Nassim Taleb is back.  Citing a disgust for the lack of effective action on the growing global economic and financial crisis, he’d essentially gone into hiding over the last two years.  (I don’t recall seeing Taleb on TV since May 2010 when he discussed the “flash crash.”)  In fact, his website, Fooled by Randomness, championed this fact (check out the caveat he puts next to his email address at the bottom of the page).

The attached video shows Taleb discussing why he supports Ron Paul for the 2012 Republican Presidential candidate.  He lists four main reasons why: 

1) Paul’s position on reducing government spending in order to decrease the deficit and, in turn, the national debt.

2) Paul’s desire to audit and possibly abolish the Federal Reserve Bank.

3) Paul’s position on America's rampant militarism and defense spending.

4) Paul’s belief that America is resilient and can recover if we commit to rebuilding what was once a vibrant economy.

We’ve all heard the countless cries by our leaders and government officials about “ending poverty,” “waging the war on poverty,” and “eliminating poverty for future generations.”  They claim that if we just give them more of our wealth, more of our earnings, then we can finally, once and for all, put an end to poverty.

Meanwhile, the very system we live under, and which our government preserves and protects at every turn, continues to create poverty for millions of Americans – a system which in turn, supports and funds those leaders telling us to sacrifice more for the good of all.  That system is called the “monetary system.”  

You’re probably not familiar with this term, not only because it’s never mentioned in the mainstream media or in your school textbooks, but also because when you think of our economy you think of capitalism.  This is not surprising since we’ve been conditioned to think we live in a capitalist society.  And to some extent, we do.  But the problem is, by thinking of it that way and describing it by that one word alone, we omit an important aspect of the overall system that governs our economic livelihood.

Now, the term monetary system is quite broad, and so we need to look closer at what that really entails.  In general, a monetary system is any economic system that assigns goods and services a value that is exchangeable through a medium such as paper (fiat) money, gold/silver, or other means.  Capitalism per se does not imply the use of money – rather, it traditionally refers to things like the free market exchange of goods and services and private property rights.  Thus, it is important that we separate capitalism and the monetary system in our minds in order to understand the true nature of the overall system we live under.

The use of money to govern transactions within a capitalist system is not a bad thing in and of itself.  In fact, if the money has intrinsic value (such as gold or silver), this can improve the integrity of the overall economy by ensuring that the monetary value remains stable and intact, versus fluctuating significantly over time.  An example of such fluctuation would be the US dollar (a fiat currency not backed by anything of value), which has lost over 90% of its purchasing power in the last century.  (Indeed, most of this erosion in value occurred after 1971, when the dollar was unhinged from the gold standard.)

The US monetary system, of course, is based on the use of fiat money, which can be created arbitrarily through policy decisions originating from the Federal Reserve System.  In conjunction with this capability, the employment of “fractional reserve banking” provides further flexibility to the monetary system, and encourages the creation of money from, essentially, nothing.  Simply put, fractional reserve banking is when banks only maintain a portion or fraction of customer deposits in reserve, while using the remainder to originate loans and thus create higher amounts of interest income.  The amount of money the bank must retain in reserve is called the “reserve ratio.”  Traditionally, US banks have maintained a reserve ratio of 9 to 1, meaning for every dollar kept on deposit, $9 can be lent out.

The practice of fractional reserve banking is actually detailed in a booklet issued by the Chicago Federal Reserve Bank (one of the 12 regional banks under the purview of the Fed), called Modern Money Mechanics.  While I think it’s worth reading the entire 40 pages of this document, this quote should suffice as a summary:

“The purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system. The approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System - the central bank of the United States….The illustrations in the following two sections describe two processes: first, how bank deposits expand or contract in response to changes in the amount of reserves supplied by the central bank; and second, how those reserves are affected by both Federal Reserve actions and  other factors.”

We can translate this summary to mean one thing: banks create money out of nothing.  By illustration, we can see how fractional reserve banking accomplishes this:

Bank A receives a deposit of $10 million from a customer.  It places $1M in reserve (according to its 10% reserve ratio requirement), and then lends out the other $9M to Bank B, collecting interest payments from Bank B.

Bank B puts $900,000 in reserve (again, 10%), and lends out the other $8.1M to Bank C, collecting interest from Bank C in the process.

