Volume X11, Number 8 August 1996 $10.00

In This IssueThe Impact and Influenceof the Federal ReserveSystem on the U.S.Economy1Ask Customer Service4(TopicD to fromvTous sources)Computer Glitches MarIndependence DavWeekend5Product Summary5Market StatisticsUpdate & IPOs6,7 & 8

Editor : Sabrina CarlePublisher : Commodity Systems, Inc.Layout/design: Moran Advertising, Inc.

Notice : The views and informationexpressed in this document reflectexclusively the opinions andexperience of the author, Robert C .Pelletier. NEITHER CSI NOR THEAUTHOR UNDERTAKE OR INTENDTO PROVIDE TAX ADVICE ORTRADING ADVICE IN ANY MARKETOR ENDORSE ANY OUTSIDEINDIVIDUAL OR FIRM. ALLRECOMMENDATIONS AREPROVIDED FOR THEIR INFORMA-TIONAL VALUE ONLY . Readersshould consult competent financialadvisors or outside counsel beforemaking any trading, softwarepurchase, or investment decision.CSI does not stand behind or endorsethe products of any outside firms .

Advertisements Enclosed: We haveenclosed advertisements for: "How IMade $1,000,000 Trading CommoditiesLast Year" offered by Windsor Booksand "FMC" offered by PeregrineFinancial Group, Inc.

CSI accepts advertisements toaccompany our Technical journal forthe sole purpose of defraying postagecosts.

Copyright © 1996 Commodity Systems,Inc. (CSI) . All rights reserved .

The Impact and Influence of the Federal ReserveSystem on the U.S. Economy An Essay - Part I

Bob Pelletier has resumed his sabbatical from writing the CSI TechnicalJournal while he devotesmore of his energies to engineering and implementing CSI's forthcoming data delivery system . Thisarticle is a slightl r modified reprint from the June,1995 issue . It is the first installment in a two-part

The enormous economic powerwielded by the U .S . Federal ReserveSystem has a very great impact on thelives of every American. Even ouroverseas trading partners are notexempt from its mind-boggling influence .Knowledge of how theFederal Reserveoperates has supportedthe efforts of manysuccessful traders.This first installmentof our series aboutthe Federal ReserveBoard explores twoeconomic views thathave influenced thiscountry. Through theseviews we hope to explain how theFederal Reserve System works. Nextmonth we will dig into the mechanicsand consequences of controlling U .S.monetary policy by the Federal Reserveand we will address the politicalconnection of this arm of government .

The basic responsibility of the U .S .Federal Reserve System is to controlthe credit and the supply of money inthe Federal Reserve System . This includesjust about every money depositoryinstitution in the United States .

The Federal Reserve System wascreated with the passage of the FederalReserve Act of 1913. The Act createdtwelve Federal Reserve Banks distrib-uted around the country which aresupervised by the Federal ReserveBoard and the Federal Open Market

Committee (FOMC). The intent of thelegislation was to give the FederalReserve Board in Washington theauthority to stabilize the credit andmoney markets so that inflationaryand deflationary pressures could be

controlled. Theexpress objectivesincluded stabilizingthe dollar, maintain-ing high employ-

ment, fosteringeconomic

growth, achievingbalance of paymentsequilibrium andmaintaining a risinglevel of consumption .

The concept of "con-sumption," not production, is

explicitly quoted from The FederalReserve System: Purposes and Func-tion~ fifth edition published by theFederal Reserve Board, 1965, p . I .The Fiscalists and the Monetarists

The emphasis on consumption,rather than production, is a fiscalview, as opposed to the now-practicedmonetarist view. The fiscal view wasadvanced by John Maynard Keynes, aBritish economist known for hiseconomic theory circa 1919. His theoryinvolved controlling the economy withtax rates and government spending. Themonetarists, on the other hand, controlthe economy by manipulating themoney supply and rates of credit .

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Unfair Advantage.. .still in the works andcoming soon!

The Impact and Influence .. .(continued from page 1)

Keynes' theory has had its trials asapplied to the American economy, butthe latter view on monetary controlrepresents the flavor of the officialpolicy which is adopted today .

