11/22/2002 Death to the 'Bubble Poppers' *

This is one incredible financial and emotional roller-coaster, with good and bad days, weeks, months and quarters. We are, however, afforded an extraordinary opportunity to truly live financial history on a daily basis. For the week, the Dow enjoyed its seventh consecutive gain, adding 3%. The S&P500 gained 2%, with the Utilities and Morgan Stanley Cyclical indices up 3%. The Morgan Stanley Consumer index added 1%, while the Transports declined 1%. The strong rally in the broader market continued, with the small cap Russell 2000 gaining 4% and the S&P400 Mid-Cap index adding 3%. The technology rally turned into a buyers’ panic, as the NASDAQ 100 jumped 5%, the Morgan Stanley High tech index 7%, and the Semiconductors 13%. The Street.com Internet index and the NASDAQ Telecommunications indices gained 7% and 4%. The tech sector is putting together a rather respectable showing, with the NASDAQ100, Morgan Stanley High Tech, Semiconductors, and The Street.com Internet indices sporting quarter-to-date gains of 34%, 40%, 52%, and 46%. For the week, the Biotechs were up 7%, the Securities Broker/Dealer 6%, and the Banks 4%. Although bullion ended the week unchanged, the HUI Gold index dropped 5%.

The Treasury market was none to pleased by it all. For the week, two-year Treasury yields jumped 19 basis points to 2.06%, and five-year yields jumped 22 basis points to 3.24%. The 10-year Treasury note saw its yields rise 15 basis points to 4.18%, while the long-bond yield added 11 basis points to 5.02%. Benchmark mortgage-back yields increased 11 basis points, and the implied yield on agency futures jumped 12 basis points. The spread on Fannie Mae 5 3/8% 2011 notes narrowed two to 48, while the benchmark 10-year dollar swap spread narrowed one to 48. December three-month Eurodollar rates added 1.5 to 1.425%. With stocks sprinting, the dollar jogged cautiously to a 1% gain for the week. Corporate spreads generally narrowed significantly this week. Whether stocks (especially companies with fundamental issues/short positions), corporate bonds, or Credit default swaps, the timely news of a buyer for Household International has proved a catalyst for a major reversal of “risk” bets and hedges. Or, stated differently, it’s been one heck of a squeeze for anyone short stocks, corporate bonds or Credit protection. Markets will be markets, and we are today dealing with truly extraordinary financial market dynamics.

Broad money supply (M3) jumped $41 billion last week to $8.4 Trillion, with five-week gains of $111.2 billion. Over the past 30 weeks, broad money supply has jumped $369 billion, or at an 8% annualized rate. Led by surging Savings Deposits (y-t-d growth rate of 22.1%), M2 has expanded at a 10.5% rate over 30 weeks. Since the beginning of 1997, broad money has ballooned $3.4 Trillion, or 68%. For the latest week of monetary inflation, Savings Deposits increased $24.5 billion, while checkable deposits declined $9.3 billion. Large Time Deposits declined $14.4 billion, while Small Time Deposits added $1.7 billion. Institutional Money Fund deposits jumped $24.5 billion and Retail Money Fund Deposits were about unchanged. Repurchase Agreements gained $11.8 billion (up $25.9 billion in three weeks), and Eurodollars were up $2.4 billion. Commercial paper borrowings increased $4.6 billion last week ($17 billion in two weeks), with financial sector issuance up $6.4 billion ($19.5 billion in two weeks). Bank Credit jumped $38.9 billion, with “other” securities holdings up $27.4 billion. Total Bank Securities Holdings have surged $107.7 billion over four weeks to $1.72 Trillion, with year-to-date growth of $238 billion (18% annualized). Loans and Leases increased $17 billion, with Real Estate Loans up $14.5 billion. Commercial and Industrial Loans declined $1.7 billion. Total Bank Assets jumped another $65.1 billion to $6.98 Trillion. Total Bank Assets are up $164.8 billion over five weeks and $592.1 billion over the past 30 weeks, or 16% annualized.

