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Amidst Bullish Hoopla
A "Behind the Curtain" Look at Fed Desperation
and Intervention Wizardry
by Bill Fox
Sammons Securities
July 20, 2003

The Fed made its 13th consecutive rate cut since Jan 2001 on June 25th, lowering the Federal Funds rate 1/4% to 1%, the lowest level in 45 years. The U.S. stock market finished a second quarter resurgence with a historically high 75% bullish rating of investment advisors and a 95% fully invested level for mutual funds. The volatility indices (VIX and VIN) show high levels of investor complacency. With every effort being made by President Bush's "war economy" spending and the central bank to stimulate the economy, the national media asks why any bear would dare to "fight the Fed?" Ken Fisher titled his July 21, 2003 Forbes column "Dumb Bears II" and CNBC's Louis Rukeyser told Fidelity Investor's Weekly in June "Not only do I think the bear market is over, I think it has been over for several months now." (1)

Is this situation for real, or is it more analogous to quiet forest murmurs in the Ardennes not long before the Battle of the Bulge? James Puplava of San Diego-based Puplava Securities and www.financialsense.com points out that insider selling, an important contrarian indicator, has not been this high since the market peak in early 2000. He feels this rally fits the pattern of a countertrend rally within the context of a long term secular bear market trend. First there is intervention (discussed later), then hedge funds and other short sellers buy back to cover their positions driving prices higher, then institutions and momentum players add to the up trend, and then lured in by national media hype, Mr. and Mrs. John Q. Misinformed Public get in last to hold the bag as the pros clear their positions. 75% bullishness and 95% fully invested figures can be a contrarian indicator that the pros have already committed their reserves and are now looking to take profits. A June 3rd-25th breakdown in Dow Transports, combined with rising commodity and gold prices and a sliding dollar, are all negative indicators. If interest rates start moving back up to complete this dismal picture, we may see an eerie similarity to the conditions that preceded the 1987 crash. (2)

With the funds rates at 1%, the Fed hopes to drive out some portion of the $5 trillion in money market funds to prop up the market. But if the Fed cuts below .75%, notes James Puplava, this would threaten to wipe out money market fund managers, so the Fed is running out of bullets with rate reductions. He notes that Fed officials now appear to be discussing "unconventional means" at their meetings. Bloomberg and the Wall Street Journal have run stories revisiting the idea of instituting a carry tax to flush more money out of savings and cash to prop up the stock market and other asset areas. In the long run, history shows that markets always win out over central bank and government intervention, which means that "unconventional means" might ultimately only succeed in turning more average American investors into cannon fodder for failed Fed policies. (3)

Fed Chairman Alan Greenspan is concerned that stimulus measures have been increasingly pushing on a string to revive the overall economy. In recent years more and more debt has been required to produce GDP growth. It now takes about five dollars of debt to produce each new dollar of GDP growth. In April the Fed pumped more money into the economy at a $1.1 trillion annualized rate (about $1 trillion was injected in M3 between 2001 and 2002, or about 10% of GDP). Other money creation sources such as bank loan departments and Government Sponsored Entities (Freddie Mae and Freddie Mac) have also been expanding liquidity at a torrid rate. Ballooning total debt (government, personal, and corporate) now totals about $34 trillion. According to the Grandfather Economic Report, this comes to around $119,442 per individual American. It is almost hard to imagine that the American economy once grew at a much faster average annual rate when Americans focused on savings and prudent investment in the 1800s before they got saddled with a privately-owned central bank, confiscatory taxes, and the welfare state. (4)

