The Fed Underwrites Asset Explosion

"That the economists...can explain neither prices nor the rate of interest nor even agree what money is reminds us that we are dealing with belief not science."

-James Buchan, Frozen Desire (1997)

The Federal Reserve is in disarray. Unsure of whether its QE2 strategy (quantitative easing - second round) should be tabled (see speeches of Thomas Hoenig, president of the Kansas City Federal Reserve Bank) or if it should pump $10 trillion into the economy (the unsolicited advice from economic columnist Paul Krugman), the New York Federal Reserve Bank has now asked bond dealers what it should decide at its upcoming November 3 meeting. [ "Fed Asks Dealers to Estimate Size, Impact of Debt Purchases."]. Since it is the belief in the integrity and competence of the Fed that backs the dollar, asking Wall Street what it wants is another reason to sell dollars.

Two recent speeches by Federal Reserve officials clarify the dishonesty and paranoia of this debauched institution. Both were delivered on October 25, 2010.

Speech number one is a fabricated history of the housing crisis, delivered by Chairman Ben S. Bernanke in Arlington, Virginia. He gave it at the Federal Reserve System and Federal Deposit Insurance Corporation Conference on Mortgage Foreclosures and the Future of Housing. The conference title alone is enough to know that no good will come from this boondoggle:

"It was ultimately very destructive when, in the early part of this decade, dubious underwriting practices and mortgage products inappropriate for many borrowers became more common. In time, these practices and products contributed to problems in the broader financial services industry and helped spark a foreclosure crisis marked by a tremendous upheaval in housing markets. Now, more than 20 percent of borrowers owe more than their home is worth and an additional 33 percent have equity cushions of 10 percent or less, putting them at risk should house prices decline much further. With housing markets still weak, high levels of mortgage distress may well persist for some time to come.

"In response to the fallout from the financial crisis, the Fed has helped stabilize the mortgage market and improve financial conditions more broadly, thus promoting economic recovery."

You may note, not a word of the Federal Reserve's complicity - not its mad money expansion, not its one percent interest rate (the fed funds rate) that turned susceptible mortgage-buyers into highly leveraged speculators, not the Fed's decade-long enticement of Americans out of savings and into "risk assets," not its terrorist tactics at frightening the American people into saving the parasite banks, and then, having successfully terrorized itself, cutting the fed funds rate to zero, a condition that is suffocating the lower 99%.

In Bernanke's final sentence (In response...), he claims the Fed saved the mortgage market and restored the American dream, or whatever the imposter is trying to sell. It would be more accurate to confess that if the Federal Reserve did not exist, there is a good chance there would have been no need to stabilize anything.

There are moments when Federal Reserve officials speak the truth. In 1934, Eugene H. Stevens, chairman of the board of the Federal Reserve Bank of Chicago, spoke clearly about ridding ourselves of zombie banks. Quoting the October 24, 1934, New York Times: "The cleansing of the American banking structure of the parasites of 'occasional incompetency and dishonesty' in the last year and a half has put it in the strongest position of safety and good management."

Two years after the United States missed its opportunity to clean house, the banking system is in a weak position of instability and bad management.

Speech number two, by New York Federal Reserve President William C. Dudley, is an insult to anyone not getting rich within the parasitic Washington-Wall Street nexus: In response to a question from his audience at Cornell University, Dudley asserted:

"To the extent that we can do things to improve the economic environment, we certainly owe it to the millions of people who are unemployed to do so."

In his speech, Dudley, a former managing director at Goldman, Sachs & Co., described how the Federal Reserve has amortized this debt to the American people:

"The Fed responded aggressively and creatively... [to the] financial crisis that broke in mid-2007.... [W]e took aggressive steps to ease monetary policy in order to support economic activity and employment.... When the Fed buys long-term assets, it pushes down long-term interest rates. This supports economic activity in a number of ways, including by making housing more affordable and boosting consumption in households that can refinance their mortgages at lower rates."

In other words: the Fed has cornered markets in an attempt to induce overextended households to spend money again and restore an economy the Federal Reserve has hollowed out. Again, this is a warning to investors: any substantive rationale for holding assets that trade on markets needs to be weighed against the knowledge that prices are not real. There are consequences - intended now, unintended later - to trillion dollar experiments dreamt up by academic economists.

Dudley said what is demanded of Federal Reserve officials when they discuss the bank bailouts:

"A handful of times, we made the difficult decision to make emergency loans to prevent the disorderly failure of particular firms. We did so not because we wanted to help the firms, but because allowing them to collapse in a disorderly fashion in the midst of a global crisis would have harmed households and business throughout the United States." [My underlining.]

Why does he use the word "firms" instead of "banks?" There is probably no Federal Reserve official who knows better the disorderly fashion in which the Too-Big-To-Fail banks collapsed. His then-current employer, Goldman, Sachs, an investment bank, had failed. It was saved by the dubious Federal Reserve maneuver of turning the investment bank into a commercial bank.

Dudley told his audience to leverage its portfolios:

"With regard to monetary policy, the Fed has in place a highly accommodative stance. The FOMC has said that it will keep short term interest rates at exceptionally low levels for an extended period of time. The Fed also retains large amounts of mortgage-backed bonds acquired in order to support the housing market and help bring down mortgage and other long-term interest rates to the historically low rates in place today.

"The FOMC and the Chairman have stated their commitment to take further actions to bring interest rates down further should economic conditions warrant."

Dudley avoids typical Federal Reserve euphemisms here. He states the Fed controls short-term interest rates, is supporting long-term interest rates (is preventing them from rising), and is supporting the mortgage market (is preventing mortgage securities and house prices from falling). Not in this speech, but elsewhere, Dudley and other Fed officials have indicated they are propping up the stock market. It is doing more than that: U.S. stocks have risen 10% since this latest Federal Reserve, carpe diem, open-mouth policy debuted last month.

Federal Reserve ringmasters do not discuss how their capricious manipulations disturb the dollar's relationship with other currencies. When foreign buyers have decided it is time, the dollar, the stock market, the mortgage market, house prices, long-term interest rates and short-term interest rates will respond to the Bernanke "puts" just as they did to the Greenspan "puts" (the Nasdaq in 2000, houses in 2006). They will explode.

Unpublished Letters to the Financial Times and the New York Times

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).



To the Financial Times, October 7, 2010:

Dear Sirs,

It is scandalous that you continue to give Alan Greenspan a forum ["Fear undermines American economy," FT, October 6, 2010]. He prattles on in his successful effort at rehabilitation by writing and speaking with the imprimatur of the Financial Times, the Brookings Institute, the Council on Foreign Relations and other institutions that should have no truck with the man most responsible for the financial ravages inflicted on The American people, and, indeed on the rest of the world.



To the Financial Times, October 13, 2010

Dear Sirs,

Edwin Truman, regarded as the wisest staffer during his time at the Fed, argued for the U.S. Treasury to sell the country's gold stock. ["Time to Unlock Fort Knox and Sell the Bullion" FT, October 13, 2010]. Truman rebuts the common argument for the gold stock to be held as a "rainy day precaution" with a question: "But after the recent economic and financial crisis and with the prospect of misery for several more years, how much more rain must pour before the US acts?"

In the Walt Disney movie Aladdin, the wise Blue Genie states: "You'd be surprised what you can live through".

It's a shame Mickey Mouse is not running the Fed. On second thought, he already is.


To the New York Times, October 15, 2010

Dear Sirs:

In "The Next Bubble," [editorial: October 13, 2010] you rue the "large inflows of capital" that "complicate macroeconomic management" of emerging economies. You identify the deadly consequences: These flows "promote fast credit expansion - which can cause inflation, inflate asset bubbles, and usually leave a pile of bad loans."