Weekly bankruptcy filings declined to 30,181; although they remain 16% above the year ago level. Housing starts dropped 11% to the lowest point in six months, although new permits were strong. The Mortgage Bankers Association’s Refi Application index jumped 27.9% (up 23.5% y-o-y) to the fourth highest level on record. The Purchase Application index rebounded 3.5% from the previous week’s nearly 10% decline and remains almost 17% above the year ago level. The annualized growth of Freddie Mac’ total “book of business” slowed to 5.9% during October (to $1.27 Trillion), with its retained mortgage portfolio expanding at a 12.9% rate (to $536 billion).

Fiscal year 2003 is off to a discouraging start with respect to federal government finances. October’s fiscal deficit of $54 billion - a record for the first month of a fiscal year – compares to the year ago deficit of $7.6 billion. Government spending was up 8.6% (defense spending up 15%), while revenues were down 20%. The timing of corporate tax payments apparently explains part of the revenue shortfall, but it is worth noting that individual tax receipts were down 13% y-o-y.

This week from the Bond Market Association: “Domestic bond issuance totaled $3.8 Trillion in the first three quarters of 2002, a 19.6% increase over the $3.2 Trillion issued in the same period of 2001, itself a record year. Gains were seen across all sectors, with the exception of the corporate market, where issuance decreased 26% when compared to the first nine months of 2001… Treasury gross coupon issuance totaled $424.6 billion in the first three quarters of 2002, up from the $238.6 billion issued during the same period last year… Daily trading volume by primary dealers averaged $361.4 billion during the first three quarters of 2002, up 26.4%...from the same period of 2001… Long-term debt issuance by federal agencies totaled $740.0 billion for the first three quarters…up 12% (from last year’s same period)…

“Continuing what will be a record year for municipal bond issuance, state and local bond sales totaled $302.5 billion in the first three quarters of 2002, topping the previous record of $264.3 billion set in the same period of 1993. Municipal issuance increased 26.5% (from last year’s same period)… The surge in issuance resulted from the need to meet ongoing infrastructure requirements and finance new projects. In addition, state and local governments are using the proceeds to fill budget gaps resulting from lowered tax receipts brought about by slow economic growth.” Average daily muni trading volume jumped 31% to $10.6 billion. Total corporate issuance dropped 26% to $491.1 billion, with investment grade issuance down 20.6% (to $430B) and junk issuance down 39.7% (to $43.4B). Corporate trading volume was down 14.3%.

“Issuance in the asset-backed securities (ABS) market is on pace to break the record set in 2001. New issue activity totaled $357.9 billion in the first three quarters of the year, up 11.9% (from last year’s same period)… Among the major sectors, home equity loans experienced the largest increase…with volume totaling $115.9 billion during the first three quarters, up 32.5% (from last year’s same period)… Total issuance in the auto loan sector increased 20.2% to $71.6 billion… Issuance in the credit card sector decreased 19% to $52.8 billion… Mortgage-related securities issuance, which includes agency and private-label pass-throughs and CMOs, is on pace to break the record of $1.67 Trillion set in 2001. Issuance totaled $1.54 Trillion in the first three quarters of the year, up 39.4% from the $1.1 Trillion issued (y-o-y)…On a quarterly basis, new issuance volume totaled $532.1 billion in the third quarter… Daily trading volume in agency mortgage-backed securities by primary dealers averaged $145.4 billion in the first three quarters of 2002, up 39.5%... The average volume of total outstanding repurchase (repo) and reverse repo agreement contracts totaled $3.64 Trillion for the first three quarters of 2002, an increase of 20.6% over the average volume of $3.02 Trillion during the same period of 2001. Outstanding repo agreements averaged $2.10 Trillion through September of 2002, an increase of 21.0%...” Outstanding repurchase agreements are up 81% since the end of 1997 and 46% since the end of 2000, claiming title to the “epicenter” of the Great Credit Bubble.

From the Consumer Federation of America (CFA): ‘Nearly one-third of adult Americans are very concerned about making debt payments, and that percentage is up significantly from last year,’ said Stephen Brobeck, CFA executive director. From last year to this one, consumer concern about ‘meeting your monthly payments on all types of debt other than your mortgage’ rose from 39% to 46%. And those ‘very concerned’ about making these debt payments rose even more sharply, from 19% to 30%...” At the same time, “Nearly three-quarters (73%) of those with incomes over $50,000 say they plan to use credit cards for holiday purchases, and 37% say they intend to use plastic for most holiday purchases.”