Greenspan can not control where all the Fed's stimulus will go or whether it will be productively put to use. America's manufacturing base has dropped from 30% down to less than 15% of the work force since 1970, and real productivity growth has slowed from an average 2.5% a year from 1947 to 1973 to somewhere closer to 1% a year since then. Manufacturing and productivity growth provide a vital bedrock for the creation of jobs and for the service economy. America has changed enormously in terms of such factors as demographics (immigration since the 1960's has been massively tilted towards less skilled Third World peoples, and California is now majority Mexican in origin), its level of savings (now nearly zero), trade policy (running historically high trade deficits), size of government (growing at about two to three times the rate of the overall economy with 60 percent devoted to entitlements), and energy self-sufficiency (declining). When Americans get extra spending power, they frequently buy goods made overseas rather than "buy American" and reinvest in American industry. They keep going further out on personal and corporate debt, yet no country has ever been able to perpetually borrow its way to prosperity. Too many corporate leaders unwisely use the time that "stimulus" buys them to subsidize malinvestment and overcapacity (currently 25%) or to carve out more perks for themselves rather than pursue the disciplined and prudent investment policies required for sustainable growth. Last but no least, Greenspan's liquidity pump has major hose leaks even on the asset level. James Puplava notes the beginning of a trend similar to the 1970's, where investors started losing confidence in "paper" (to include credit-related financial instruments) and started shifting their investment focus towards "things" (commodities). (5)

Regardless of intermarket spillovers and malinvestment issues, keeping the real estate and stock market asset bubbles inflated remains a top priority for Greenspan. His lowered interest rates help to reduce market rates of return on capital and support financial models with higher valuation multiples for the stock market. The S&P 500 is trading at about 32 times trailing one year Generally Accepted Accounting Principles (GAAP) earnings, and is still more overvalued than where most bear markets in American history have begun. Housing prices are straining historical relationships to income levels and rent rolls. American banks tend to be highly leveraged, and they desperately need for real estate and the stock market prices to stay propped up. Americans have more of their wealth in their homes than in the market, and rising housing prices have somewhat offset bear market losses over the last few years. Since consumer spending constitutes about 75% of gross domestic product, the Fed is worried that a sharp drop in both home values and stock market prices could trigger a "negative wealth effect," scaring people into spending less. This could slow down the economy. This in turn could create a vicious circle involving more layoffs, more bankruptcies, and more foreclosures. This could cause more asset prices to come down, resulting in even more fear and even less spending, leading to a steady downward spiral effect. (6)

James Puplava points out that when the Fed talks about deflation, what it really means are the bubble values in the stock and real estate markets that help prop up our dangerously leveraged financial system, and not the prices of things you buy every day in the store which have generally been steadily going up in price. Fed Governor Ben S. Bernanke gave a speech last November declaring that the Fed is prepared to inflate without limit if necessary to prevent [asset] deflation. Financial commentator Jim Rogers wrote an article for a summer 2002 issue of Worth magazine titled "They Are Lying to Us Again" about how the numbers that go into U.S. Government inflation statistics regarding the things that consumers ordinarily buy are so edited, re-massaged, and understated that they are a joke. The cost of living has risen to about 60% of average consumer income, and discretionary income continues to shrink. It is possible to see deflation (in assets) and inflation (in consumer goods) and stagnation (in the overall economy) all at the same time. In the 1970's this combination was referred to as "stagflation.". (7)

Bears worry that if Fed intervention and national media spin doctoring were to stop tomorrow, and if free markets and normal intermarket relationships were allowed to work themselves out, 30 year bonds would sink, interest rates would rise back up towards high single digit or double digit levels, gold would rise to over $600 an ounce, the S&P would drop by over 50%, housing prices nationwide would crack by at least 20%, and the dollar would slide another 20-30%. (8)

It is possible that deep down inside, Greenspan agrees with the Bear viewpoint, but is concerned that if any market corrects too quickly, it could precipitate a crash, spook the other markets, and shock the economy into a downward spiral?  Greenspan, and the Wall Street firms and banks that are closely intertwined with the Fed, would all prefer a "soft landing." An example of a "soft landing" market is one that declines at a steady angle, zigzagging between parallel top and bottom channel lines on technical charts. This is the kind of bear market the S&P has in fact been through in the last three years with the help of interventions. A soft landing market allows major banks and Wall Street insiders time to adjust their most vulnerable positions, tweak some profits out of up and down market swings, and pawn their riskiest "matured" positions off on Mr. and Mrs. John Q. Misinformed Public. (9)