Bank C puts $810,000 in reserve, and lends out the remaining $7.2M to Bank D, while collecting interest from Bank D.

…And so on, until approximately $90M (nine times the original $10M) has been created, loaned, and monetized into interest payments for all banks involved in the transaction.  Thus, you can see how $1 of actual “wealth” (I use quotes because even the original fiat money deposit has no intrinsic value) becomes $9 of artificial money.

There are two things that are very pernicious about this.  First is the simple fact that money that never existed in the first place is used to make even more money, through the payment of interest.  Second, and more insidious since it is unseen and intangible, is what I would call the “debt-to-wealth gap” that is created by the monetary system and fractional reserve banking.  Here’s what I mean by this:

There are only so many goods and services that can be produced or performed, and subsequently sold in the marketplace.  In other words, there is a physical, tangible limit to it (however large and unquantifiable it may be to us).  At the same time, the creation of money from nothing is dislocated from this reality, since the money is created artificially and arbitrarily, when compared to the actual value of all the goods and services available in the marketplace.

In other words, there is simply more available debt than available wealth.  The ease with which new and virtually endless amounts of debt/fiat money are created is the reason why there is so much more available debt than wealth.

Again, the catalyst for this is relatively simple to understand -- through our monetary system and the use of fractional reserve banking, debt is generated rapidly and artificially.  Conversely, wealth (for the vast majority of us) can only be generated through the exertion of labor over time.

Think of it this way: in one day’s time, assuming I placed no limits on you from a credit perspective, how much debt could you get into in that one day?  Probably a whole lot.  A house purchase, a trip to the Ferrari dealership, maybe a new yacht – you could easily be millions of dollars in debt in the span of 24 hours.  Now in that same one day’s time, how much wealth could you create?  If I gave you one whole 24 hour span to generate wealth from scratch, how far do you think you’d get?  Probably nowhere, and it would have nothing to do with your aptitude.  Simply put, the creation of wealth would take time, energy, and effort that would far exceed one day’s time.

This surplus of debt compared to available wealth comprises the debt-to-wealth gap.  So what, you might be thinking…what does this have to do with you, or the poverty problem I referred to in the beginning of this article?

Here’s why it is directly relevant to you: you cannot function in our economic system without getting into debt.  It’s virtually impossible.  If you are able to pull it off, it probably means you’re living something unlike the “American dream.”  You certainly don’t have a house, and you probably don’t have a car.  You most likely never went to college.  In other words, all of the trappings of the American lifestyle are unavailable to you – until you take on that debt load.

Once you’ve taken it on, you must generate enough cash flow to service that debt.  In other words, you need a job.  Now of course, we all need cash flow for the necessities of life, but the kind of job, frequency of how often we must perform that job, and length of time we must keep that job changes considerably when we have a mortgage, car loan, student loan and other debt payments to service.  It’s one thing to truly work to pay for the basics (food, rent for shelter, medical care when needed), but another thing entirely to work to cover the trappings of the American lifestyle we’ve been conditioned to believe are “necessary” (nice house, two cars, vacations, yearly wardrobe changes, sundry electronic gadgets, other luxury items, etc.).

In other words, the availability – and more accurately, the necessity – of debt, turns us into indentured servants, who must hold jobs whether we like them or not in order to function economically.  Furthermore, when that imperative is combined with the illusion that we must continue to spend/consume in order to achieve the “American dream,” the average person’s debt load rises considerably.

And what about the poverty issue I mentioned at the beginning of this post?  How does the system create poverty purposefully?  Now that you understand the monetary system and fractional reserve banking, it’s easy to see how.  Let’s look at it through a rudimentary example:  

Say a bank has a home loan portfolio totaling $100 million.  It created these loans off of just 10% of that figure, or $10 million (so there is only $10 million of actual deposits at stake here).  The other $90 million is artificial debt created through fractional reserve banking.  Now let’s say of the $100 million, $15 million worth of loans is spoiled by foreclosures and bankruptcies.  Let’s see where that leaves the bank:

$10 million of initial capital, turns into…
$100 million of loans, with an average of 7% interest a year yielding…
$7 million a year in interest income…
With only $15 million of the total loan portfolio gone bad.