November 21 American Banker: “In markets where demand is outstripping the supply of homes for sale, and where soaring land prices are pushing up builders’ costs, there’s just no reason to worry about a so-called bubble.” The president of the National Association of Home Builders (I guess that’s one way to look at it)

November 20 – PRNewswire: “‘Overall, (California) luxury home values remained stable throughout California in the third quarter, but there are signs of softening,’ said Katherine August-deWilde, Chief Operating Officer of First Republic Bank. ‘Inventory is rising, days on the market are lengthening, and multiple offers are infrequent. Given the softness of the economy and uncertainty about world events, we remain cautious about values as we look ahead.’”

November 18 - The Indianapolis Star (Shannon Tan): “Weeds snarl the yard of the house at 814 E. 24th St., and yellowed newspapers lie abandoned on the front porch. Inside, electrical wires poke through the torn blue carpet and shattered fixtures crowd the bathroom. Purchased for $16,000 in April, the home just north of downtown Indianapolis sold a month later, unimproved, for $323,000. The mortgage brokers who created the fake appraisal for that sale have been charged with fraud, while the two-story house sits empty - one of 500 properties ‘sold’ in Indianapolis for greatly inflated prices in recent years... Bad as the problem is in Indiana, it is worse in other parts of the country. Reports of appraisal fraud nationwide tripled in the past six years, according to the Mortgage Asset Research Institute… The fraud most commonly involves a team of professionals faking paperwork to cheat a lender… Such fraud would seem difficult, since people - and banks - rely on expert professionals to oversee the purchase of a home. But if all those pros are working together to defraud a buyer or lender, it can be hard to tell.”

November 18 – Bloomberg: Comments from David Coles, a managing director at restructuring firm Alvarez & Marsal, appointed chief executive at National Century Financial Enterprises Inc.: “It’s all very unfortunate. We had, inadvertently, become the sole source of financing for many of the providers. We were supposed to be a receivables financing operation, but we were lending against equipment, future receivables, pro forma receivables, and providing advances that weren’t secured. I imagine that some of the providers will have difficulty obtaining collateral financing quickly enough to avoid bankruptcy proceedings… The scale of the deficits are quite staggering, about $500 million to $700 million in NPF VI and $1.5 billion to $2 billion in NPF XII, which has been a shock to many people… An average of about $30 million a day was coming into NPF XII in mid October. That has dribbled to about a million.”

November 19 - Bloomberg: “ING Bank NV, which is part of the biggest Dutch financial-services company, has helped fund $500 million of debt for National Century Financial Inc., a health-care financing company… ING’s commitment is through an asset-backed commercial paper program that it administers, Dow Jones said, citing Jay Eisbruck, a managing director at Moody’s Investors service… Credit Suisse First Boston funded a similar program for $225 million, Dow Jones said. Under such programs, banks package a variety of debt products into an off-balance sheet securitization which funds itself by selling commercial bonds…”

There is now no doubt that National Century Financial was an outright fraud involved in misappropriating funds, self-dealing, and fraudulent accounting on a massive scale. Asset-backed securities that were top-rated until recently are destined to suffer heavy losses. Cash-flow into ABS “lockboxes” has slowed to a trickle. One health care official was quoted by USAToday: “Millions are missing. It’s a health care Enron. Health care providers from sea to shining sea are involved in this thing.” But unlike Enron, there were no opaque off-shore vehicles, arcane derivative trading, sophisticated financial engineering or complex accounting. And that’s what troubles us the most. Two JPMorgan Chase bankers were on National Century’s board (one ran the audit committee!) and Morgan was trustee on one of the company’s main funding vehicles. Bank One was trustee on the other. CSFirstBoston was National Century’s investment banker and Moody’s was there to confer its top-rating to NCFE’s asset-backed securities. Deloitte Touche had been certifying the company’s accounting statements. Like Enron and too many other situations, we are troubled that our major financial institutions are all too comfortably partners in “business” with crooks – rather conspicuous ones at that.