Here, you have stated matters of fact. But, you then write, there "is little policy makers in the rich world can do to stop these flows." There is everything the policy makers in the rich world ("formerly rich" -?) can do to stop these flows. We simply don't want to do what needs to be done; that is a different matter. The heart of the problem lies with the enormous creation of money and credit, most conspicuously in the United States, and which the Federal Reserve largely controls, that ricochets around the world and leads to such ruin.

The solution to this problem, both at home and abroad, is for the Federal Reserve to reduce the supply of money and credit. Your economic writer, Paul Krugman, wants the Federal Reserve to increase the supply of money and credit by several trillion dollars. Obviously, this will cause even greater "inflation, asset bubbles, and pile of bad loans" than those that are asphyxiating us today.

Leadership is not easy. You must choose your poison: Save the world or publish Krugman.


To the Financial Times, October 25, 2010

Dear Sirs,

Frederic Mishkin has made a useful suggestion in "The Fed must adopt an inflation target," [Financial Times, October 25, 2010]. He has not always been so radiant.

In 2006, when he served as adviser to the Icelandic government, Mishkin gave the green light to the country's banking system, claiming, "financial fragility is currently not a problem, and the likelihood of a financial meltdown is low." In 2007, Federal Reserve Governor Mishkin stated: "To begin with, the bursting of asset price bubbles often does not lead to financial instability....There are even stronger reasons to believe that a bursting of a bubble in house prices is unlikely to produce financial instability."

In this morning's Financial Times, Mishkin, the current A. Barton Hepburn Professor of Economics at Columbia University, and, co-author with Ben S. Bernanke of the text Inflation Targeting, writes that the Federal Reserve should adopt "a specific numerical inflation objective." The pen pal of the Federal Reserve chairman thinks 2% is the rate to hit.

In 1957, an Ivy League economics professor on the make (Sumner Slichter) charmed the Senate by claiming the United States needed 2% inflation. Federal Reserve Chairman William McChesney Martin told the senators that such a plot would place the heaviest burden on those who could not protect the value of their income or savings. Those "savings in their old age would tend to be the slick and clever rather than the hard-working and thrifty."

This may have been the best market prediction of the past half-century.

The advantage of Mishkin's proposal will be to put the long-running Fed policy of impoverishing the American people into writing. It will be official, as follows:

The Federal Open Market Committee (FOMC), in its September 21, 2010 press release, stated: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent..." As a consequence, the average bank passbook savings rate in the U.S. is 0.09% (Bankrate.com, September, 21, 2010).

The adoption of Mishkin's 2% numerical inflation objective will be an official confiscation of Americans' savings, at an annual 2% rate. Once this policy is in writing, the Federal Open Market Committee will be as guilty of robbery as Willie Sutton and FOMC members can be prosecuted and sentenced with the same determination and result.

Orwell Targets Bernanke: An Unteachable Hole in the Air

On Friday, October 15, 2010, Federal Reserve Chairman Ben S. Bernanke delivered a dishonest speech: "Monetary Policy Tools and Objectives in a Low-Inflation Environment." What follows is not a critique of the talk, since that would be redundant. Please see one of my recent articles "Exploiting Bernanke" (September 21, 2010), which discussed the anticipated speech of October 15, 2010. Also see, "Central Bankers are Paid to Lie - Buy Corn" (October 5, 2010), which showed how Federal Reserve Chairman Arthur Burns fibbed his way through the 1970s. Investors who either believed him or were not adept at translating signals from the real world suffered.

Bernanke's mendacious speech confirmed my general investment advice in "Central Bankers are Paid to Lie": "Courses of protection include buying farms (including machinery companies, grain commodity funds, water rights, and desalinization companies), as well as precious metals, mining and drilling companies, and freeze-dried food." As a guess, Bernanke's current intention (this will change, and change often) is to add a trillion dollars to the economy. Such a wild, mad experiment has never been attempted before, outside of Argentina, Zimbabwe, and such.

The reason last Friday's speech could be analyzed three weeks before it was delivered is Bernanke's predictability. He will do nothing that veers from the course he found convenient for personal advancement three decades ago. He has neither said nor would dare process a thought that deviates from his doctoral thesis.

Even the title of his latest speech is a lie or stupid, as you wish - broadcasting as he did our "Low-Inflation Environment." Inflation is practically everywhere that counts: food, insurance premiums, utility bills, tuitions. ("Where it counts" does not include the deflation of what really counts: wages, net wealth, house prices. This is why the "inflation vs. deflation" question is false.) Commodity prices keep rising, partially because there is greater demand than supply; partially because we are used to seeing oil and corn quoted in dollars. Producer and consumer prices generally lag commodity prices. The length of the lag differs. Anywhere from three months to one year captures most instances, under normal conditions. (When further depreciation of the dollar against commodities is anticipated, the lag will be compressed.) The dollar has fallen against a basket of currencies by 13% over the past 18 weeks. It is prudent to at least hedge for a contraction of this lag.

Bernanke's speech was characteristic. He turned logic on its head and ignored the most debilitating consequences of his past actions. The Fed chairman used official government numbers to claim inflation was too low. Homage to government inflation calculations should have, alone, been enough for the media to ignore anything else he said. Of course, he was dutifully quoted and taken at his word.

It was not that long ago when an economist who claimed inflation was too low would have lost credibility. Bernanke stated "that FOMC participants generally judge the mandate-consistent inflation rate to be about 2 percent or a bit below." The FOMC is the Federal Open Market Committee - the body that has absolute authority to act upon such inverted thinking as 2% inflation being good for the country.

A step back, to 1957: This was a time when academic economists were learning that theories manipulated to satisfy politicians could put themselves in positions of power. Most from this guild never dreamt anyone outside a college classroom noticed their existence. They miscalculated, as is the rule for these humbugs.

Politicians want money and credit to fulfill their constituents' every wish. A Harvard economist told Congress that the U.S. needed a 2% rate of inflation to defeat communism. Washington loved him.

On August 13, 1957, William McChesney Martin, the Federal Reserve chairman at the time (and not an economist - he had been a Latin scholar at Yale, so understood that shortcuts destroy empires), lectured the Senate Banking Committee on the specific topic of the Federal Reserve "targeting" (Bernanke's word - not Martin's) a 2% rate of inflation: "Consumers are encouraged to postpone saving and instead purchase goods which they do not immediately need, and the incentive to strive for efficiency no longer governs business decisions...and speculative influences impair reliance upon business judgment." Of utmost importance, groups struggle to insulate themselves from the loss of purchasing power, then "fundamental faith in the fairness of our institutions and our government deteriorates."

The Bernanke Fed has stated its current policy is to chase consumers out of savings and into speculative ventures. (See The 2004 Fed Transcripts: A Methodical, Diabolical Destruction of America's "Wealth".) That is exactly the recipe for the Fed to accelerate its impoverishment of the American people. Alan Greenspan, of course, was the master at jumbling a few words to distract attention from this long-running plan to prevent the Fed's extinction. Bernanke also resorts to nonsense. From his October 15, 2010, speech: a 2% rate of inflation is to "attain... price stability" and to "bring the unemployment rate down significantly." He is doing exactly the opposite of what he pretends.

George Orwell wrote about "[t]his lunatic world in which opposites are turned into one another." That was not lunacy for lunacy's sake, nor is it today.