Since the $15 million of bad loans is fake money anyway, the bank doesn’t care, since it never had that money to begin with.  Its loan portfolio is generating $7 million a year, which across a 30 year standard mortgage period yields the bank revenues of over $200 million.  Ultimately, the bank turned $10 million of seed capital into over $200 million…do you think it cares one bit about the $15 million in bad loans (which really translates to foreclosed homeowners, homeless people, etc.) it perpetrated along the way?  Of course not – it’s just the cost of doing business.

The bottom line is, the bank doesn’t care who goes bankrupt or forecloses – the bank simply cares that enough debt is created to generate enough interest income for it to be profitable.  If it overshoots the mark on debt creation, and individuals go bankrupt/lose their home, it matters not – it simply performs a write-down of the loan on its books and moves on.  It was fake money anyway – it never existed in the first place.

The key for the banking/monetary system is to continue creating enough debt to generate enough interest to continue to be profitable and aggregate more wealth.  The collateral damage along the way, in the form of impoverished/bankrupt/homeless individuals, is simply the byproduct – the remainder off of the proverbial mathematical equation – that is tolerated in the overall process.

Using this premise as a backdrop, I would go on to assert that the entire 2007-09 housing collapse was nothing more than the rabid creation of debt in order to fuel more interest payments into the system, with zero regard for how many loans went bad or homeowners were devastated along the way.  Why would this matter, when the banking system knew the government would step in, bail them out and cover the losses?

But put the recent housing market crash aside for a moment.  The real problem is this: the monetary system is on its last legs.  Eventually, there is too much debt created, and no one left to service it.  And when not enough entities can afford to take on debt, then the debt creation begins to grind to a halt.  And when debt creation grinds to a halt, interest payments decrease and profits begin to shrink.  The outstanding debts remain, but there’s less profit to offset it and make the process worthwhile for lenders.

We are seeing this breakdown in the monetary system in the news every day, when we read about bank failures, rising foreclosures and shrinking home sales, states going under financially (i.e., California), entire countries going bankrupt in the EU due to systemic financial failure (i.e., Greece, Ireland, etc.), and the rising ranks of unemployed who’ve been victimized by the system and will never return to the same standard of living they once had.

Once you understand that the system you’re living within places you into servitude, creates poverty knowingly and purposefully, and is impossible to get ahead within, as an individual you begin to realize that your financial and investing priorities must adapt to such realities.  Ultimately, the monetary system needs to change, as it simply does not serve the interest of the vast majority of the people.  When we make such a claim, and it’s a significant one, we need to do so with the full and accurate knowledge of what the system actually is and how it operates, and only then can the proper reforms be put in place.

Last week, the Federal Reserve announced the next step it planned to take to intervene in the economy and attempt to aid in its recovery.  This step is called "Operation Twist."  I want to briefly discuss it here so you understand what's actually being referred to when you hear this term.

US Treasury bonds range from short term (such as 2 year notes, though there are even shorter terms than that) to long term (30 year Treasuries).  The bonds have price and yield characteristics that move opposite each other (picture a seesaw -- when a bond's price rises, its yield falls, and vice versa).  These characteristics can be plotted along what's called a "yield curve," which under normal circumstances, depicts low yield for short term bonds and high yield for longer term bonds.  The reason for this is, if you buy a short term bond, the duration of time over which you're risking your capital is brief, and therefore lower on the risk scale -- thus, you don't get much yield back for it.  On the other hand, if you risk your capital over a long period of time, say 30 years, you would normally be rewarded for it by receiving a higher yield.

That's under normal circumstances.  We are not operating under normal circumstances.

The Fed has already used various monetary policies to push down interest rates to the 0-0.25% range, which influences the rate at which banks lend to their customers (and which has resulted in historically low rates for borrowers today).  The problem is, there still isn't as much borrowing going on as the government/Fed would like.  The reasons for this are not the point of this article -- suffice it to say that borrowing remains below target.

Enter Operation Twist.  Picture that yield curve again, with the line sloping upward from the 2 year note to the 30 year bond.  If you could grab each end, like a dishrag, and twist it (like you were ringing it out), you'd flatten out that curve.  Yields on 2 year notes would rise; yields on 30 year bonds would fall.  That's the objective behind this policy move.

So how does the Fed accomplish this?  Simple.  The Fed has a certain number of 2 year notes on its balance sheet.  It sells them in the open market.  This increases the supply of 2 year notes, diluting demand and thus lowering the value/price of the notes.  As the price falls, yields rise.