THERE MAY BE AN EVEN DARKER SIDE TO THE DARK SIDE

The most likely enemy of a "soft landing" scenario might be summarized as the "rogue wave" phenomenon. We have seen numerous examples in the last ten years, although none large enough yet to decisively crash the overall US stock market. In his excellent "Perfect Storm" series, James Puplava discusses how an unexpected shock to the market, (analogous to freak tidal waves that can appear out of nowhere in the open ocean) such as the Russian default and Asian crisis in 1997-1998, can cause the behavior of markets to radically change from the outcomes predicted by theoretical computer models. This is somewhat analogous to the way in which a radical change in temperature can cause the properties of water to change into the hard properties of ice or the randomness of vapor. Sometimes rogue waves are spontaneously generated by external economic or political events, and sometimes they are created by malfeasance, or "rogue trader" situations. (10)

A major rogue wave detonator that could bring the markets quickly crashing down involve unregulated derivatives. Derivatives now total an estimated $127 trillion, or roughly 13 times the size of the U.S. economy. A large portion of derivatives are unregulated and unlisted, and they are typically created and valued by computer models. Derivatives are essentially time sensitive "bets" designed to leverage reward and shift risk. Their creators assume "normal" market behavior in which people and institutions act rationally without excessive fear or greed and have the financial strength to settle their contracts under all conditions. Major banks and Wall Street firms promote derivatives because under normal conditions they are extremely profitable. America's largest banks, which hold perhaps a third of all derivatives, can use unregulated credit derivatives to get around conventional reserve and margin requirements to support ever expanding lending activities. Hence, the "derivatives" lobby has enormous power on Capitol Hill. (11)

Billionaire investor Warren Buffet has reported from his own experience in trying to unwind the derivatives of acquired company General Reinsurance that even under normal conditions they can be very tricky, time consuming, and treacherous to deal with. This is why Warren Buffet has publicly denounced unregulated derivatives as "Weapons of Mass Financial Destruction." (12)

To get a truer understanding of Greenspan's predicament, one must first appreciate his contradictions. Here is a man who frequently uses the term "soft landing" in his Congressional testimonies, yet he has lobbied to keep the derivatives market unregulated and beyond the scrutiny of the Financial Accounting Standards Board (FASB). In doing this, he has defended a financial system with escalating levels of risk that encourage the opposite of soft landings. Greenspan once wrote a pro-gold and pro-hard money paper in 1966 titled "Gold and Economic Freedom" while a member of Ayn Rand's libertarian, pro-laissez-faire inner circle, yet he has helped to suppress gold in favor of pumping out more fiat money currency and has frequently used heavy-handed central bank interventionist policies while Fed Chairman. He publicly decried "irrational exuberance" in market valuations in late 1996, yet he refused to raise margin rates to constrain speculators and has presided over one of the largest credit and monetary expansions and speculative stock market bubbles in history. (13)

In his book "Secrets of the Temple: How the Federal Reserve Runs the Country," author William Greider points out how the Fed Chairman is arguable more powerful than the President of the United States, particularly when it comes to monetary policy. He also compares the Fed Chairman to a temple priest, who must maintain a quasi-religious level of public confidence in the currency and economy for things to function smoothly. The children's story and social satire "The Wonderful Wizard of Oz" written by L. Frank Baum in 1900 captured this magical dimension when it depicted a professor behind a curtain manipulating the smoke and mirrors image of Oz. Baum meant for Oz to symbolize the President of the United States, but as Greider suggests, the Fed Chairman may be more appropriate.(14)