In 1940, Orwell wrote of World War II: "After 1936, of course, the thing was obvious to anyone except an idiot." He was not erasing his own past, as was common with many others and is universal among "experts" today. (See the first paragraph of Ben Bernanke's October 15, 2010, speech.) In 1938, upon returning to England from continental Europe, Orwell had written about the "familiar streets, the posters telling of cricket matches and Royal weddings, the men in bowler hats, the pigeons in Trafalgar Square, the red busses the blue policemen - all sleeping the deep, deep sleep of England, from which I sometimes fear that we shall never wake till we are jerked out of it by the roar of bombs." The bombs flattened London in 1940.

The British institutions in the 1930s were in the same condition that the Federal Reserve, other government manipulators, the so-called economics profession, and the revered think tanks are in today. Orwell wrote of Neville Chamberlain, British Prime Minister from 1937 to 1940: "He was merely a stupid old man doing his best according to his very dim lights. It is difficult otherwise to explain the contradictions of his policy, his failure to grasp any of the courses that were open to him. Like the mass of the people, he did not want to pay the price either of peace or of war. " At another point: "Tossed to and fro between their incomes and their principles, it was impossible that men like Chamberlain should do anything but make the worst of both worlds."

This is an apt summation of the desiccated American hierarchy today. It is withering into dust.

Chamberlain had trusted Hitler, as had his predecessor, Stanley Baldwin. As prime minister, Baldwin had suppressed information about Hitler's rearmament, sleeping, as was his wish, the deep, deep sleep of England. Orwell wrote: "One could not even dignify [Baldwin] with the name of stuffed shirt. He was simply a hole in the air." Baldwin did everything he could to prevent any disruption to the exact relations that existed among the social and political institutions of the day.

Winston Churchill, not in office but a nuisance to the established order, knew the proportions of Nazi rearmament and gave speeches in Parliament with uncomfortable details. Baldwin's cabinet voted to ban "independent views" from the BBC. Sir John Reith, dictator of the BBC, prevented Churchill from speaking. CNBC does much the same today, as does the print media.

Geoffrey Dawson, editor of The Times of London, suppressed Churchill's views as well as those from Times reporters whose dispatches from Europe might upset Hitler. In 1935, Dawson wrote, "I do my utmost, night after night, to keep out of the paper anything that might hurt their [Nazi] susceptibilities." He wrote this letter because he could not understand the Fuhrer's ingratitude after, in the words of William Manchester, "five years of jumping through Hitler's hoops."

Dawson was not a Nazi but a dense, frightened old man who wanted the world to stand still. We can see the same combinations of dis-enlightenment that keep the American public in the dark today. An example is the coordination among government agencies (their data dissemination propaganda) and the Federal Reserve's contorted views as expressed through the country's news collection agencies.

The Associated Press released the following on October 14, 2010, a day ahead of Bernanke's speech:

Wholesale prices tame beyond volatile food, energy

(AP) "Wholesale inflation stayed tame last month outside of a sharp rise in food and energy prices. Moderate price inflation allows the Federal Reserve to keep the short-term interest rate it controls at a record low of nearly zero, where it has been since December 2008."

With that, the AP assured its access to the Fed chairman.

In 1952, Bernard Iddings Bell wrote Crowd Culture, in which he discussed a wartime incident: "When Russia was Hitler's ally in World War II, the American people were told by the papers, and believed, that the Russians were little short of fiends. Suddenly Russia changed sides.... [S]he became our ally. At a dinner in New York at that time, I sat next to a high-up officer of one of the great news-collecting agencies. 'I suppose,' I ventured, 'now that the Muscovites are on our side, the American people will have to be indoctrinated so as to stop thinking of them as devils and begin to regard them as noble fellows.' 'Of course,' he replied. 'We know what our job is in respect to that. We in the working press will bring about a complete and almost unanimous volte face in the belief of the Common Man about the Russians. We shall do it in three weeks.' He was right about it. The papers, fed by the news agencies, did just that."

On March 29, 1943, Life magazine published a "Special Issue USSR." On the front cover is a portrait of Uncle Joe Stalin, beaming downward, as if the dictator is looking upon his 3-year-old nephew who just counted to 10 for the first time. Over 100 pages of the issue describe the Soviet Union's wholesome leaders and their obliging peasantry.

Among the wholesome leaders is Vladimir Ilyich Ulyanov (Lenin), with a similar, avuncular portrait, as if he's looking at the same nephew who just counted to 20. The article, "The Father of Modern Russia," starts off "Perhaps the greatest man of modern times was Vladimir IIyich Ulyanov." It goes uphill - or downhill - from there, depending on one's view.

Flipping through the issue, the article "Collective Farms Feed the Nation" is worth a look. Pictures of the peasants are inspiring. They were a happy lot. The story starts off: "Although Russia was always overwhelmingly an agricultural country, most Russians used to go hungry." Later in article: "Whatever the cost of farm collectivization, in terms of human life and individual liberty, the historic fact is it worked." The cost of farm collectivization included several million Ukrainians who had been starved to death in the early-1930s.

"Collective Farms" could be written by an economist - then or now - without irony or conscience. Such a contortion of reality would do wonders for a rising academic or Federal Reserve staffer.

Orwell was harsh in his criticism of the intelligentsia, whose loyalties were as fickle as their abstractions. He did not confuse the term, intelligentsia, with intelligence. It was a collection of layabouts who, in a "desire for psychological escape" indulge in "chauvinistic sentiments that would be totally impossible if you recognized them for what they were." Such a person is "capable of the most flagrant dishonesty, but also - since he is conscious of serving something bigger than himself - unshakably certain of being right."

In their world: "Material facts are suppressed, dates altered, quotations removed from their context and doctored to alter their meaning." Communism was an outpost for many of the intelligentsia in the 1930s. John Reed, author of Ten Days That Shook the World, (about the Russian Revolution), had willed the publication rights of his book to the British Communist Party. Reed died in 1920. The British Communist Party did exactly what Moscow wanted: it published an edition that excised Leon Trotsky's role in the revolution and deleted an introduction by Lenin.

Orwell wrote: "Events which, it is felt, ought not to have happened are left unmentioned, and ultimately denied." British Communists were badly shaken by the Russo-Nazi pact (Molotov-Ribbentrop) in 1939, an eventuality not difficult to forecast by a party whose subservience to Moscow should have animated its consciousness towards Russian self-interest.

Bernanke, the Fed, and the other weary institutions fall within Orwell's description of Chamberlain and his circle: "What is to be expected of them is not treachery or physical cowardice, but stupidity, unconscious sabotage, an infallible instinct for doing the wrong thing. They are not wicked, or not altogether wicked; they are merely unteachable. Only when their money and power are gone will the younger among them begin to grasp what century they are living in."

Of Bernanke today, he is a combination of both the establishment and the regimented intelligentsia that has acquired power. Orwell wrote of the intelligentsia: "Clearly there was only one escape for them - into stupidity. They could keep society in its existing shape only by being unable to grasp that any improvement was necessary" After a time, which looks like it will be after Bernanke and his comrades have done their worst, a leader, looking at the world as it is, may state:

"Difficulties began to build up in the economy in the 1970s, with the rates of economic growth declining visibly.... A lag ensued in the material base of science and education, health protection, culture and everyday services. Though efforts have been made of late, we have not succeeded in fully remedying the situation. There are serious lags...in the improvement of the people's standard of living."

Thus spoke Mikhail Gorbachev in his 1986 speech to the 27th Communist Party Congress when he effectively declared the institutions which had colluded to bankrupt the nation's economy and spirit were dead.

A letter to Senator Scott Brown - The Fed's Political Interference Must Be Stopped

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).