With the money it receives from the sale of the 2 year notes, the Fed enters the 30 year bond market and buys those Treasuries.  As it buys them, supply drops, increasing demand and thus increasing the value/price of those bonds.  As the 30 year prices rise, their yields fall.

Ultimately, as the 30 year bond yield falls, the eventual interest rate you or I might receive on a 30 year loan (read: mortgage) should fall, as well.  At least that's the hypothesis.  Whether banks actually lower the rates any further than they already have (as opposed to just pocketing the wider margin), remains to be seen.

But in the abstract, what does all this really signify?

Desperation.

The government, using the instrument of the Fed, is desperate to juice the economy, by stimulating more borrowing and consumption on the part of the consumer.  Specifically, juicing the housing market has all kinds of (temporary) positive effects on the economy, since so many industries benefit from home construction/remodeling/etc.  Of course, I'd thought we'd already found out in 2007-09 what happens when a housing bubble bursts...but hey let's face it, we don't learn lessons too well around here.

The key point is to see past the fancy jargon and terms of reference that the government and the Fed will throw at you, which only serves to obscure the often negative reality involved, and to understand what is actually happening and how it affects you.

Back on May 26, I blogged about how the raising of the debt ceiling is a foregone conclusion.  I podcasted on it last week as well.  I'm posting this brief article as simply an update for those of you who weren't as tuned into the debate back then (I don't blame you, this stuff is painful to watch/follow), but now find themselves drawn into the inanity of it all.

Building on the May 26 post, I assert here that Congress never had any serious intention of reforming anything with our national debt or deficit as a result of the debt ceiling situation -- and this is precisely why the ceiling would be raised.  No hard decisions would be induced, no tough medicine for anyone to swallow.  In the absence of that, the outcome is clear: the government as a whole -- Congress and President -- would collectively find a way to delay the inevitable, yet again, and thus make that inevitability that much more painful when it finally arrives.

Don't get me wrong -- there was some tough talk that initially appeared promising.  Talk of a "grand bargain" that would cut $4 trillion of spending over the next several years; proposals that would initiate the difficult yet necessary job of reforming our bloated entitlement programs; and claims of politicians being willing to finally make the tough calls and in turn, receive heat from their respective political party.

And yet now we're told that the fallback plan, presented by Republican Senator Mitch McConnell, which would allow the President to have the ad hoc authority to raise the debt limit autonomously and then allow a symbolic series of votes on it by the Congress in order to record opposition, is gaining steam as time runs out to the August 2 deadline.

Surprise.  The government has failed to act responsibly, again.

But isn't that how the story always ends?  So there are really no surprises here, just more of the same as the country's finances swirl into the depths of the toilet.

To the Congress, I'd like to issue the following challenge going forward: instead of debating who you are going to tax to make up for your mistakes, or debating whose social program you're going to cut to reduce spending (however necessary either of these actions may now be), how about turning the debate towards limiting your own powers to create these messes in the first place?  Here are some points of debate I challenge Congress to take up:

-- Institute term limits on all Representatives and Senators.  Remove the incentive that drives politicians to make a career out of lying and stealing.

-- Make an unbalanced federal budget illegal.  (Perhaps a Constitutional amendment would achieve this, though I'm not sold -- Congress already ignores most of the Constitution anyway.)  Cut off the temptation to rack up deficit after deficit in every budget year.

-- Abolish the Fed.  It's stated objectives are twofold: stable prices and low unemployment.  Grade for each of these: F and F.  Dollar has lost 90+% of purchasing power since the Fed's inception -- I don't call that price stability; and numerous boom/bust cycles fueled by Fed monetary policy have created too-long periods of high unemployment.

I look forward to your comments and questions on the debt ceiling debate.

These guys are good.  Really good.

They know how to steal, and when they do it, they call it something so innocuously confusing, you don't even realize what's actually going on.

I mean, when the Federal Reserve steals your money, they practically have you thanking them for doing it.  I'm serious.

Before I explain to you the most creative and insidious manner in which the Fed steals your money and repurposes it, allow me to back up for a second:  How much did you learn about the Fed in school?  Do you even remember it being mentioned more than once or twice?  Did you even come close to being told how it operates, how it accomplishes its obtusely stated objectives?  Have you ever wondered why you were taught next to nothing about it?

