Information clearinghouse regular, Cruxpuppy, pointed out
the glaring weaknesses in yesterday's
article. I thought this criticism was fair, well-argued,
principled and accurate. He was right and I was wrong. I have
rewritten the article which, I believe, shows how I really
feel about the Federal Reserve. I agree, it must be abolished.
Thanks for the criticism, cruxpuppy. I found it very constructive.
me control over a nation's currency and I care not who makes its
- Baron M.A. Rothschild
loves cheap money. That's why traders were celebrating last Tuesday
(Sept 18, 2007) when Fed chief Ben Bernanke announced that he'd
drop interest rates from 5.25% to 4.75%. The stock market immediately
zoomed skyward adding 336 points before the bell rang. The next
day the giddiness continued. By mid-morning the Dow was up another
110 points and headed for the stratosphere. Everyone on Wall Street
loves Bernanke. He brings them candy and sweets and lets the American
worker pay the bill.
So far, the
scholarly-looking Bernanke has shown that he is no different than
his predecessor Alan Greenspan. Facing his first crisis, the new
Fed chief chose to reward his fat-cat friends at the hedge funds
and investment banks by savaging the dollar. As soon as he announced
his plan to cut the Fed funds rate by .50 basis points; gold soared
to $736 per ounce, oil shot up to $82 per barrel, and the euro
climbed to a new high of $1.40. These are all the predictable
signs of inflation. Food and energy prices will surely follow.
The bottom line is that the investor class has been bailed out
at the expense of everyone else who trades in dollars.
invoked the "Greenspan put", which means that he used his power
to protect his friends from the losses they should have incurred
from their bad bets. Now, the big market players know that he
can be counted on to bail them out whenever they make poor investment
decisions. He's also lived up to his nickname, "Helicopter Ben";
ready to deal with every new calamity by tossing trillions of
freshly-minted US greenbacks into the jet-stream over the NYSE
so elated traders can jack-up their PEs and fatten their bottom
We think Bernanke should abandon the helicopter altogether and
personally deliver pallet-loads of $100 bills to Wall Street's
doorstep, just like Bush does with contractors in Iraq. That way
the fund managers can keep stoking the market with cheap cash
without dawdling at the Fed's Discount Window.
the merriment on Wall Street, there is a downside to Bernanke's
actions. The Fed chief has shown foreign investors that he WILL
NOT DEFEND THE DOLLAR. That is a powerful message to anyone who
hopes to profit by investing in the US. It alerts them to the
fact that the "strong dollar" policy is a fraud and that they're
better off getting out of US Treasuries and dollar-backed assets.
many have already gotten the message. Last month, foreign central
banks and investors dumped $9.4 billion of US Treasuries and
bonds compared to net purchases in June of $24.7 billion. That
means that foreigners have stopped buying our debt which is
currently $800 billion per year. That's the last leg holding
up the wobbly greenback. The dollar will undoubtedly fall precipitously.
So, why would
Bernanke weaken the dollar even more by lowering rates 50 basis
Is he crazy
or did he panic?
know, but we do know that this is the beginning of Capital flight
- the sudden exodus of foreign investment from US debt and equities.
Most likely, it will be accompanied by the hissssing sound of
gas escaping from a punctured equity bubble followed quickly by
a painful round of deflation, massive unemployment and the gnashing
soon as Fed chief Ben Bernanke announced his plan to cut
the Fed funds rate by .50 basis points; gold soared to
$736 per ounce, oil shot up to $82 per barrel, and the
euro climbed to a new high of $1.40. These are all the
predictable signs of inflation. Food and energy prices
will surely follow. The bottom line is that the investor
class has been bailed out at the expense of everyone else
who trades in dollars.
of the current account deficit, which peaked in 2005 at 6.8%
of GDP, has dropped to 5.5% by the end of the second quarter
of 2007. This is an indication that the maxed-out American consumer
is running out of gas and that our foreign trading partners
are slowing their intake of US dollars. Now comes the painful
part. As the trade deficit shrinks, foreign investment will
become scarcer and the dollar will tumble. That means interest
rates will have to go up and Americans will face an agonizing
This is all
part of the Federal Reserve's master-plan for reorganizing the
US economy and political system. Since Bush took office in 2000,
the dollar has been deliberately weakened; losing more than 40%
of its value when compared to the euro (from $.85 per euro in
2000 to $1.40 per euro in 2007).
It has fared even worse against gold. The Fed "rubber stamped"
Bush's $400 billion per year tax breaks for the wealthy and looked
on approvingly while $4 trillion of national wealth was transferred
to foreign investors and banks via the current account deficit
(the result of currency deregulation). Also, we now know that
Alan Greenspan supported the plan to invade Iraq. He even shamelessly
admitted that the war was really about oil which suggests that
he was attempting to preserve the dollar's link to petroleum.