And somehow the Greenspan “Teflon” Fed’s perpetual ultra-easy money policies and Bubble accommodations are not held responsible for what will surely be unending revelations of widespread financial shenanigans (just wait until fraudulent activity surfaces in the mortgage area). Yet, history tells us in no uncertain terms that an environment of rampant uncontrolled money and credit growth (with consequent Bubbling asset markets) promotes fraud and mismanagement. It is then no coincidence that the current era with the most lax and acquiescent to Wall Street Federal Reserve since the Roaring Twenties is also the period with the most pervasive financial corruption since the 1920s. Has the public interest been served by the Federal Reserve ceding control over the nation’s financial system to the leading Wall Street firms and their coterie of accomplices? Who is minding the bustling ABS and MBS store?

November 21 - Federal Reserve governor Ben S. Bernanke: “I think it is extraordinarily dangerous for the Fed to make itself the arbiter of security values. And I think, moreover, that if the Fed tries to, quote, “Pop Bubbles” it’s likely that it creates disasters. The example I gave in my speech (Asset-Price “Bubbles” and Monetary Policy, October 15, 2002) was the 1929 (experience). The Fed during that period was concerned about a bubble in the stock market. And it raised interest rates so much that it not only killed the stock market, it also killed the rest of the economy. I think in general that the right way to address an asset price bubble is not with monetary policy but rather by structuring your financial markets in a way to make them as safe and sound as possible. For example, by having good regulations and provisions on your banks – making sure they are not lending against dubious collateral; by increasing transparency in accounting and other forms of revealing information about firms and about shares. History shows, and theory I think supports the view, that attempting to manipulate asset prices with monetary policy is really a loosing game.”

Truly dangerous is what passes for sound monetary thinking these days. Dr. Bernanke, a career academic economist, has given two major speeches since he was appointed Federal Reserve governor in July. From what I have read thus far, he approaches the closest yet to the incarnate of the accomplished monetary theorist and great inflationist John Law. And as Law learned the hard way, “attempting to manipulate asset prices with monetary policy is really a loosing game.”

From his speech yesterday – “Deflation: Making Sure ‘It’ Doesn’t Happen Here:” “As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place.”

“As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero - its practical minimum - monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero…”

“The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.”

“What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation… If we do fall into deflation…we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”

We appreciate that Dr. Bernanke speaks his mind, and he certainly leaves little room for doubt as to where he stands. And I will salute him for diving headfirst into the critical economic issues of our time. We live in a democracy and these things need to be discussed and debated. But he is both a blatant historical revisionist and wolf in sheep’s clothing inflationist - what he professes is generally both reasonable and seductive, therefore potentially quite harmful. We won’t let this get out, but I guess we should be rather thankful that such an individual exists. He embodies, in a single contemporary economist, a rather inclusive package of the flawed analyses we are most eager to argue against: the antithesis to sound money and prudent central banking. Although it is one more disturbing sign of the times that he is one of our newest Federal Reserve governors. From what I have seen thus far, Dr. Bernanke is well on his way to creating a place for himself in economic history.

From his October speech: “New eras bring new challenges… As you know, the Fed has two broad sets of responsibilities. First, the Fed has a mandate from the Congress to promote a healthy economy - specifically, maximum sustainable employment, stable prices, and moderate long-term interest rates. Second, since its founding the Fed has been entrusted with the responsibility of helping to ensure the stability of the financial system… Policy tightening might therefore be called for - but to contain the incipient inflation not to arrest the stock-market boom per se…

“Let me discuss the two parts of this recommendation in a bit more detail. The first part of the prescription implies that the Fed should use monetary policy to target the economy, not the asset markets. As I will argue today, I think for the Fed to be an ‘arbiter of security speculation or values’ is neither desirable nor feasible…”

“The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system. In particular, alone and in concert with other agencies, the Fed should ensure that financial institutions and markets are well prepared for the contingency of a large shock to asset prices. The Fed and other regulators should insist that banks be well capitalized and well diversified and that they stress-test their portfolios against a wide range of scenarios… If necessary, the Fed should provide ample liquidity until the immediate crisis has passed. The Fed’s response to the 1987 stock market break is a good example of what I have in mind.”