The Honorable Scott Brown
United States Senate
317 Russell Senate Office Building
Washington D.C. 20510


Dear Senator Brown:

I am a constituent who would like to help. My father sent you my book, Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession. You wrote my father a thank you note, for which I am thankful. None of the other 20 or so senators and congressmen to whom we mailed my book sent an acknowledgement.

I am writing because the Federal Reserve has interfered with the November elections to an unprecedented degree. I know this, having read Federal Reserve officials' speeches, their testimony, and the warnings of senators (in committee) to not loosen or tighten money in the weeks before forthcoming elections. Even my protagonist, Alan Greenspan, a master politician, muzzled his mouth and the Fed's pocketbook before an election. The current interference has not been mentioned by the popular media or by any politician, to my knowledge.

I am suggesting that you denounce the Fed's activities. It is an institution that, more and more, believes it operates outside the law and above the political process. This is for good reason, given its unaccountability for the financial meltdown and greater authority awarded in the Dodd-Frank Act. It must be reduced to serve the bureaucratic functions that legislation permits.

Motive:

Ben Bernanke and his cohorts at the Fed are promising to gird the stock and bond markets at elevated levels. This is an insider's game, understood on Wall Street. Its purpose is to fulfill the axiom that a strong stock market aids the incumbent party in an election. The Fed wants the Democratic Party to hold its majorities in both the Senate and the House because it is frightened of what the Republicans might reveal. The Federal Reserve reached an agreement with the Democrats in the past session of Congress, in which obvious failures and possible criminal acts of the Fed were dismissed. The Fed is the prime culprit in the continuing impoverishment of the American people, and its active interference will cause more destruction.

Background:

The Federal Reserve has long believed that boosting the stock market inflates the economy as a whole and influences people to spend beyond their means. The following is Alan Greenspan, then chairman of the Fed, speaking at the Federal Reserve Open Market Committee's (FOMC) November, 2004, meeting: "The household savings rate has come down dramatically and now is close to zero....The idea of having a negative savings rate is not out of line with the way the world works. Remember...the average household looks at the market value ...of its equity holdings.... We can have a negative savings rate with a significant part of the population believing that they are saving at a fairly pronounced rate."


Greenspan's policy as Federal Reserve chairman was to draw the masses into the markets (stocks, mortgages, bonds) and then create asset bubbles that leave "a significant part of the population believing that they are saving at a fairly pronounced rate." After the bubble crashes (even the Fed knows this is inevitable), it creates another bubble by leading the People to the Wall Street insiders' latest manipulated market.

How:

The means by which the Federal Reserve has boosted the stock market is two-fold. First, it pumps money into the banking system. Second, in recent days, several Federal Reserve officials have spoken about artificially boosting the stock market. The Fed does not control where the money goes once it enters the banking system. By coordinating these speeches, Wall Street knows the stock market is being supported. Thus, the large, recent infusions of money into the banking system by the New York Federal Reserve Bank are going into the stock, bond, and commodity markets.

The method by which the Federal Reserve draws money into riskier assets (stocks, bonds) from safer assets (money markets, for instance) is diabolical. In 2003 (and thereabouts) the Fed drove short-term interest rates to 1%. This was a level below which those who live on interest, such as retirees, could not eat. The Fed's tactic was explicitly stated. (I have enclosed an article I wrote, on my website, "Greenspan Came Not to Save Consumers but to Bury Them.")

Ben Bernanke's Fed is doing the same. Federal Reserve Governor Donald Kohn stated the current policy, in October 2009: "[R]ecently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

This flight from "liquidity and safety" has been forced upon savers, many of whom do not understand that the Fed's stock market support operation can only work for a limited period of time.

Alan Greenspan described this tactic of fooling the people on March 27, 2010. He told Bloomberg TV: "Ordinarily, we think of the economy affecting stock prices. I think we miss a very crucial connection here in that this whole economic recovery, as best as I can judge, is to a very large extent, the consequence of the market's bottoming last March, and coming all the way back-up. It is affecting the whole structure of the economy, as well as creating the usual wealth effect impact."

Greenspan operated under this precept when he was Federal Reserve Chairman. This is Greenspan speaking at an FOMC meeting in 1995: "I think the downside risks are basically coming from the possibility of significant increases in stock and bond prices.....Ironically, the real danger is that things may get too good. When things get too good, human beings behave awfully."

The Current Publicity Campaign:

The following are comments in speeches by Federal Reserve officials over the past week:

On October 1, 2010, William C. Dudley, Federal Reserve President of New York, speaking at City University of New York: "We have tools that can provide additional stimulus at costs that do not appear to be prohibitive.... [P]urchases of long-duration assets [by the New York Fed will] pull down the level of long-term interest rates.... [L]ower long-term rates would support the value of assets, including houses and equities and household net worth."

Dudley was a managing director and partner at Goldman Sachs before taking his position at New York Federal Reserve. On October 1, 2010, Goldman Sachs published a guide to "quantitative easing" for its clients. Quantitative easing is the Fed's euphemism for creating unlimited amounts of money.

The firm wrote: "As [New York Federal Reserve] President Dudley pointed out, those who are able to borrow will do so at lower rates.... Perhaps more importantly, [quantitative easing] works on other elements of financial conditions, including equity prices and the exchange rate." In its guide, Goldman Sachs went on to write that higher equity prices increase consumer confidence and decrease the savings rate.

I write "unlimited amounts of money," since this was made clear by Federal Reserve Chairman Ben Bernanke on October 4, 2010. He spoke in Rhode Island: "I do think the additional purchases - although we don't have precise numbers for how big the effects are - I do think they have the ability to ease financial conditions."

On October 4, 2010, Brian Sack, an Executive Vice President at the New York Federal Reserve, spoke in Newport Beach, California. He discussed the Fed increasing the size of its balance sheet. This is a euphemism for money printing: "[B]alance sheet policy can still lower long-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be."

On October 1, 2010, Chicago Federal Reserve President Charles Evans spoke in Rome: "In my view, the evidence suggests that the expansion of the securities portfolio to date has helped to foster more accommodative financial conditions, and further expansion would likely provide additional accommodation."

He is correct that "evidence suggests that the expansion of the securities portfolio to date has helped to foster more accommodative financial conditions." The S&P 500 rose 8.8% in September, its best September since 1939. This is a dangerous game being played, particularly for the novice.

Conclusion:

The Federal Reserve, its constituents on Wall Street, and those on Capital Hill have their backs against a wall. They know that ultimately there is no way for them, or us, to escape another wave of impoverishment. That will happen when the enormous creation of money and credit crashes. It will crash because there is no increase in the productive economy to validate it.

In his October 1, 2010, speech, New York Federal Reserve President William Dudley talked about the recent mortgage boom. By simply removing "in home prices" from the following, he described exactly how his current contribution to the economy will end: "The surge in home prices was fueled by products and practices in the financial sector that led to a rapid and unsustainable buildup of leverage and an underpricing of risk during this period. These dynamics in turn provided the fuel that caused house prices and consumer spending to rise much faster than income. The boom, of course, was unsustainable."

It is necessary to publicize the goals, the intentions, and the tactics of the Federal Reserve. I hope that you are able to help.

Central Bankers are Paid to Lie - Buy Corn

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).


"I assure this committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest."

-Prospective Federal Reserve Board Chairman Ben Bernanke, confirmation hearing, 2005

"The last duty of a central banker is to tell the public the truth."

-Federal Reserve Board Vice Chairman Alan Blinder, Nightly Business Report, 1994

"If we exerted our 'independence' we'd certainly lose our independence."

