have failed to keep pace with productivity gains.

From 1979 to 2025, net productivity grew at an average annual rate of 1.4%, while typical workers’ hourly compensation rose only 0.6%, widening the wealth gap between workers and asset owners. Labor has been left in the dust, which has fostered desperation (gambling, prostitution, drug use), anger, and populist demands for wealth redistribution. Although most Americans still don’t understand how, they know they have been cheated.

By 2025, the top 1% in America held a record $52 trillion in wealth, representing 29% of total household wealth. The 1% own nearly 50% of all corporate equities and debt securities!

The world mimicked the Fed’s actions, leading other central banks to monetize diverse assets. The Swiss National Bank (“SNB”), managing vast foreign reserves from franc interventions, holds $167 billion in U.S. equities, with $42 billion in just five tech giants: Amazon (AMZN), Apple (AAPL), Meta (META), Microsoft (MSFT), and Nvidia (NVDA). This positions the SNB as a major Silicon Valley investor.

Why do you think stocks never go down anymore? They’ve been monetized too.

The European Central Bank (“ECB”) followed suit, launching its own QE in 2015 with €60 billion monthly purchases, expanding to include corporate bonds and, during COVID, “fallen angels” – junk bonds downgraded from investment grade. By 2022, the ECB’s balance sheet reached €8.8 trillion, monetizing sovereign debt and junk bonds to avert fragmentation.

The Bank of Japan (“BOJ”) owns vast holdings in equity exchange-traded funds (“ETF”).

These actions have blurred the lines between money, debt, and equity. The result has been an enormous expansion of financial assets: the financialization of everything.

Warsh views the Fed’s $6.5 trillion balance sheet as “bloated.” He is openly advocating “regime change”: limiting Fed purchases to short-term Treasuries in emergencies only. He plans to restore the market’s natural discipline. And that spells big trouble for Wall Street: no more “Greenspan Put.”

We’ll focus on what that means for our own strategies on Wednesday. But I’ll say this for now: It means the return of genuine equity risk premiums, wider spreads for corporate bonds (over Treasuries), and, most likely, a severe recession like we saw in the early 1980s.

We aren’t in Kansas anymore, Toto.

Tell me what you think of today’s Daily Journal: [email protected]

Porter Stansberry
Stevenson, Maryland

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1. U.S. manufacturing activity surged in January. This morning, the Institute of Supply Management (“ISM”) reported that its U.S. Manufacturing Purchasing Managers’ Index (“PMI”) rose to 52.6 in January, a big increase from December’s 47.9 reading – and the strongest month of expansion since August 2022. Figures above 50 indicate that economic activity in the sector is expanding. While one month does not make a trend, this report suggests the U.S. economy could be re-accelerating for the first time in years.

2. Long-term unemployment is surging – with 3.1 million people now out of work on average 15 weeks or more, the highest level in over four years. Roughly 26% of the 7.5 million unemployed have been actively searching for a job for at least six months. Stress is building beneath the surface as the labor market weakens.

3. Nvidia’s $100 billion OpenAI investment is in question. The Wall Street Journal reports that Nvidia’s (NVDA) previously announced $100 billion investment into artificial-intelligence leader OpenAI has “stalled” – with CEO Jensen Huang saying it was “never a commitment.” Nvidia executives, it seems, have grown cautious due to rising competition and OpenAI’s “lack of business discipline.” We expect more fundraising struggles for OpenAI as the company faces intense competition from well-financed rivals, like Google’s (GOOGL) Gemini.

Bitcoin rose steadily to nearly $125,000 after we recommended it at $27,000 in Complete Investor in May 2023 – and now trades for $79,000, after weeks of volatility… with many seeing it poised to rise once again.

John C writes:

Porter Comment: What I believe Warsh will bring is an end to the “Greenspan Put” – the notion that the central bank should bail out speculators. That idea has been in the market since the collapse of Long-Term Capital Management in 1998. It has been terrible for the dollar, terrible for Main Street, and great for Wall Street. I hope he’ll put a stop to it.

I suspect that Trump could see from the soaring prices of gold and silver that the Fed was losing all credibility. I don’t think Warsh was his first choice, but I think he was persuaded that it was necessary to restore faith in the dollar.

While it may prove to be a painful transition, I’m looking forward to markets that are allowed to go down. It will make my job more interesting and a lot more valuable to people.

Barry H writes:

Porter Comment: You’ll get a complete refund for your subscription.

I don’t need people like you in my life.

Regards,

Porter

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