“Taken together, (these two principles) provide a strategy for policy that has a number of advantages: It keeps monetary policy focused on the appropriate goal variables, economic activity and inflation. It is transparent and easy to communicate to the public. It does not require that central bankers be systematically better than the market at valuing financial assets nor substitute policymakers’ judgments of company prospects for those of investors. Finally, and crucially, it is a robust strategy, in that - although it certainly does not eliminate all economic and financial instability - it protects the economy against truly disastrous outcomes, which history has shown are possible when monetary policy goes severely off the track. ”

While most of what he asserts is reasonable, we take strong exception to the most critical aspect of Dr. Bernanke’s analysis: Categorically, his prescription for contemporary central banking to ignore asset-prices Bubbles, while being quick to both inject liquidity into faltering markets and stimulate a weakening economy, is precisely the course where “monetary policy goes severely off the track” and fosters “truly disastrous outcomes.” A monetary regime of uncontrolled fiat money and Credit requires strict central bank regulation of lending and speculative excess. Nurture Credit market speculation and you have a problem; resort to sheltering and, worse, inciting leveraged speculation for policy purposes (stimulating the financial markets and economy) and you court disaster. I would argue that the Fed’s conduct of ignoring gross Credit excess, rampant speculation, and Bubbles generally, while guaranteeing the aggressive financial players liquidity support in the event of systemic stress - and artificially stimulating spending to circumvent the business cycle - is PRECISELY the prescription for eventual disastrous financial and economic collapse. The “How To” for depression…

Dr. Bernanke acknowledges that “a number of critics have argued that monetary policy should be more proactive in trying to correct incipient ‘imbalances’ in asset markets.” “This debate is clarified considerably, in my view, by recognition that, in practice, the advocates of a more vigorous monetary policy response to asset prices fall into two broad camps, differing primarily in how aggressive they think the Fed ought to be in attacking putative bubbles. The first group, who favor what I will call the lean-against-the-bubble strategy, agree that the Fed should take account of and respond to the implications of asset-price changes for its macro goal variables… the Fed should try to gently steer asset prices away from the presumed bubble path… My sense is that this more moderate camp comprises the great majority of serious researchers who have advocated a monetary-policy response to bubbles...”

Well, at this point we would have zero faith in the effectiveness of “leaning against” the Bubble. There’s simply no painless short-cut to sound finance. “The second group of critics is those preferring a more activist approach, which I will call here aggressive bubble popping. Aggressive bubble-poppers would like to see the Fed raise interest rates vigorously and proactively to eliminate potential bubbles in asset prices. To be frank, this recommendation concerns me greatly, and I hope to persuade you that it is antithetical to time-tested principles and sound practices of central banking.”

Where did they find this guy – the consummate antithesis to sound money? I hope to persuade you that Dr. Bernanke’s views are “antithetical to time-tested principles and sound practices of central banking.”

Dr. Bernanke : “Aspiring bubble poppers cannot get around the fact that their strategy requires identifying bubbles as they occur, preferably quite early on. Identifying a bubble in progress is intrinsically difficult… If we nevertheless persist in trying to measure bubbles, what indicators might be useful? Several have been suggested, including the rate of appreciation of asset prices, various ratios that attempt to measure the return on stocks, and growth in bank credit. None of these provides a reliable indicator of a developing bubble.”

Well, it is always our belief that economists make this much more difficult than it need be. Why can’t we look at total Credit growth, both non-financial and financial, to better appreciate the quantity of new purchasing power created? The focus must be broadly on the creation of financial sector liabilities (money and Credit creation), identifying the institutions, entities, securities, instruments, mechanisms and sectors responsible for the new financial claims (Credit/purchasing power). At the same time, analysis should attempt to identify the sector(s) most-likely to be at risk from the associated inflationary distortions (such as extraordinary GSE Credit creation and attendant inflationary manifestations in rising home prices, over-consumption and trade deficits). Greenspan spoke of incipient stock and bond market Bubbles behind closed Fed doors back in 1994, with the fledgling financial Bubble conspicuous with regard to the 1993 bond issuance boom and proliferation of leveraged speculation. The expansive Credit Bubble has become only more obvious in the data by the year. Without a doubt, the analytical focus must be on the Credit system and NOT stock prices. Arguing appropriate P/E ratios is like debating religion, politics or abortion.