A Pre-Halloween Trip Through the Rogue Wave, Rogue Trader, Derivatives Cemetery

A review of derivates casualties in the last decade may give us a better feeling for the growing level of risk permeating the financial system, and the credibility of financial industry leaders who reassure us that they have everything under control. In 1993, mismanaged derivatives caused Wisconsin's State Investment Board to lose $95 million. They lost for Japanese company Showa Shell Sekiyu over $1 billion and cost German company Metallgesellschaft $1.3 billion. In 1994, suddenly rising bond interest rates lost $1.6 billion for the leveraged bond positions managed by Orange County Treasurer Robert L Citron and put Orange County, California into bankruptcy. 1994 was also a bad year for Proctor and Gamble ($157 million derivatives loss) and Air Products and Chemicals ($122 million loss) which also made leveraged bets on interest rates. The following hedge funds took hits (estimated losses in parentheses): Askin Capital Management ($420 million), Argonaut Capital Management ($110 million), and Vairocano Limited ( lost $700 million or 60% in six months, blowing a good six year track record). In 1994 PaineWebber spent $268 million to bail out a money market fund marketed as a safe and secure investment, and Bank of America and Piper Jaffray (now owned by US Bancorp) took similar actions. In 1995, a 28 year old trader named Nick Leeson lost $1.3 billion, wiping out Barings Bank, a 233 year old British institution. In 1995, Fenchurch Capital Management lost $1.3 billion or 50% in three months, blowing a six year 21% a year track record. In 1996, the trading losses hidden by Joseph Jett at Kidder Peabody were enough to cause GE to sell his company to PaineWebber. Kidder Peabody sued Jett for nearly $100 million in damages. Following the Asian and Russian debt crises of 1997 and 1998, the hedge fund Long Term Capital Management blew up ($3.6 billion bailout required) when normal intermarket relationships went haywire; at one point the fund had $3 billion in equity leveraged to $140 billion in debt and $1.25 trillion in derivatives, totally beyond what it disclosed to its capital sources. Three Nobel laureates were on its staff. It required a Fed-orchestrated bailout by 14 banks and Wall Street firms to avoid a financial system melt down. Continuing with the casualty list: Michael Smirlock's leveraged Shetland fund ($300 million loss) in 1998; got sued for hiding $71 million in losses by the SEC.  Michael Berger's leveraged Manhattan Investments lost over $400 million in 1999.  During a 13% dip in the Dow in 1997, Everest Capital lost $1.3 billion or 50% of its funds. Everest burned the Brown, Yale, and Emory university endowments. In the 1997-2000 period the casualty list included some top hedge fund celebrities: Victor Niederhoffer completely blew up his $130 million fund in three trading days in Oct 1997, Julian Robertson's Tiger Management suffered a combination of losses and withdrawals that dropped his fund from $22 billion to $6 billion by 2000; Robertson had made a 32% average annual return for 18 years, then suddenly dropped 43% in less than six months and decided to retire. Soros Fund Management suffered perhaps a $3 to $5 billion loss by May 2000 blamed in part on unusual Nasdaq volatility. In 2001 Enron, which had morphed from an energy company into a derivatives trading firm and de facto hedge fund, imploded and wiped out $70 billion in shareholder equity and tens of billions in debt. In Jan 2003, a Japanese hedge fund called Eifuku Master Fund, which was up 70% in 2002, lost over 98% of its $200 million capital in only seven trading days. (15)

As discussed later, the Fed forms an axis with major banks and Wall Street firms, which in turn closely support hedge funds. Hedge funds provide an estimated 25% to 30% of daily trading volume on the exchanges. They are also major players in derivatives and provide a major source of earnings for Wall Street firms (when they do not blow up). Hedge funds are unregulated, just like most derivatives themselves. Their very highly compensated managers are the envy of mutual fund managers and research analysts, who often view hedge fund managers as the "rock stars" of the  financial system and as the focus of their next career step. (16) 

In his book "Infectious Greed: How Deceit and Risk Corrupted the Financial Markets," law professor Frank Partnoy describes how the ability of certain hedge fund managers to make staggering amounts of money very quickly has influenced supposedly unrelated entities in America to imitate their highly leveraged, speculative, and short term-oriented style, such as the aforementioned cases of Proctor and Gamble, Orange County, and Enron. Professor Partnoy also describes how certain ace traders have been able to build their own fiefdoms and escape scrutiny by their employers and the SEC because their derivatives transactions are so complicated that the authorities feel too intimidated to try to figure them out and take disciplinary action. (17)

Unlike the "engineering" mentality that is central to manufacturing industries, which encourages ferreting out and solving problems with scientific precision, the hedge fund culture actually encourages the reverse. In many ways it is a "wise guy" culture. Hedge fund managers have to always keep up the appearance that they are "lucky," insinuate that they have special relationships with inside information sources, and have the "magic gut" to profitably interpret and trade erratic and complex market developments. A hedge fund study conducted by Yale professor William Goetzmann highlights the luck element, claiming that the probability that a hedge fund will survive seven years is only 20%. That kind of mortality rate makes both the Wall Street firms that profit off hedge fund managers and the hedge fund managers themselves who collect high fees from investors look like casino operators. (18)