That linkage is what maintains the dollar's position as the world's
things indicate that the Central Bank plays a vital role in
the policy decisions which are reshaping American life. We assume
that the Fed's members are equally supportive of the repressive
police-state measures which have been put in place in anticipation
of problems that will undoubtedly arise from the economic meltdown
they have painstakingly engineered.
cuts tell us that the Fed is now planning to balance the current
account deficit on the backs of the American middle class. Prices
at the supermarket and gas pump will rise immediately; probably
within the next few months if not weeks. It will be harder to
get credit. Wages and living standards will decline. Stocks will
fall. Consumer spending will shrivel.
Bernanke's rate cuts don't even address the underlying problems
they are supposed to cure. Millions of homeowners who took out
subprime and Alt-a loans are headed for foreclosure. Only a small
percentage of these will benefit from the rate cuts and avoid
default because of lower "resets" on their loans. Most of them
will not qualify for refinancing UNDER ANY TERMS because they
don't meet the new standards for securing a loan. Banks and mortgage
companies have become much stricter in their lending practices.
rate cuts don't really help the banks or hedge funds either.
Their stocks may lurch upward for a day or two, but that won't
last. Money is getting tighter and spending is down. It's not
a good time to be holding hundreds of billions in mortgage-backed
liabilities (CDOs) which may have been levered many times their
original-value. There's no market for these CDOs. They're turkeys.
The debt will either have to be written off or the companies
will be forced into bankruptcy.
Fed chief has shown foreign investors that he WILL NOT
DEFEND THE DOLLAR. That is a powerful message to anyone
who hopes to profit by investing in the US. As
the trade deficit shrinks, foreign investment will become
scarcer and the dollar will tumble. That means interest
rates will have to go up and Americans will face an agonizing
won't stem the tide of insolvencies or fix the deeply-ingrained
problems in the financial markets. All they will do is forestall
the impending recession by sustaining abnormal levels of liquidity.
But as consumer spending contracts and unemployment continues
to rise; the Fed's "band-aid" approach to these systemic problems
will prove to be ineffective. Bernanke is sacrificing the one
thing he'll need most in the bumpy months ahead; his credibility.
and author Henry Liu says, "A market that catches on to the impotence
of central-bank intervention can go into free fall."
most compelling argument for interest rate cuts was made by
economist Martin Feldstein in a Wall Street Journal article
"Liquidly Now". Feldstein summarized the issue like this:
but related forces are now threatening economic activity: a credit
market crisis, a decline in house prices and home building, and
a reduction in consumer spending. These developments compound
the general weakening of the economy earlier in the year, marked
by slowing employment growth and declining real spendable income...
The subprime mortgage defaults have triggered a widespread flight
from risky assets, with a substantial widening of all credit spreads,
and a general freezing of credit markets. Official credit ratings
came under suspicion. Investors and lenders became concerned that
they did not know how to value complex risky assets.
some recent weeks credit became unavailable. Loans to support
private equity deals could not be syndicated, forcing the banks
to hold those loans on their own books. Banks are also being forced
to honor credit guarantees to previously off-balance-sheet conduits
and other back-up credit lines, further reducing the banks' capital
available to support credit of all types.
inability of credit markets to function properly will weaken
the overall economy in the coming months. And even when the
credit market crisis has passed, the wider credit spreads and
increased risk aversion will be a damper on economic activity.
addition to these general credit market problems, the decline
of house prices and home building will be a growing drag on the
economy... Falling house prices would not only cause further declines
in home building but would also shrink household wealth and thus
has a good understanding of the problem, but backpedals on the
resolution. He says:
to lower interest rates cannot solve the credit market problems,
but it would help the economy: by stimulating the demand for housing,
autos and other consumer durables; by encouraging a more competitive
dollar to stimulate increased net exports; by raising share prices
to increase both business investment and consumer spending; and
by freeing up spendable cash for homeowners with adjustable-rate
cuts won't stem the tide of insolvencies or fix the deeply-ingrained
problems in the financial markets. All they will do is
forestall the impending recession by sustaining abnormal
levels of liquidity.
paradoxically wants rate cuts even though he admits that "lower
interest rates cannot solve the credit market problems" but
will just stimulate more wasteful "consumer spending".
a cure. That's just more Greenspan snake oil.
much liquidity" is the problem not the solution. The reason
the markets are so volatile and likely to implode at any minute
is because every asset-class has been foolishly inflated by
a monetary policy that followed Feldstein's prescription. Now
he wants to avoid the consequences of these misguided policies
by reflating the bubble and destroying the dollar in the process.