-Former Federal Reserve Board Chairman Arthur Burns, 1981 (possibly paraphrased)


Federal Reserve Chairman Ben S. Bernanke has talked about the 1970s, the decade associated with "stagflation." This word (originally applied to the United Kingdom in 1965) fuses recession with price inflation. He brushes off comparisons between then and now, as he should, but not for the reasons he gives.

The 1970s were a relative paradise. Prices rose, but so did wages. The 1970s did not open with an unserviceable level of debt. (It was during that decade when Americans unbalanced their balance sheets.) In 2010, real wages are falling and real estate, both residential and commercial, is not close to a bottom. Central bankers will do what they can to restore wages and asset prices, no matter the cost. One cost will be much higher prices.

Exploiting Bernanke is a chronology of how Chairman Bernanke remained baffled, and baffled his camp followers, during the food- and energy-price boom from 2006 through 2008. Those were his first three years of his Fed chairmanship. Simple Ben will continue to pretend our cost-of-living is not rising, even when prices are increasing at double- and triple-digit rates. Some already are. Courses of protection include buying farms (including machinery companies, grain commodity funds, water rights, and desalinization companies), as well as precious metals, mining and drilling companies, and freeze-dried food.

As discussed in Exploiting Bernanke, the degree to which asset prices (stocks, bonds, currencies, commodities) are influenced by the Federal Reserve's public opinion of inflation confirms our degraded mental state. Bernanke has been consistently wrong. He might be ignored, but that is difficult given the influence of a speech by any Fed governor in the media and in the markets.

To help remain aloof from the noise, and to possibly preserve one's living standard along the way, what follows is a look at how Federal Reserve Chairman Arthur Burns fibbed his way through the 1970s. In that decade, as will probably be the case in the years ahead, money was made by those who sold what the central bank destroyed: the dollar.

Like Bernanke, Burns was an academic. He co-authored a significant economic tract, Measuring Business Cycles, in the mid-1940s. He taught at Columbia University. One of his students was Alan Greenspan. The latter is not germane to the current discussion other than as a receptacle of learning. On the first day of Greenspan's doctoral training, the professor asked his students, "What causes inflation?" Silence followed. Burns enlightened the class: "Excess government spending causes inflation." According to one of Greenspan's colleagues, this statement made a powerful impression on the students.

Burns was not persuaded by the then-current Keynesian fashion. "Burns was an empiricist; Keynes a theorist." It might be closer to the truth that Burns wanted to protect his turf, not his beliefs. As it turned out, he did what he was told. This is the standard course of academics placed in a position of responsibility. They follow orders and rationalize their betrayal as a means to acquire more influence on policy.

Inflation was a problem by the mid-1960s. Burns' stated culprit, excess government spending - as expressed in the federal deficit - had risen from $3.7 billion in 1965 to $25.2 billion in 1967. He stated his prognosis to a Joint Economic Committee hearing in 1967: "Once an inflationary spiral gets underway, I am afraid there isn't a great deal that can be done constructively."

President Nixon awarded Burns the chairmanship of the Federal Reserve in 1970. At his confirmation hearing in December 1969, Burns created the template copied by Ben Bernanke that was quoted at the top of the article. Burns' prototype: "We must rely on sound fiscal policy and not leave it to the monetary authorities to do it all themselves." Burns went on: "I fully believe the Federal Reserve should not become the handmaiden of the Treasury. We may have to go to war with Treasury, but hope it will not happen."

After Arthur Burns was sworn in as chairman, President Nixon told the assembled: "I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed." After the crowd cheered, Nixon added: "You see, Dr. Burns, that is a standing vote for lower interest rates and more money."

Understanding his position, Arthur Burns displayed the characteristic most noteworthy of intellectuals in public life. That is, he was a coward.

Blame for state interference did not lie entirely with Nixon. On August 6, 1971, a congressional report by the Reuss Commission ("Action Now to Strengthen the U.S. Dollar") concluded, "The dollar is overvalued." Ergo, it was time to weaken it. Nine days later, Nixon announced the United States was defaulting on its promise to redeem dollars under the Bretton Woods gold exchange standard.

The wheels were off, and economists, to retain their high-grade government rating, made preposterous claims. Arthur Burns fell easily into the role of state apparatchik. Before the Joint Economic Committee in February 1972, Burns intoned that unbalancing the budget by $40 billion only "gives me some pause." At his December 1969 confirmation hearing, Burns had been asked what he would recommend if the budget could not be balanced: "We must raise taxes, as unpopular as they may be." The Consumer Price Index rose by 3.3% in 1972, 6.2% in 1973, 11.0% in 1974 and 9.1% in 1975.

It is often said that when a novitiate to Washington succumbs to its allures, he "has grown." Burns was now a giant among trimmers. His acrobatics grew more offensive to common logic. After his chairmanship, Burns wrote: "When the government runs a budget deficit, it pumps more money into the pocketbooks of the people than it withdraws from their pocketbooks...This is the way the inflation... first got started and later kept getting nourished." (Published in Federal Reserve Bulletin, September 1979.)

Burns was disingenuous. The U.S. Treasury "prints" money but Burns' Fed bought deficit-funding Treasury securities at a price convenient to the national purse. This is the chief mechanism available to a Federal Reserve chairman that fulfills Burns' warning to his students: "Excess government spending causes inflation."

Fed officials, including Bernanke, have taken to blaming the federal deficit for our ills, but the same holds true today. Bernanke has bought over a trillion dollars of mortgages and continues his "quantitative easing". This is a deceptive name to fulfill the Fed's role as waste dump for discredited securities and euthanasist of the People's currency. These are crimes against humanity.

As inflation rose, Burns applied tactics then current among Stasi counterintelligence colonels. After oil prices quadrupled in 1973, Burns told his staff to remove energy costs from the Consumer Price Index. Burns' rationale was the Yom Kippur War, over which the Fed had no control. A few months later, with food prices raging, Burns told his staff to remove them from the CPI calculation. Burns claimed the disappearance of anchovies off the coast of Peru was the cause of food inflation, and beyond the Fed's jurisdiction. In time, Burns discarded used cars, children's toys, jewelry and housing - about half the costs consumers battled in their daily struggle with rising prices.

The corruption of the consumer price index today is far worse and is only worth watching to record the deprivation it causes to social security recipients and those who own Treasury Inflation Indexed Securities.

To put an end to this, Arthur Burns resigned on March 31, 1978. The dollar was the most hated currency in the world. It was on its way to annihilation, but, just as we see today, no other country wanted a strong currency. The Consumer Price Index rose from 5% in 1970 to 9% in 1978 and to 13% in 1979. Given Burns' malicious manipulation of the CPI, consumer prices were probably rising by 50% in 1979.

Arthur Burns was named ambassador to West Germany by President Ronald Reagan in 1981. This was a prestigious position during the Cold War and is an example of how so-called policy makers who operate within the academic-political cocoon are never held responsible for their words or actions.



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Exploiting Bernanke

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

It is unfortunate the media does not make better use of an accessible resource: itself. Newspapers and financial TV are generally content to report what is being said today with no reference to the past. There seems to be no memory. A recent instance is Federal Reserve Chairman Ben Bernanke's opinion that inflation is not a concern. In a sane world, his opinion would not matter much. We live in a more nonsensical atmosphere in which abstractions substitute for reality.

The Fed chairman's inflation prediction is thought to reflect whether the Federal Reserve's Open Market Committee (FOMC) will raise the fed funds rate from zero. It is not, then, Bernanke's opinion about inflation that stirs imaginations (very limited imaginations, to be sure), but the train-of-thought that the global yield curve is a consequence of his purported wisdom. If the Fed Chairman's public view changes, the residence of several trillion dollars will also change: carry trades, institutional asset mixes, and potential reallocations from stocks into money markets are examples of financial securities that are shipped from asset class to asset class according to the Fed chairman's price-change gazetteer.

