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Central Bank’s Distortion Creation

May 12, 2014

So April has come and gone and there appears to be no end in sight for this “economic recovery,” once again proving how wrong I am. What Harold Camping was to religion, Jon Hamm is to economics. One year ago, I reluctantly made a prediction that around April 2014 there would be another economic event. This prediction was based on how history has proven that not long after something becomes the consensus, it seems to be proven wrong, particularly in the field of economics. So, one year ago, Fed Chairman Ben Bernanke graced the cover of Atlantic magazine with the title, THE HERO, written in very bold print across the cover. Ironically, the consensus in the world of finance and economics is that the central banks know what they are doing and their unparalleled manipulations and intrusions into the “free markets” saved us from certain doom.

Admittedly they have been able to keep a recovery façade alive much longer than I ever expected. But what kind of recovery is this? One might ask, “Aren’t the financial markets (Wall Street) proof that our economy is improving?” I don’t think so. I think it is proof just how broken our “free markets” have become. For all the free money the Central Bank and the federal government have thrown around to help our economy, it has all gotten bungled up in only one small part of our overall economy. And this small part of our economy just happens to be the most inefficient and fraudulent part of our economy — Wall Street. If you read Money Aplenty, you will see the theory I think is currently being proven. Money Aplenty also answers the quandary our Fed Bankers can’t seem to figure out: Why can’t they create inflation through their massive money creation and easing policies — especially if you include our government’s own money creation through their own trillions of dollars of increased debt?

The bubble machine’s experiment is not working out exactly the way they had planned! That doesn’t seem to prevent them from taking credit for saving the world and claiming their policies really do work. The real question, for quite some time now, should have been: who will save us from the central bankers? I have to wonder if they recognize the pickle they have themselves in or whether they are still in self-denial. Of course we all know that when the economy is good it is because of our central banker’s monetary policies, but when the fecal matter hits the fan, no one could have seen it coming.

I wrote about Janet Yellen’s inaugural address to congress where she admitted as much, but justified the central banker’s monetary policy even though it hurt our savers, particularly the elderly living off investment returns from what little savings they might have. Essentially, she stated that all those fixed-income retirees could go out and get one of the jobs the Fed has created to supplement their lack of interest income. This has led me to think, “What if I had known exactly how the markets would have responded to all the Fed manipulation? What would have been the right financial moves to profit from it all?” Or expressed another way, “What kind of investor is the Fed really rewarding and creating?”

So let’s say I had a crystal ball 20 years ago that accurately told me what the major market moves would be as a result of Fed policy and what would have been all the right moves. So that takes us back to 1994 (the Greenspan wonder years). The early 90s had been marked by a minor recession and real estate was coming close to bottoming out while the stock market was just beginning one of its strongest bull markets in history, especially the young upstart known as the NASDAQ. So if I was smart (major assumption, I know!) I would have leveraged to the hilt and bought the biggest home using an adjustable rate mortgage, and if they had it at that time, an interest-only loan; the very things I have the most disdain for. Then I would go and buy all the stock in tech companies I possibly could. But the real secret to my success would be to maximize my leverage (debt). Of course I would have cashed out of all my stocks in February 2000 and turned around to short the NASDAQ and buy gold and silver and maybe some more real estate. By 2003 I would have sold my NASDAQ short positions and doubled down on real estate. By early 2006 I would need to sell every piece of real estate I owned to short Lehman Brothers, home builders and just about anyone holding a mortgage. In 2008 I could bet against just about anyone or anything and have been a winner. At the right time I could have thrown in some high-yield bonds; the ones with the highest risk spreads. By March of 2009 I could reverse my short positions and go all-in in the equity markets. And then in 2010/11, I could diversify a bit by buying foreclosed homes out from under your average working family. Then in 2015 I would short the Federal Reserve, short the federal government and move out of the country.

Seriously, what if someone in 1994 came to you and said here is how you will be able to maximize your investment returns over the next 20 years — you would have thought they were crazy. There has been no period in history where investments have been so dramatic in their movements. Likewise, there has been no period in history where the central bankers have attempted to manipulate markets in such a huge way. Gee, what a coincidence! The picture I get when I look at the above paragraph is a system that rewards high risk-taking and leverage, and punishes savers, fiscal prudence and fiscal discipline. One thing we can be certain of: the Fed’s massive manipulation has created massive distortions in investments and really, the more responsible you are, the more likely you are to have been on the wrong side of Fed Policy. That, ladies and gentlemen, is the definition of a “moral hazard.”

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