Interestingly, Dr. Bernanke meanders closely to the heart of the issue: “Another possible indicator of bubbles cited by some authors is the rapid growth of credit, particularly bank credit (Borio and Lowe, 2002). Some of the observed correlation may reflect simply the tendency of both credit and asset prices to rise during economic booms. However, to the extent that credit expansion is indicative of bubbles, I think that empirical linkage points to a better policy approach than attempts at bubble-popping by the central bank. During recent decades, unsustainable increases in asset prices have been associated on a number of occasions with botched financial liberalization, in both emerging-market and industrialized countries. The typical pattern is that lending institutions are given substantially expanded powers that are not matched by a commensurate increase in regulatory supervision - think of the savings and loans in the United States in the 1980s. A situation develops in which institutions can directly or indirectly take speculative positions using funds protected by the deposit insurance safety net--the classic ‘heads I win, tails you lose’ situation.

“When this moral hazard is present, credit flows rapidly into inelastically supplied assets, such as real estate. Rapid appreciation is the result, until the inevitable albeit belated regulatory crackdown stops the flow of credit and leads to an asset-price crash. Bubbles of this type may be identifiable to some extent after they have begun, but the right policy is to do the financial deregulation correctly - that is, in a way that does not allow speculative misuse of the safety net - in the first place. Or failing that, to intervene and fix the problem when it is recognized. ”

The real story of the Great Credit Bubble is the explosion of non-bank Credit creation by quasi-governmental organizations. With “Big Three GSE” exposure at an unimaginable $3.8 Trillion (Fannie and Freddie’s “book of business” plus FHLB assets), are we not seeing an S&L-type “moral hazard” play out in historical proportions throughout mortgage finance? So where’s the “regulatory crackdown?” And now that this Bubble is completely out of control, how will it be possible “to intervene and fix the problem?” Who is willing to take responsibility? The answer is no one.

From Dr. Bernanke: “Although neither I nor anyone else knows for sure, my suspicion is that bubbles can normally be arrested only by an increase in interest rates sharp enough to materially slow the whole economy. In short, we cannot practice ‘safe popping,’ at least not with the blunt tool of monetary policy… A truly vigorous attempt by a central bank to rein in a supposed speculative bubble may well succeed but only at the risk of throttling a legitimate economic boom or, worse, throwing the whole economy into depression.”

Again, this is dangerous analysis – it implies absolute disregard for asset inflation and asset Bubbles; that is, until they eventually begin to collapse on their own accord (NASDAQ). The goal of sound monetary management must to promote financial stability and nip incipient Credit, speculative, and Bubble excess in the bud. A healthy economy and financial system can handily weather small, correctable central bank errors. Errors on the side of caution are easily reversed. Errors on the side of accommodating financial excess, as we have witnessed, do not reverse but compound seductively and exponentially. Somehow contemporary thinking at the Fed and in academia have the costs of potential small central bank errors of caution as unacceptably high, and the costs of stimulating and inflating non-existent. Apparently, with China now an endless source of cheap goods, the absence of CPI risk affords the opportunity to inflate money and credit “till the cows come home.” This is very warped, although certainly expedient, “analysis.”

What we must avoid at all cost – because it risks financial derangement, severe economic maladjustment, systemic collapse and depression – is the major mistake of not dealing forcefully with Credit and speculative excess to the point of unleashing uncontrollable and precarious financial and economic Bubbles. And it must also be recognized that the longer Credit excess compounds upon Credit excess, the tinier the Fed’s “little” balance sheet becomes next to the soaring Mount Everest of financial claims. Last week’s total Federal Reserve Assets of $685 billion compare to total outstanding Credit market debt surpassing $34 Trillion. When that fateful day arrives, the antiquated and feeble helicopter will need replaced with a large fleet of super-jumbo cargo airships. All the same, if I were a Fed governor I’d be more careful throwing around the “always” word, as in the power of the Fed to “always be able to generate increased nominal spending and inflation.”

The more easy money encourages households to take on the debt necessary to buy a new car (artificially distorting demand) and upgrade to a larger home (or acquire stocks or munis, for that matter), the less likely they will be cajoled into a repeat performance any time soon (government electronic “printing press” notwithstanding). And finally, it is today worth pondering an issue that continues to stoke gale force economic headwinds throughout Japan. Post-Credit and assets Bubbles, risk-averse households are nonetheless holding enormous and growing quantities of government debt and other financial claims. With all this perceived financial wealth, why would we not expect Japanese consumers to play it safe – temper spending and focus on reducing borrowings? The only way many are not ok is to take on risk. At times people just feel better about grabbing the money dropping from the helicopters and stuffing it securely inside the mattress for a rainy day.