The real world today is repeating a pattern of a couple of years back. Prices are rising everywhere. This was also true when Bernanke became chairman of the Fed, in February 2006. Shortages, bottlenecks, black markets and prices were increasing when Bernanke became chairman. They continued to do so into late 2008. These conditions then retreated but are charging upward again.

To cut to the finale, a search through the files shows that Ben Bernanke was neither concerned nor understood the 2006 to 2008 inflation. It is certain, reading the evidence, that once again he will ignore (or remain malignantly ignorant, as the case may be) inflation until long after rice riots outside California supermarkets are a feature on the evening news.

To those unaccustomed to Fed-foolery, there is a motive for the chairman to day-dream through an inflationary swindle. The Federal Reserve wants to print money at will. An admitted problem with inflation would make it difficult to keep pumping money into the market.

Two conclusions can be drawn with near-certainty: the FOMC will not raise its zero-percent fed funds rate as long as Ben Bernanke remains Federal Reserve chairman. (A trivial 0.25% or 0.50% increase is possible.) Prices of things, particularly of commodities, will keep rising. This is an area to make money.

The Prosecutor's Brief

In 2006, Bernanke had the excuse of being new to the job, without his predecessor's experience at judging how every comment would be interpreted and analyzed. In the end, his inexperience with the media was not a disadvantage. (Discussed in the past tense, all of this is just as true today.) He talked in circles, made little sense, but criticism of the Federal Reserve Chairman's remarks was confined to vocabulary. He could have bellowed his discontinuities of thought, of logic, of basic economics through the public address system before a full house at Yankee Stadium and the financial media would have remained deferential. An instance was his inflation commentary. An abbreviated sequence of Bernankeism follows.

Chairman Bernanke discussed inflation before the Joint Economic Committee on April 27, 2006. He sent written responses to the committee following his testimony. In this take-home exam, the new Fed chairman pronounced "inflation is overstated" and expectations are "well contained." His contentions were controversial, not for the obvious reason that crude oil prices had risen 50% since the beginning of 2005. Such comparisons between what is real and what Bernanke recites do not interest the media. Again, his economics are illogical. This was the real story, but was not discussed.

Instead, the press and financial TV grew aggressively neurotic when the Federal Reserve issued a statement, on May 10, that inflationary expectations are "contained." The media was consumed with the distinction from "well contained" in Bernanke's April 27, 2006, statement.

On June 5, Bernanke, speaking at the IMF, admitted inflation, not inflationary expectations, was a problem. Again this distinction in vocabulary was front page news. Barely discussed were announcements in the same week that mergers and acquisitions for the year had already passed the record level of 2000 ($1.4 trillion), private equity in Europe was "loading companies with a record amount of debt," and home mortgage debt in the U.S. was increasing at a 12.2% pace (when the national income was rising at a 3% rate).

On June 15, 2006, Bernanke spoke about expectations (not inflation, as he had on June 5). He believed expectations remained within historic ranges, which seemed to be consistent with his May 10 statement, but he was chastised for "giving mixed signals," maybe because he discussed expectations rather than inflation, though this was not clear, and who cared other than the panting, breaking-news media and the trading desks that might unwind billion-dollar arbitrage positions in reaction to the media's portrayal of the Fed chairman's word choice?

On November 28, 2006, he told the National Italian American Foundation that inflation expectations were "contained." He repeated this assessment on many other occasions. The chairman may have thought his personal contentment would sooth the masses. Whatever the case, Simple Ben applied the formula to any topic that popped into his head. On March 28th, 2007: "At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."

In his November 2006, address to the National Italian American Foundation, Bernanke talked in clichés that had lost all meaning. He would "continue to monitor the incoming data closely." The FOMC is "prepared to take action to address inflation if developments warrant." The chairman, at best, made glancing references to what he was monitoring, when the FOMC would take action, and what form the action might take.

Seven months later, in July 2007, Bernanke finally gave a speech devoted to the Federal Reserve's measurement of inflation: "First, how should the central bank best monitor the public's inflation expectations?" Bernanke's description of the Fed's methods could not be refuted, since there was nothing to refute: "The Board staff employs a variety of formal models, both structural and purely statistical, in its forecasting efforts. However, the forecasts of inflation (and of other key macroeconomic variables) that are provided to the Federal Open Market Committee are developed through an eclectic process that combines model-based projections, anecdotal and other 'extra-model' information, and professional judgment. In short, for all the advances that have been made in modeling and statistical analysis, practical forecasting continues to involve art as well as science." This means nothing. Dan Quayle was ransacked for misspelling "potato," yet the media adored Bernanke for sounding like an idiot savant.

He went on to ask critical questions (e.g.: "Do we need new measures of expectations or new surveys?"). There were no answers. Bernanke described some of the inputs to the Fed's models, but then crushed hopes of those who were trying to understand how the Fed measures expectations: "[T]he model specifications employed differ considerably in their details, including how lagged inflation enters the equation, how resource utilization is measured, and whether a survey-based measure of inflation expectations is included. In principle, formal econometric tests could determine how much weight should be put on the forecast of each model, but in practice the data do not permit sharp inferences...." In the end, he confirmed what Fed skeptics already believed - the Federal Reserve is a Works Project Administration for failed statisticians: "Because of these considerations, as I have already noted, the staff's inflation forecasts inevitably reflect a substantial degree of expert judgment and the use of information not captured by the models."

Others disagreed. In April 2007, Harry Landis, 107 years old, a World War I veteran, was interviewed by the St. Petersburg (Florida) Times: Landis had "lived through the invention of airplanes, televisions, interstate highways and cell phones. But the biggest change? 'Money has decreased in value,' he said. 'There is so much more of it.'"

Not according to Simple Ben. On July 10, 2007, Bernanke addressed current inflation, then dismissed it: "The steep run-up in oil prices in recent years has not triggered either high inflation or recession, in large part because consumers and businesses expect price increases to remain tame." Three days before Bernanke spoke, Lehman Brothers (R.I.P.) released its food ingredients cost index for the first 6 months of 2007. It had risen 14.9%.

The value of stuff was rising against dollars and against paper assets in general. Detachment of prices from previous levels leads to poverty, desperation, and crime.

California suffered a copper crime wave. Irrigation systems were stripped from farms; their replacement had cost $2 billion in 2006, a 400% increase from 2005. Value investors "pulled plaques off cemetery plots, raided air-conditioning systems in schools, yanked catalytic converters from cars." The copper in a penny was worth more than one cent; the Treasury Department decided melting pennies for the copper was a crime with a sentence of up to five years in jail. In Britain, Monopoly, the board game, cut costs by replacing paper money with a calculator. In the United States, those who lacked formal education knew best: Twenty-two percent with a high school education or less named the economy as the country's worst problem, compared to eight percent with college degrees. Through history, inflation first attacked the lower classes and not stopped until it consumed the upper classes. This time looks no different.

Currencies everywhere were devaluing against tangible assets and necessities. Corn prices doubled between April 2006 and January 2008. The principal cause was energy: ethanol, fertilizer, water, transportation. The best topsoil in North America had eroded from 18 to 10 inches over the past 50 years. The erosion would have been much greater without fertilizers. More fertilizer, which might slow topsoil erosion, needed more energy. Potash Corporation from Canada expected the cost of producing potash fertilizer would rise by nearly 70% in 2007 due to increased demand for food and fuel. Cambridge Energy Research Associates estimated the worldwide cost to produce oil and natural gas (labor and equipment) had risen 53% since 2004. In some cases the rising costs had led producers to scrap exploration. Exxon estimated the cost of building a gas-to-liquids plant in Qatar at $3 billion in 2004. Estimates in 2007 were $18 billion. The joint project of Exxon and Qatar was dropped.