It's a bad idea.
cuts coincide with the dismal earnings reports from Wall Street's
investment giants; Lehman Brothers, Morgan Stanley, Bear Stearns
and Goldman Sachs. The four banks have taken a combined 22% haircut
in the last quarter and are expected to sustain heavy losses from
the billions of dollars of subprime CDOs they'll have to either
downgrade or write-off.
So far, Bernanke's rate cuts have diverted attention from the
grim news and falling profits from America's investment core.
The big financials aren't the only ones feeling the pinch from
the housing meltdown either. There are many others including Bank
of America that announced "unprecedented dislocations" in credit
markets will have a "meaningful impact" on third-quarter results
at its corporate investment bank. "Chief Financial Officer Joe
Price told investors at a conference in San Francisco, 'These
are quite challenging financial times, and I cannot remember when
credit markets in particular have been as volatile and unpredictable
as they have been for the last few months'." (Bloomberg News.)
rate cuts are "thin gruel" for the banks' bottom line, but they
do offer a welcome distraction from the relentless drumbeat of
bad economic news. The subprime sarcoma has spread to every part
of the financial markets. It's not just the steady up tick of
foreclosures and mushrooming real estate inventory. The banks
are also hoarding capital to cover their losses on unmarketable
CDOs and leveraged buyouts (LBOs) which means that new mortgages
will slow to a crawl even to credit-worthy applicants.
An article in Bloomberg News gives us some idea of how quickly
the market for housing-related bonds has deteriorated: "Sales
of US asset-backed securities, such as bonds that repackage subprime
loans or credit card debts as well as collateralized debt obligations,
FELL73% FROM A YEAR EARLIER to $30 billion last month, according
to estimates from analysts at Deutsche Bank AG." (Bloomberg News.)
is just prolonging the pain by not allowing the market to complete
its cycle so that bad debts can be written off and industry can
retool for the future. He's buying time for his banker-friends,
but doing considerable damage to the dollar in the process. Jim
Rogers, the chairman of Beeland Interests Inc. summed up the rate
cuts like this: "Every time the Fed turns around to save
its friends on Wall Street, it makes the situation worse. The
dollar's going to collapse, the bond market's going to collapse.
There's going to be a lot of problems in the U.S.'' Rogers is
not alone in his conclusions.
leaders, like Venezuelan President Hugo Chavez, have commented
recently on the worrisome state of US markets. Three days ago
Chavez said on public television that we may be facing a "global
financial earthquake" as the result of "irresponsible" US economic
policies. Chavez quoted Nobel Laureate Joseph Stiglitz's warning
that we may be facing a major economic disaster which could lead
to "widespread misery, hunger and severe unrest. And the United
State is to blame."
Chavez added that the Bush administration "has had to inject $300
US billion into the private banks this month to avoid a collapse
of the dollar and the world economy... The dollar is going down,
they don't see that it isn't supported by reality" and "because
its fiscal deficit is the largest in history."
predictions appear to be accurate as we can see that gold has
suddenly skyrocketed while the dollar continues to fall.
that began with the Fed's low interest rates in 2002-2003 and
evolved into the subprime-lending crisis of 2006-2007 is now threatening
the stability of the entire financial system and the broader global
economy. The reason for this is that mortgage debt is the foundation
upon which all manner of bizarre-sounding debt-instruments are
now resting. These debt-instruments (derivatives) greatly magnify
the leverage on the underlying asset which often is nothing more
than a shaky subprime loan.
spiral of borrowing on an increasingly thin base of
real assets... ultimately created a world in which
derivatives... this year stood at $485 trillion -
or eight times total global gross domestic product
of $60 trillion.
to Satyajit Das, a respected authority on derivatives trading,
"A single dollar of 'real' capital supports $20 to $30 of
loans. This spiral of borrowing on an increasingly thin
base of real assets, writ large and in nearly infinite variety,
ultimately created a world in which derivatives outstanding
earlier this year stood at $485 trillion - or eight times
total global gross domestic product of $60 trillion." (Are
We Headed for an Epic Bear Market" Jon Markman.)
We are now
seeing the first signs that this enormous debt-bubble is beginning
to unwind. There's very little the Fed can do to affect the inevitable
crash that (we believe) they engineered. As defaults in housing
continue to rise; the swaps and derivatives in the secondary market
will implode. Trillions in market capitalization will vanish in
GDP for the last six years has largely depended on transactions
involving the exchange of massively over-levered assets. Production
in the real economy has remained flat. The investment banks
are at the epicenter of this controversial new system called
"structured finance". We continue to believe that the banks
that depended on mortgage-backed securities (MBSs) and collateralized
debt obligations (CDOs) (as well as asset-backed commercial
paper) for the bulk of their income; are in deep trouble.