I'm almost 100% sure of the way you'd answer those questions.  You see, not teaching us anything about this institution has helped maintain the disguise placed on its operations.  A great example of this is "quantitative easing," which is a fancy way of saying "creating more money that never existed before."  It's important we pay attention to the language being used here, and not view it as semantics.  We can inadvertently come to believe something that's not true, simply by being told that something over and over again.  The key is to go behind the language and truly understand what it’s referencing.

So when we take time to explore what the Fed is actually doing on a day-to-day basis, we discover the theft that is taking place right before our eyes.  And so I come to the subject of today's post: recently, I've been reading more about another one of the Fed's operations, something called a "central bank liquidity swap," or CBLS as I'll abbreviate it here.

Sounds great, doesn't it?  Sounds official, like something that central banks need to do, right?  I mean, on the surface, nothing suspicious here...

Let's look at what a CBLS really is.  First I'll use an analogy, then describe the operation in actuality.

The Analogy:

Let's say there are two people, person A and person B, and each holds something of value.  Person A holds object X, and person B holds object Y.  Object X is actually owned by someone else (call them person C), who's left it in A's possession to look after.  Thus, person A has no emotional attachment to the object, just a stated intention to look after it.

On the other hand, person A looks favorably upon person B, at least for this moment in time, and wishes to convey favor upon B for whatever reason.  Even knowing that object Y is less valuable than object X, and knowing Y may very well depreciate in value while X appreciates in value, the two objects are exchanged for each other nonetheless.  Now person A holds object Y and person B holds object X, creating an imbalanced exchange in favor of person B.

The terms of the exchange allow person B to do whatever he pleases with X; however, person A must hold onto object Y for a stated period of time.  This is all well and good -- until one day, person B comes to A and states that object X has been lost, and he does not have anything left to exchange in return to make up for the loss.  However, he tells A that he enjoyed using object X while it lasted.  Thus, things shake out as follows:

Person A is happy, because he had no attachment to object X, and was able to fill person B's need at the time.
Person B is happy because he had the opportunity to attain and use something of higher value than what he started with, and once lost, had no emotional attachment to it anyway.
Person C should be pissed...but has no clue that Object X is gone.  In fact, person A has convinced C that all is well, nothing's changed, and Object X is in good hands.

(Person A is the Fed.  Person B is another central bank.  Person C represents you and I.)

In Actuality:

The Fed maintains what are called swap lines with many other central banks, allowing it to execute CBLS's whenever it needs to.  Many of these swap lines were emplaced in 2007, shortly before the 2008 financial crisis went into full bloom.

A swap line works like this (I'll use the euro as the example currency here):

Assume the Fed is executing a CBLS on August 1.  On that day, the European Central Bank (ECB) sells euros to the Fed at the prevailing USD-EUR exchange rate, after which the Fed deposits the appropriate amount of dollars into the ECB’s account at the Federal Reserve Bank of New York.  Commensurately, the ECB deposits the appropriate amount of euros into the Fed's account with the ECB.  In essence, the two central banks have swapped currencies.

The Fed cannot do anything with the euros it receives; it simply holds them until a certain maturity date, say September 1.  On the other hand, the ECB is allowed to use the dollars it received however it sees fit: loan them to European member banks, or possibly to EU governments whose finances aren't in very good order (i.e., Greece).  On September 1, the Fed receives dollars at the same exchange rate that prevailed on August 1 (not the exchange rate of the date the funds are returned), and conversely, the ECB receives euros.  In addition, the ECB pays a market-based interest payment to the Fed.

See anything wrong with this picture?

1) The Fed is accepting a currency it can't do anything with, so the asset is effectively frozen.  Meanwhile, the other central bank (the ECB in my example) is able to freely invest, loan and otherwise utilize the dollars it receives.

2) What if the dollar strengthens during the wait period of the swap?  The Fed would not benefit from that strengthening since the original exchange rate is in play, not the exchange rate on the date of funds returned.  You might say to that, "well can't the opposite happen, and the dollar weakens during the wait period, which would benefit us in the exchange?"  To that I'd say yes, but...the problem is the Fed is taking the risk of lost appreciation on the dollar, but they are not consulting with any elected official (and certainly not with you and I) as to whether our funds should be risked in this fashion.