Keynes authored Indian Currencyand Finance and The EconomicConsequences of Peace, which werevery popular works in their day .Keynes' view that peace is a

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deterrent to prosperity hasoutlasted him. My recollectionfollowing World War II was that theKeynesian "beware of peace" positionwas well entrenched in the minds ofall well-educated people. My ownmoney and banking professors of the'50s believed that only through"prudent fiscal policy" could we avoidanother depression . I don't think I'mbeing unkind or inaccurate when Irecall my professors saying, "We canalways tax our way out of a jam orstart a war somewhere to keep theeconomy on track ."

Keynes, in attempting to apply hisown economic theory to the currencymarkets, made substantial profitsspeculating on the strength of thedollar versus European currencies.However, in 1920 he suffered bank-ruptcy when speculating on a bearishposture for the German Mark. Afterreplenishing his capital and reputationthrough his writings, he successfullyspeculated in commodities, accumulat-ing over one-half million pounds . Inspite of his later wealth, he wasknown for offering his guests meagermeals and sending them away hungry .In one report, he paid native boys inAlgiers such a pittance for shining hisshoes that he was stoned in return. Hisreaction: "I will not be a party todebasing the currency."

Milton Friedman advanced themonetarist view that the quantity ofmoney, prices, national income, andvelocity of money interact to keep oureconomy in check . Mr. Friedman wasborn in 1912, some 22 years after John

Maynard Keynes and one year afterthe enactment of the Federal ReserveAct. He was short in stature (five feetfive inches), but a giant in his contri-bution to economic theory .

He was not the first to advancemonetaristic views concerning thesupply of money, but he was an avidlecturer and probably the mostconsistent advocate of monetarypolicy. He believed that control of themoney supply, not government fiscalpolicy, should be the primary means tomanage the economy. He also believedthat an insufficient money supply wasthe major contributor to the GreatDepression.Banks, the Money Supply & the Fed

Banks represent one mechanismthrough which the U.S. governmentexercises the monetarists view es-poused by Friedman. To a large extent,the banks themselves implement Fed-directed changes in the nation's moneysupply. Increases in the money supplyare facilitated by commercial bankswhen they loan money or purchasesecurities. The Federal Reserve regu-lates the amount of money a bank canloan by requiring the bank to main-tain a percentage of its assets ondeposit at the commercial bank'sregional Federal Reserve Bank . Thispercentage is known as the reserverequirement. If a commercial bank, forexample, has $1000 on deposit in theFederal Reserve Bank and the FederalReserve is currently imposing a reserverequirement percentage of 10%, thenthe bank can grant loans totaling$1000/.10 or $10,000 and effect a$10,000 increase in the nation's moneysupply .

If the Federal Reserve wants toincrease the money supply, it mightbuy U.S. Government Securities(T. Notes, for example) on the openmarket with a check drawn on theU.S. government. (The only cost to thistransaction is the ink used to write

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the check because the money iscreated out of thin air.) When theseller of the securities deposits thegovernment check in his commercialbank, the bank's deposits (reserves) atthe commercial bank's Federal ReserveRegional Bank increase. With theseincreased reserves, the commercialbank can now increase the moneysupply (at a multiple of 10 times theamount of the government checkusing the above example) by makingnew-loans-based upon the increasedreserves from the seller's deposit .

In reverse sequence, the FederalReserve can decrease the moneysupply and commercial bank reservesby simply selling government securi-ties out of its own inventory . Thecheck received from the buyer that isdrawn on a commercial bank is paidby the commercial bank. This transac-tion serves to decrease the commercialbank's reserves and the commercialbank is then forced to trim its loanportfolio by calling in loans . In lieu ofcalling in a portion of their loanportfolio, other alternatives for thecommercial bank would be to borrowexcess reserves from some other com-mercial bank at the Fed Funds rate orto borrow the necessary funds at theFederal Reserve discount window.

This latter alternative, althoughless expensive for the borrower, istaken by the Fed as a sign that theborrower is overextended. Therefore,to keep the Fed from imposing anaudit, banks usually get their neededfunds from other banks who areoperating below the Federal Reserve'sreserve requirement . Such loantransactions are usually temporarymeasures by banks which keep themfrom having to abruptly disturb theirloan portfolios .

The Fed is not responsible for thespread between the prime rate andthe federal funds rate (the interestrate commercial banks charge eachother) or the spread between the

prime rate and the federal discountrate (the rate of interest charged bythe Federal Reserve District Banks ofcommercial banks). But this spreadrepresents the minimum gross totalmargin a bank earns for arranging aloan to a favored business . The spreadrepresents an enormously lucrativeopportunity for banks in general. It isno wonder that current Federal ReserveChairman, Alan Greenspan, is known tobe a close friend to the banker.