Robert E. Lucas alluded to potential bank-woes in an article
in the Wall Street Journal, "Mortgages and Monetary Policy":
"There is an immediate risk of a payments crisis, a modern analogue
to an old-fashioned bank run. Many institutions - not just banks
- HAVE PAYMENT OBLIGATIONS THAT ARE FAR IN EXCESS OF THE RESERVES
TO WHICH THEY HAVE IMMEDIATE ACCESS. Against these obligations
they hold short-term securities that they believed could be
liquidated on short notice at little cost. If some of these
securities turn out not to be liquid in this sense (and especially
if no one is sure who holds them) then everyone wants to get
into Treasury bonds."
It's rare when we are in agreement with the far-right viewpoints
of the WSJ's Editorial page, but in this case, Lucas nailed
it. The banks have "obligations that are far in excess of the
reserves to which they have immediate access." This is a direct
result of the new market architecture of "structured finance"
which stacks debt on debt until the whole system is pushed to
the breaking point. Low interest rates can't fix this "systemic"
problem. Only fiscal policy can soften the blow of a deflating
credit bubble. Economist Henry Liu offers this constructive
"New Deal-type" proposal which is a sensible (and ethical) way
to address the prospect of growing unemployment and increasing
economic hardship for the middle and lower classes:
"A case can
be made that what is needed under current conditions is not more
cheap money from the Fed, but full employment with rising wages
by government fiscal stimulants to boost consumer demand. The
US government should make use of the money that the banks cannot
find worthy borrowers to lend to, with money-cautious investors
seeking to lend to the government, creating jobs for infrastructure
rehabilitation and upgrading education to get the economy moving
again off the destructive track of privatized systemic financial
manipulation." ("Either Way, It could be an Unkind Cut" Henry
C K Liu, Asia Times.)
Liu is right. We should be enacting the policies which reflect
our values on social justice and the equitable distribution of
wealth. Instead, the system is being manipulated by an oligarchy
of racketeers who have savaged the currency, drained our treasury,
and paved the way for a painful cycle of deflation. The
US consumer is now being blamed for the massive current account
deficit; as if shopping at Walmart for the lowest prices was a
crime. But the Fed is the real culprit. They have been opposed
to protective tariffs or currency regulation from the very beginning.
No country in the history of the world has ever allowed its industrial
base to be so ruthlessly decimated (offshoring, outsourcing, factory
closures) just to feed the insatiable avarice of its criminal
The current account deficit is the logical upshot of "free trade".
And, free trade is the Orwellian moniker used to describe the
millions of decent paying jobs which are sacrificed on the altar
of globalization. The workers had no part in creating this destructive
self-aggrandizing system. Nor did they have any say-so in the
design of the modern market, which is often referred to as "structured
Structured finance has been promoted as a way of using capital
more efficiently by distributing risk more evenly throughout the
system. In fact, it has turned out to be a colossal swindle which
is now threatening to break the banks and bring the stock market
crashing down. It is essentially a mortgage-laundering scheme
concocted by the investment banks; winked-at by the so-called
regulators, facilitated by the ratings agencies, and exploited
by the hedge funds. The victims of this scam are the insurance
companies, foreign investors, pension funds and over-leveraged
homeowners. Their losses are liable to soar into the trillions
Alan Greenspan enthusiastically endorsed every dodgy "structured
finance" idea; including subprime lending, ARMs, Mortgage-backed
securities, currency deregulation, credit expansion and structural
changes to the financial services industry. These are the pavers
on the road to perdition carefully put in place by the Federal
Kolko summed up "structured finance" in a recent article "The
Predicted Financial Storm Has Arrived":
"We are at
an end of an era
Now begins global financial instability.
It is impossible to speculate how long today's turmoil will last
- but there now exists an uncertainty and lack of confidence that
has been unparalleled since the 1930s - and this ignorance and
fear is itself a crucial factor. The moment of reckoning for bankers
and bosses has arrived. What is very clear is that losses are
massive and the entire developed world is now experiencing the
worst economic crisis since 1945, one in which troubles in one
nation compound those in others.
"Internationalization of finance has meant less regulation
than ever, and regulation was scarcely very effective even at
the national level... Greed's only bounds are what makes money.
Existing international institutions - of which the IMF is the
most important - or well-intentioned advice will not change this
The people must take over control of their own currency again.
The Federal Reserve must be abolished.
Mike Whitney is a well respected freelance writer living in Washington
state, interested in politics and economics from a libertarian
perspective. He can be reached at [email protected].
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