3) What if the other central bank can't return the dollars to complete the exchange?  To continue my example from above, what if the ECB loans the money to an EU country such as Greece; Greece uses the money to shore up its balance sheet, but then falters and fails to repay the ECB loan; Greece's default roils the markets and EU banking sector, creating another financial crisis a la 2008; subsequently, the EU defaults on the currency exchange with the Fed.  Effectively then, taxpayer money was siphoned off to Europe, with no return of those funds at the end of the swap agreement.  While such a scenario is unlikely due to the apparent robustness of the ECB/EU, I would not say it's impossible (look at the 2008 crisis for a fractal representation of what is possible), and of course not all swap agreements are made with central banks as viable as the ECB.

I guess if I had to boil this down even further, I'd say that the Fed can take our money, give it to another country, never get it back, and then never tell us about it.

It's called a "central bank liquidity swap."  Sounds harmless enough to me...

One of my favorite market pundits to follow and keep track of is Jim Rogers.  Rogers partnered with George Soros to form the Quantum Fund in the 1970s, and enjoyed a large measure of success from this endeavor.  Rogers continued to grow his wealth largely through the commodities markets, and established another fund in 1998 called the Rogers International Commodities Index, or RICI for short.  He's an extremely successful investor worthy of your attention.

Anyway, Rogers has written a bunch of books, on everything from his trip around the world in a custom Mercedes, to investing in China, and commodities investing.  I've read some of these books and enjoyed them, but perhaps most of all I enjoy seeing Jim Rogers get on TV and level no-nonsense, common sense critique at the government and especially the Federal Reserve for their handling of the economy and 2008 financial crisis.  Some of Rogers' YouTube clips are so priceless I've watched them numerous times over for the humor value, as well as the underlying insights he shares.

One of my favorite facts about Rogers is that, in 2007 he packed up his wife and daughters and moved to Singapore, while mandating his daughters learn the Mandarin language.  When asked about this -- and this is one of my favorite (paraphrased) sayings of his -- he replies that as much as Britain was the place to live during the dawn of the 19th century, and America was the place to be during the 20th century, so East Asia will be the same for the 21st century.  Of course, China's meteoric growth rate (however inflated) and the highly business-friendly policies of locales like Singapore and Hong Kong have fueled much of this growth, while the US has moved aggressively in the opposite direction by over-regulating and stifling companies based here with high taxes.

All that said, today I read a few articles highlighting Rogers' disdain for the current economic recovery policies, his famous opinion on the Fed (shut it down), and his continued optimism on China.  While I believe this is good reading, I still encourage you to search YouTube for clips of Rogers.  You'll thank me.

This article revolves around Rogers' opinion of the Fed and the economic recovery efforts.

This article covers his opinion on China and shorting US bonds.

This one discusses why the dollar will collapse and the benefits to owning commodities.

I think we might be witnessing the last vestiges of the Keynesian economic model dissipating before our very eyes.  The supposed economic recovery that has been touted for the last several months is faltering in all-too-rapid fashion, and even the government's cheerleaders are sobering up to the notion that there might never have been a recovery to begin with.  The last few weeks have seen one disappointing economic report after another, and Friday’s job report drove the point home with uncomfortable emphasis.

It’s a momentous occasion, so it’s worth saying again: I think we’re witnessing the beginning of the end for the Keynesian economic theory.

John Maynard Keynes, an esteemed economist in the first half of the 20th century, maintained that government involvement in the economy was a healthy thing, and that money supply expansion during economic downturns was a viable option for reversing such downtrends.

Austrian School theorists have always maintained that Keynes had it all wrong -- money supply expansion was dangerous in terms of its propensity for causing inflation, and government involvement would invariably lead to market distortions and myriad unintended consequences for the whole of the economy.

For decades now, there hasn't been much in the way of hard and fast evidence with which to prosecute the Keynesian model.  However, the 2008 financial crisis, and the response to it since then, has placed Keynesian theory front and center, where it may now be subjected to the most rigorous scrutiny to date.

You see, the Keynesian response to the crisis -- the swift and unprecedented expansion of the money supply, on a scale never before attempted -- has seemingly produced little effect on our overall economic health.  Trillions of new dollars pumped into circulation (quantitative easing, or QE) have provided only the smallest of bounces to the economy, contrary to the belief that we'd be placed on a firmer path to recovery after QE1 (early 2009) and QE2 (late 2010).