After promulgating dubious prescriptions for contemporary monetary management, Dr. Bernanke then commits a most atrocious act of historical revisionism by blaming the Great Depression on the “Bubble Poppers.” I kid you not.

From Dr. Bernanke: “The U.S. experience of the 1920s illustrates many of the points I have been making. As you know, the ‘Roaring Twenties’ was a prosperous decade, characterized by extensive innovation in technology and in business practices, rapid growth, American economic dominance, and general high spirits. Stock prices rose accordingly. As early as the mid-1920s, however, various policymakers and commentators expressed concern about the rapidly rising stock market and sought so-called corrective action by the Federal Reserve. The corrective action was not forthcoming, however. According to some authors, this was in large part because of the influence of Benjamin Strong, long-time Governor of the Federal Reserve Bank of New York and America’s pre-eminent central banker of that era. Strong resisted attempts to aim monetary policy at the stock market, arguing that raising interest rates sufficiently to slow the market would have highly adverse effects on the rest of the economy. ‘Some of our critics damn us vigorously and constantly for not tackling stock speculations,’ Strong wrote about the debate. ‘I am wondering what will be the consequences of such a policy if it is undertaken and who will assume responsibility for it.’ However, Strong died from tuberculosis early in 1928, and the Fed passed into the control of a coterie of aggressive bubble-poppers…”

“The correct interpretation of the 1920s, then, is not the popular one - that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy -both domestically and, through the workings of the gold standard, abroad… This interpretation of the events of the late 1920s is shared by the most knowledgeable students of the period, including Keynes, Friedman and Schwartz, and other leading scholars of both the Depression era and today… monetary policy had already turned exceptionally tight by late 1927… A small compensation for the enormous tragedy of the Great Depression is that we learned some valuable lessons about central banking. It would be a shame if those lessons were to be forgotten.”

This is stunning, misguided commentary. The harsh reality is that we learned absolutely the wrong lessons from the Great Depression, and I would suggest Dr. Bernanke and others go to the Mises.org website and order the recent compilation of Murray Rothbard’s writings, The History of Money and Banking in the US. It is wonderfully written, brilliant and exceedingly pertinent history (although the long introduction misses this critical point!). Diligent true students of this seminal period (and money and Credit generally) will have a very difficult time refuting Rothbard’s cogent and comprehensive analysis that the Depression was the consequence of years of inflationary policies, monetary mismanagement, and the Fed’s accommodation of rampant financial excess on Wall Street. It was a long road to unsound money, a dysfunctional Credit system, and perilous financial and economic Bubbles. “Exceptionally Tight” money no more caused the crash in 1929 than it did the bursting of the NASDAQ Bubble in 2000. Instead, there was a dilemma distressingly similar to today’s, with Bubbles only sustained by looser money and greater Credit and speculative excess. It is only a matter of when, at what cost, and under what circumstance Bubbles meet their inevitable fate. The “printing press,” Dr. Bernanke, is the problem and not the solution.

Again using Dr. Bernanke’s own words (but from our antithetical analytical framework): “In other words, the best way to get out of trouble is not to get into it in the first place.” Precisely! And that is what Dr. Richebacher has been preaching for years. Paraphrasing the good doctor, “There is no cure for a Bubble other than not letting it begin in the first place.” If the Wall Street darling Benjamin Strong would have acted responsibly to safeguard sound money and financial stability – thus thwarting financial and economic excess in the mid-twenties as things began running completely out of control - it is likely that financial collapse and depression could have been avoided. And applying Dr. Henry Kaufman’s quote regarding the Greenspan era: “The Fed missed its timing.” Well, Benjamin Strong bet the farm and lost. Greenspan has lost the ranch, although the “house” apprehensively consents to his gambling on his neighbors’ homesteads. Blaming the Great Depression on those that were rightly fearful of escalating dangerous financial and economic imbalances – those dreadful “Bubble Poppers” – is such a gross distortion of the facts and an injustice to sound economic analysis. Long live the Bubble Poppers!