The United States has imported more than it has exported for decades. Central banks, such as China's, collect dollars from its domestic exporters (from whom Americans had bought goods). The Chinese exporters are handed yuan in exchange for dollars by the central bank. This causes a rising supply of yuan in the local economy. Incomes rise. Necessities improved (more chicken and less rice was eaten) and the Chinese bought machines long considered part of the furniture to Westerners - air conditioners, refrigerators and televisions. China needed more energy.

These permutations of inflation, as they reentered the United States, were understood by Harry Landis and non-college graduates, even if Fed staffers with their "expert judgment" could not comprehend the damage.

On November 7, 2007, Bernanke demonstrated that he had no understanding of inflation. In testimony, Congressman Ron Paul accused Bernanke of a loose money policy that was devaluing the dollar and causing consumer prices to rise. According to the Fed chairman, this was not the case: "If somebody has their wealth in dollars, and they're going to buy consumer goods in dollars, for the typical American, then the deval-, the decline in the dollar, the only effect it has on their buying power is it makes foreign goods more expensive." This extraordinary demonstration of ineptitude was barely mentioned by the same group that thought the spelling of "potato" was of national importance.

On the same day, the Marxist president of Venezuela, Hugo Chavez, showed he understood economic claptrap better than the U.S. media, establishment economists, and the Wall Street publicists who regularly appear on Bubble TV. Chavez addressed an OPEC gathering: "Don't you see how the dollar has been in free-fall without a parachute? The empire of the dollar has to end." The next day, the Archaeological Survey of India announced it would no longer accept dollars for admission to the Taj Mahal The dollar had fallen 12% against the rupee since the beginning of the year.

Oil moved above $90 a barrel in October 2007: the number of dollars needed to buy a barrel of oil had risen from around $40 to $95 since the beginning of 2005. Prices across the U.S. were rising, including - maybe most importantly - manufacturing costs. The Associated Press reported that over 3.2 million factory jobs had been lost in the U.S. since 2000, many of those jobs going to countries with cheaper costs. Wilbur Ross, long-time veteran in the buyout business, was interviewed by the Financial Times in April 2007. He noted the amount of debt used in private-equity acquisitions was at an all-time high, "a very dangerous phenomenon," with only a few making fortunes at the expense of many: "The danger isn't so much inequality as that we're gradually losing the middle class from the population [which is] one of the big contributors to social stability and the relative political stability of the country."

The commercial banks supplied much of the financing for buyouts. The Federal Reserve chairman could have slowed this to a crawl. The Fed has the authority to reduce reserve ratios of the banks. This was not discussed.

In March 2008, 91% of Americans polled were concerned about inflation. Commodity markets boomed. Rice prices passed their all-time high, which had been set in 1973. Costco and Sam's Clubs in California rationed rice purchases.

On June 9, 2008, Chairman Bernanke stated "[t]he Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing from growth as well as inflation." Two weeks later, theUniversity of Michigan found consumers expected prices to rise 7.7% over the next year. Bernanke, before Congress on July 15, 2008, admitted "inflation expectations have moved higher." He reassured the politicians: "[L]onger-term inflation expectations remain reasonably well anchored."Given his July 2007, explanation of how the Federal Reserve thinks about inflation (see above), it is obvious he was talking through his hat.

Oil peaked at $147 a barrel in July 2008. In August 2008, the chairman told the world's leading economists in Jackson Hole, Wyoming that inflation should moderate later in the year due to "well-anchored inflationary expectations" and the "increased stability of the dollar." (The dollar had been rising for all of six weeks.) When had he discovered the dollar's influence on inflation? The day before his Jackson Hole appearance, the U.S. Department of Agriculture projected 2008 food costs would be the highest in 20 years.

By the summer of 2008, the U.S. was submerging in the financial crisis, of which Chairman Bernanke has shown no more understanding than of inflation. Prices retreated but are rising again.

In August 2010, the U.N. Food and Agricultural Organization announced its (international) food index has risen 16% over the past year and is at the highest since 1990. Global meat prices are at a 30-year high. Lamb prices are at their highest since 1973. Wheat and corn prices are rising at their fastest pace since 1973, a year of severe price and social disruption. In April 1973, Time reported that "[p]rofessional thieves are increasingly hijacking meat trucks." False rumors of a rice shortage led frantic Californians to drag 50-pound bags of rice from supermarkets to their cars.

Official U.S. government consumer price index (CPI) numbers have not been mentioned until now. They are important to investors since the monthly calculations, offered to the public as a single number by the media, are taken at face value by the learned financial scholars who are interviewed on TV. The calculations though are a negation of the truth.

It would have been difficult to find the CPI number that was announced when Bernanke was making his comments. The Bureau of Labor Statistics (BLS), which calculates the numbers, states on its website that the press releases (on its website archive) are not the same as the releases that were sent on the corresponding date (for instance, in June, 2006). The BLS has replaced the earlier numbers with newer, revised figures.

Since they have not yet been revised, we can compare a recent distortion between BLS numbers and a more candid approximation at reality. On August 13, 2010, the BLS announced the "index for all items less food and energy rose 0.1 percent in July" 2010. Dropping down the page, the agency claimed food prices fell -0.1% in July. J.P. Morgan analysts conduct supermarket surveys, comparing 33 current to past prices. They recently found that, in the Virginia area, food prices at Wal-Mart have risen 5.9% over the past year.

In July 2010, Chairman Bernanke appeared before the Congressional Committee on Banking, Housing and Urban Development. He stated: "Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year." He went on to make a statement that collected several hackneyed phrases of the sort that official bureaucrats use to disguise what they are thinking, assuming they do think: "At some point, however, the Committee will need to begin to remove monetary policy accommodation to prevent the buildup of inflationary pressures." He finished: "Near-term inflation now looks likely to be a little lower."

In July 2010, police in Homestead, Florida, "said thieves are striking at farms, stealing produce to sell on the black market." Three weeks later, in West Philadelphia, a four-year-old boy was "swallowed" by the sewer system after a manhole cover had been stolen. The Associated Press reported: "In 2008, the department began installing locks on some of the 76,000 manhole covers in the city but still officials are looking at options. 'We're also looking into alternative materials to where [sic] they won't be attractive for the scrap yards' ". (The four-year old lived.) In San Francisco, federal detention centers are "slowly filling up with a new type of criminal... a rising tide of copper thieves raiding abandoned government facilities for their heavy gauge electrical wire."

The Court's Conclusion

To conclude: dismiss Bernanke and discussions about the Federal Reserve. Commodity prices are rising and time is better spent reading the Northern Miner and watching the Prairie Farm Report than Bubble TV. This is not a prediction that commodity prices can be extrapolated in a predictable upward path, but that investors will be able to make money by exploiting the vast ditch between the Federal Reserve's false world and reality.

Making Money from Municipal Waste

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

Harrisburg, Pennsylvania, is defaulting; Half Moon Bay, California, is disincorporating; and the City of Miami, Florida, declared a "state of fiscal urgency," then broke contracts with workers. Yet, Pennsylvania, California, and Florida municipal bond funds managed by Blackrock are trading at or near 52-week highs.