Of course, expect defenders of this approach to simply claim that the efforts weren’t on a large enough scale.  “Had we just circulated a few trillion more dollars into the economy, everything would be fine now.”  This is the only remaining defense for the QE/Keynesian proponents.  To them I’d ask, how big is big enough?  Instead of $3 trillion, should we have printed 30 trillion?  Or maybe 300 trillion?  Why stop there?  If printing money is the road to prosperity, why did we go so small in the first place?  Print a few quadrillion dollars, and we’ll all be rich.

In other words, a little common sense goes a long way when debating with a Keynesian.  But I’m digressing...

The real point here is the recovery is ephemeral, and we need to recognize this fact and begin adjusting to that reality.  I expect a cocktail of gradually-worsening economic data to continue surfacing, and will be looking for the subsequent effect on the stock market.  In a nutshell, the declining manufacturing numbers, worsening employment situation, anemic housing market, high gas prices, decreasing consumer confidence and consumption metrics, and steadily rising inflation will create a significant drag on the economy.  I anticipate the Federal Reserve will also do their part to help lay the foundation for another financial crisis, as they toy with the idea of QE3 and leave interest rates at rock bottom levels for who knows how long.

As always, check your portfolios.  The market is down 5% in just the last few weeks, so whether it’s the beginning of a bear market or only a hiccup, either way it’s good practice to review your holdings.

It was a year ago today that we experienced what has come to be known as the “flash crash.”  On May 6, 2010, the Dow Jones Industrial Average plummeted nearly 1,000 points in a matter of 10 minutes or so.  The event was harrowing and left market participants, experts, and various pundits searching for answers: how could the impossible have occurred?

If you recall, accusations flew over the weeks after the crash.  Most pointed to electronic trading mechanisms that went haywire and simultaneously sold off billions of dollars worth of positions, thus fleetingly tanking the market.  Some said it was rigged by large institutions in order to see what would happen and thus prepare better for a repeat scenario.  Still others actually pointed to a single hedge fund, Universa (advised from a distance by The Black Swan author Nassim Taleb), as the reason for the crash, when it bought a sudden and massive position in deep out of the money options.  The hypothesis was that such a bearish position caused a psychological backlash in the market and induced a selling panic.  (Never mind that this accusation coincided with repeated critique on Taleb’s part of the US government’s and Federal Reserve’s economic and monetary policies.)

After all that hypothesizing, what did we learn about the causes?  Nothing.  Scarily, we are no smarter today about it than we were a year ago.

So today, we watch as the market continues to climb upward, in spite of a host of economic realities that suggest the market should be heading the other direction.  Consider the following:

-- The unemployment rate moves higher, even as jobs are added, because the job creation cannot keep up with the demand for work.  There simply aren’t enough jobs for all the people who want to work.

-- The European debt situation (the “PIIGS” crisis) festers, with little in the way of long term solutions firmly in place.  

-- The US credit rating is poised for a downgrade by S&P within the next couple of years.  A loss in confidence by our creditors will mean higher interest rates, shrinking loan access, and a sharp decline in our standard of living. 

-- Charts depicting housing prices in the US clearly show a double dip forming, with waves of resetting mortgages coming due in the next three years.

-- Talk persists about changing the reserve currency from US dollars to something more viable, a nightmarish scenario that would send the value of the dollar plummeting and cause almost certain hyperinflation and destruction of our currency.

So the point of this post is to simply remind the reader that, no matter how outlandish or unbelievable any of the above items sound, anything is possible, as was demonstrated to us a year ago today.  No one would ever have thought the May 6, 2010 flash crash could have happened -- a scenario like that would have been labeled “impossible,” right before it actually happened.  And the conditions for a more virulent flash crash, or even a more protracted and sustained crash, are ripening.  There has never been a better time to scrutinize your portfolio, review your risk exposure, and make any necessary adjustments now before it’s too late.  I urge you to take the time to do this in the coming weeks.

My disdain for central banking, especially our Federal Reserve Bank, is well-chronicled on this website.  But even so, I don't think I'll ever fatigue of pointing out why this institution is harmful to the prosperity of 99% of Americans.