The rate banks charge, if you thinkabout it, is realistically a form ofgovernment sanctioned price fixing . Amajor bank, noting a Fed sanctioneddiscount rate hike, will announce achange in their prime rate . Otherbanks in the U . S. will then follow suitby imposing the exact same ratechange on their books.

Obviously, banks are insulatedfrom any illegalities for price fixing .General Electric and Westinghousemanagement officials spent consider-able time in jail for fixing the pricesof heavy electrical equipment in theearly 1960s . It is difficult to under-stand how banks all over the U .S. cannot be cited for price fixing whennearly every commercial bank in thecountry can adopt a fixed pricingpolicy for loans pegged to an arbi-trarily large spread above the federaldiscount rate .

This Technical journal's introduc-tory installment hints at the enormouspower and influence exerted on eachof us by the Federal Reserve . I hopethat we have helped to heighten yourawareness of the Federal ReserveBoard and the repercussions of itsactions . Next month's installmentdelves into flaws in the FederalReserve's procedures for moneymanagement and suggests a solution tothe overall problem .

A bibliography will follow the nextinstallment. +

"It is difficult tounderstand bow banksall over the U.S cannot be cited for pricefixing when nearlyevery commercialbank in the countrycan adopt a fixedpricing policy forloans pegged to anarbitrarily largespread above thefederal discount rate."

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Each month in thiscolumn, the CSI CustomerService staff addresses atopic of interest to manyof our subscribers. Thismonth, they'll fieldquestions about usingdata from differentsources with CSI software.

Please help uskeep in contact withyou! Forward youre-mail address tobookkeeping@csidata comso we can update ourrecords.

Ask Customer Service

Q. My hard drive holds data fromseveral vendors and I wonder if I canuse it with QuickTrieve. 0 CanQuickTrieve process or help memanage data from other sources?

A. Although we certainly can'tvouch for the integrity of data fromother sources, chances are good that ifit is properly stored in CSI format,QuickTrieve can process and update it .You can tell CSI format data by thestructure of your directories . A CSI-format data directory has a master file(QMASTER) and up to 120 data files(ending in .dta). QuickTrieve canautomatically find and make availableall compatible files through option <J>Edit master path from the main menu.Simply select <F8> Scan drive, thenselect your drive and the Quick-Trieveformat for the search. All directorieswith CSI-format data will be added toyour master path list, which you maysave by pressing <F10> .

Q.whatabout writing data in non-CSIformat with QuickTrieve?A. The MetaStock (CompuTrac)format is supported for direct updatesand for conversion to and from the CSIformat. ASCII files are supportedthrough conversions only. The drive-scan procedure described above can bemodified to add existing directorieswith MetaStock format files to yourmaster path list.

Q. Should I merge data from othersources with my CSI data?A. This may be possible, but werecommend against doing so for thefollowing reasons :

1) Data integrity may be compro-mised by possible voids, omissions anderrors .

2) In many cases the free datasupplied with your subscriptionrepresents an easier and more eco-nomical means of feeding your

analysis software .3) The conversion and copying

processes can be tedious and time-consuming .

Q.Iplan to use Unfair Advantagewhen it becomes available. Iunderstand it includes historical data .What should 1 do with the history dataI already have?A. Unfair Advantage holds a fullcommodity data base on your harddrive, so other data will likely beunnecessary during your license term .We recommend archiving your existinghistory by copying it or backing it upfor storage on floppy disks .

Q. With Unfair Advantage's licenseagreement, will I actually OWN thedata I receive?A. No. Unfair Advantage's licenseagreement gives you permission to usethe data for the period of your sub-scription. Please be aware that aftertermination of your agreement, youwill lose access to the data suppliedthrough Unfair Advantage. By licensingthe data you'll have low-cost access toa data base you probably couldn'tafford to buy.

Q- A huge data base is only as usefulas your analysis software. What studieswill be included with UnfairAdvantage?A. The current pre-release versionoffers highly compressed bar charts,trend lines, moving averages and thelike, but we would like to add more. Ifthere are particular studies you wouldenjoy, please fax your suggestions to(561) 392-7761 or E-mail them totechsupport@csidata.com. Be preparedto send back-up reference materials incase they are needed. +

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