Short sales look timely. Still, there are advantages to a buy side study. First, when the time comes, the opportunities will be broader. Second, the decision to buy will be more a case of negation than attraction. Ruling out unsavory bonds when selecting what to buy will often replicate the process of choosing what to short.

Looking through the wreckage of the 1930s and of the 1970s, there was probably more money lost by premature investments than made by those who waited. This was on the short and long side. New York City is a case in point. Its bust in the 1970s was expected. The stock market had tumbled, a commercial real estate binge of unparalleled excess had desecrated the skyline (new commercial space constructed between 1968 and 1970 exceeded 100% of the city's commercial building between the World Wars), and - this is as predictable as night following day - from 1968 to 1970, 18 of the largest U.S. corporations left the city and 14 more announced their departure. These included American Can, PepsiCo, General Foods, U.S Tobacco and Shell Oil. Over 1.1 million New Yorkers emigrated from the city in the early and mid-1970s.

In other words, it was so obvious that New York City could not pay its bills that it was too obvious. Anecdotally, there were more investors who shorted New York City too early than those who waited and made money.

By the mid-1970s all New York City bonds were trading for approximately $25 ($100 being par). This was 1933 again, when all City of Miami bonds (yields ranged from 4-3/4% to 5-1/2%, maturities from 1935 to 1955) were quoted at $26. In both cases, the market sulked; yet, in both cases, there were bargains for those who were willing to read legal documents. One such case will be discussed below.

All finance is a reenactment. In his seminal study, Municipal Bonds: A Century of Experience (1936), A. M. Hillhouse wrote: "The major portion of over-bonding by municipalities arises out of real estate booms." As precedent, Hillhouse quoted H. C. Adams, who wrote in 1890 (Public Debts): "[T]he bonding of a town, and the expenditure of the money procured in showy works, is the occasion of gain to those who speculate in real estate...." Hillhouse, having quoted Adams' observations of a previous property-boom, municipal-bond bust, should have known better than to write: "There will be no justification for a city [in the future to use] the excuse... that its tax revenues have dried up in times of falling property values." So, if you miss this one, your children will have the same opportunity.

As for the current wasteland, revenue bonds are a choicer flock to choose from than general obligation bonds. The following distinction between the two is extracted from my seminal study (The Coming Collapse of the Municipal Bond Market ): "Revenue bonds are repaid using the revenue generated by the specific project the bonds are issued to fund (fees from a public parking garage, for example)." General obligation bonds are thought to be safer, at least they are advertised as such, because "they are backed by the full faith and credit of the issuing municipality. This means that the municipality commits its full resources to paying bondholders, including general taxation and the ability to raise more funds through credit. The ability to back up bond payments with tax funds is what makes general obligation bonds distinct from revenue bonds."

However, it is not possible to draw blood from a stone and we will soon see municipalities that can not meet their bond commitments unless they discover an oil field larger than BP's folly. Half Moon Bay, California, may already meet this ignoble state. From recent reports, the budget and books are so unintelligible that the city is disincorporating and may become an appendage to San Mateo County. Half Moon Bay's bonds and yawning deficit will presumably be the burden of San Mateo County.

As a side note, the depth of incompetence on display in this instance would not be tolerated in a grammar school Citizenship Day. Given the state of the country, there will be even more amazing feats of fiscal suicide. Another participant is Standard & Poor's, which stamped a AA- rating on $18 million of Half Moon Bay debt issued in 2009. Bondholders note: do not expect logic to guide negotiated workouts.

As for the bondholder, there are several difficulties here. Disincorporation has few if any legal precedents in California. ("It's an option that hasn't been tried in the state since 1972, when the tiny city of Cabazon (about 2,000 people) disincorporated." - San Mateo County Times, August 27, 2010) The Cabazon precedent is not one to take on faith. Half Moon Bay and San Mateo County may have competing interests. A judge may have different ideas yet about how Half Moon Bay should resolve an $18 million lawsuit that the city lost related to development rights on a 24-acre property.

Just where do present circumstances leave the debt holder? That is, the owners of Half Moon Bay's $18 million issue of [Legal] Judgment Obligation bonds. And what of the free-for-all that follows? Propzero.com, jumping into the Half Moon Bay debate, suggests that disincorporation "may be the answer for many California cities struggling with too many spending commitments and not enough money. Digging out of budget holes may be harder than simply shutting things down."

As goes Half Moon Bay, so goes the country, or so it seems. If San Mateo County is stuck with the Judgment Obligation bonds, and a large annual deficit, it is a sure bet the county will appeal to the state; Governor Schwarznegger will appeal to President Obama; and the president will appeal - to Congress?

It was easier to bottom fish among CDOs that were trading at $15 (as a group) in 2008 than to wager on these contingencies. Revenue bonds are comparatively easy to understand. In a large-scale, municipal-bond swoon, revenue bonds will sell off. That will be true even if these are water bonds, supported by the revenue that customers pay for services; even if these revenues cannot be touched by the grasping Yoga Instructors' Union. (Half Moon Bay residents are distraught at the loss of municipal yoga instruction - San Mateo County Times.)

We return to New York City to note the lack of perceptiveness in a time of chaos. In April 1975, the city defaulted on a short-term note. It missed an interest payment (maybe more than one, it isn't clear). The coupon was eventually paid, but the "New York City default" was highly publicized.

The Municipal Assistance Corporation (MAC) was formed. In The Bond Book, Annette Thau explained that MAC bonds were not obligations of New York City: "The revenues to pay debt service were backed, not by the taxing power of the city, but by the state of New York, and by a special lien on the city's sales tax and... on a stock transfer tax." These were revenue bonds that initially yielded "10% as compared to 8% for securities with comparable rating and maturity."

Thau went on to tell her readers that the winning team does its homework: "This episode demonstrates why it pays, literally, to be very precise about exactly which revenue streams back debt service. In this instance, MAC bonds were tarred by the woes of the city, even though they were not obligations of the city...."

Revenues used to pay MAC bondholders could not flow to the city until the coupons were already met. This is true of services in different municipalities today. Utilities often fall in this category. Advanced critical reading skills are a prerequisite to distinguish a $25 from a $75 bond.

What of critical services in municipalities without predictable sources of revenue? In July, Indianapolis, Indiana, decided to sell its water and sewer utilities. In August, San Jose, California, discussed privatizing its water utility. There are many other such discussions. The media reported both the Indianapolis and San Jose decisions as sales. From precedent, the transactions may be more complicated than that.

It would be unusual for a local government to relinquish all control. There are many different possible arrangements with investors. At one end, there have been attempts to issue corporate stock in the municipality. This was proposed in Coral Gables, Florida, during the 1930s. It did not work but investment bankers are more inventive today. (Or, maybe not. Assets to be pledged by Coral Gables included "the municipal golf course and club house, the Venetian pool, the Coliseum...." Maybe not the one in Rome, but investment bankers are inventive.)

Probably the most likely arrangements are Public-Private Partnerships. In such partnerships, the investor, a "concessionaire," steps in after bonds stand no chance of repayment. These might be for a vital service such as a water system, airport, or toll road. Concessionaires pay off all or a portion of the debt in exchange for the right to operate the asset for a negotiated return. Internal rates of return generally fall between 13% - 20%. This is a very simplified description.

There are many other investment approaches that haven't been mentioned. Those mentioned are merely outlined. If it is not obvious, it must be emphasized how preliminary this discussion has been before making an investment. The most important advice here, on the short or long side, is to be patient, to understand the documents of the security, the laws and covenants that bind related parties, and to know the history of municipal bond defaults. This will open the investor's imagination to the most improbable scenarios.