And so when I was reading an article today about Fed Chairman Ben Bernanke's press conference, to which an entirely separate blog post could be dedicated, I couldn't help but linger on the following description of the Fed (keep in mind this appeared on the mainstream Yahoo! finance news site, not a politically-leaning site):

“From its inception nearly a century ago, the Fed has been an opaque, secretive institution. It has generally communicated with the public on its own terms - issuing terse statements about changes in monetary policy, refusing to comment or explain much, resisting audits, and battling news organizations in court over whether it should release information to the public about its operations. Longtime chairman Alan Greenspan spoke in a jargon-laden patois - Fedspeak - that seemed designed to obfuscate and confuse.”

A host of questions come to mind just from reading this excerpt:

Why do we want an “opaque, secretive” central bank in charge of monetary supply and policy for our country?

Why does this bank communicate with us on its own terms?  Why not on our terms?  Why isn't it more transparent?

Why does it “resist audits?”  Is it a good idea for the central bank of our nation to be immune from having its books audited?

Why does it “battle news organizations” over information release?  What information does it not want released to us?  What is it fearful of revealing?

Why would the former Fed Chairman find it uniformly necessary to “obfuscate and confuse?”  Don’t we deserve clarity from the person deciding what will happen with our monetary system?

Given all of the above, why is there so much resistance to abolishing the Fed?  Why would we want to keep it, if it maintains the attributes listed in this article?

I think we simply need to ask ourselves why this bank exists in the first place, whose interests it serves the most, and what impact it's truly had on the American citizenry's prosperity.  I believe if we face these questions openly and honestly, we’ll decide this bank has no place in our country’s financial system.

On February 9, Fed Chairman Ben Bernanke went before Congress for his usual round of testimony, and he delivered the good news that inflation was under control; in fact, according to Bernanke, it was virtually nonexistent.  While he made a brief nod to rising gas and food prices, he followed that with the following remarks:

“Nonetheless, overall inflation is still quite low and longer-term inflation expectations have remained stable. Over the 12 months ending in December, prices for all the goods and services consumed by households (as measured by the price index for personal consumption expenditures) increased by only 1.2 percent, down from 2.4 percent over the prior 12 months. To assess underlying trends in inflation, economists also follow several alternative measures of inflation; one such measure is so-called core inflation, which excludes the more volatile food and energy components and therefore can be a better predictor of where overall inflation is headed.”

On February 15, the World Bank reported that global food prices have reached “dangerous levels” (its words, not mine).  According to the Associated Press report on this story, the food price situation “could contribute to political instability, push millions of people into poverty and raise the cost of groceries, according to a new report from the World Bank.”

Today, I read that gasoline prices hit 28-month highs.  But you don’t need me to tell you much about this fact -- you’re already experiencing it when you go to the pump, no doubt cringing as you watch prices rise almost weekly.

Another report today regarding inflation concerns pointed out that wholesale prices (measured through the Producer Price Index) rose 0.5%, the highest amount since October 2008. 

Hmm.  So inflation doesn’t sound as “stable” as Bernanke would like us to believe.

Strangely enough, throughout all of the discussion on these sordid data points, I’ve heard every explanation for them under the sun: supply issues, weather impacts, political unrest, China, greedy corporations...you name it.  Every explanation has been trotted out, except for this one:

The US (Federal Reserve) has printed over $2 trillion dollars in the last 2-plus years.  Food and energy products are priced in dollars on the global markets.  Since now there are a lot more dollars in circulation, food and energy products now cost a lot more dollars too.

Even more directly: the money we’ve been printing has led in part to the rise in food and energy prices.  But no one will acknowledge this fact, including our Fed Chairman.

How Bernanke can routinely get away with this willful ignorance of reality is nothing short of stunning.  The fact that he is responsible for our monetary policy is nothing short of chilling.

On the larger scale, I’m continually amazed at the lengths that the financial and media establishments will go to to deny the connection between the expanding supply of dollars and the rise in the prices of commodities like food and energy.  And when inflation statistics are reported, food and energy are discounted because they’re categorized as “volatile.”  Of course they’re volatile -- that volatility comes at least in part from the fluctuation of the value of the dollars they’re priced in.

So the takeaway here is, when you listen to official metrics such as the Consumer Price Index (CPI), remember that the critical items like food and energy -- the kinds of things you can’t live without -- are not reflected in those metrics.  You’re being given an incomplete picture of this important aspect of the economic conditions in our country.  The threat of inflation is being misrepresented, and it’s something you should still be accounting for when you do your personal financial planning regardless of what the government’s statistics say.