On a deeper philosophical level, one can even wonder if the Fed encourages productive use of capital as opposed to a destructive use or a "zero sum game" with a wealth redistribution function similar to a casino. In his book "When Corporations Rule the World." David Korten wrote: "Joel Kurtzman, former business editor of the New York Times and editor of the Harvard Business Review, estimates that for every $1 circulating in the productive world economy, $20 to $50 circulates in the economy of pure finance --though no one knows for sure....in the international currency markets alone, some $800 billion to $1 trillion changes hands each day, far in excess of the $20 billion to $25 billion required to cover daily trade in goods and services....this money is unassociated with any real value. Yet the money managers who carry out the millions of high-speed, short-term transactions stake their reputations and careers on making that money grow at a rate greater than the prevailing rate of interest. This growth depends on the ability of the system to endlessly increase the amount of money circulating in the financial economy, independent of any increase in the output of real goods and services. As this growth occurs, the financial or buying power of those who control the newly created money expands, compared with other members of society who are creating value but whose real and relative compensation is declining....There are two common ways to create money without creating value. One is by creating debt. Another is by bidding up asset values. The global financial system is adept at using both of these devices to create money delinked from the creation of value." (I hope to expand on David Korten's observations in a later article). (19)

We're Off to See the Wizard

Getting back to the Oz analogy, we need to part the wonderful wizard's curtain and take a closer look at the market casino levers that Greenspan has his hands on. Keeping interest rates artificially low in the bond market helps the housing market and supports lofty valuation models for the stock market. Keeping gold suppressed helps reduce the slide of the dollar in the currency markets and calm fears about rising interest rates and inflation. As mentioned, the stock market appears decoupled from an economy that is still experiencing high unemployment, overcapacity, and a lack of quality earnings growth visibility. Encouraging interventions in the stock market at strategic moments might prevent a downward slide from turning into a crash. Below are examinations of the aforementioned three major areas of Fed intervention: (20)

Buying bonds outright to artificially keep interest rates low

In his May 21, 2003 testimony before Congress, Greenspan testified that the Fed is prepared to make massive open purchases of both short and long term bonds to prop up their prices and continue to suppress interest rates. This is a big step beyond the extreme step already taken of dropping the short term Fed Funds rate down to 1%. Buying bonds outright is the Fed's ultimate way of saying, "We really mean business." The Fed is authorized to do this, incidentally, just like it can make direct purchase interventions in the currency markets. (21)

While this policy helps keep interest rates artificially suppressed in the short run, it can have disastrous effects in the long run. For starters, it introduces more "moral hazard" or speculative risk into the market and the overall economy. Feeling that they have price support from the Fed, more speculators can jump in and play the "carry trade" in which they borrow short term instruments at around 1% and buy longer term notes at around 4%, and then leverage up the 3% spread (5:1 leverage would provide a 15% annualized rate of return) . In the short run, this assists the Fed policy of suppressing short and long term bond interest rates, because when speculators buy long bonds as part of their "carry trade" maneuver, this helps to bring down long term interest rates and transmit drops in the short term Federal Funds rate out the yield curve. The bad part is that when interest rates eventually start moving back up, there are usually a lot of speculators who do not get out of the way in time. The S&L crisis in the late 1980's that cost taxpayers $160 billion was an example of a "moral hazard story" in which various S&L's gambled that risky commercial lending would be a "heads I win" scenario and that FSLIC deposit insurance would cover the "tails you lose" side. The $1.6 billion lost by Orange County Treasurer Robert L. Citron in 1994 was an example where highly leveraged "carry trade"-type bond portfolios getting whacked by rising interest rates.  (22)

Another big negative, incidentally, is that when the Fed bolsters its policy by making direct purchases of short and long term bonds, these "Open Market Operations" create money out of nothing and inject it into the system. Money injection contributes to inflation. Remember, please, that inflation is always a hidden form of taxation on Americans. When your money buys less as a result of inflation, it hurts you the same way as if your money can buy the same amount of goods, only you have less of it to spend because the government is taking more away from you. Greenspan's bond-buying operations that gun the money supply are like saying, "Whip out your wallets, citizens!"  (23)

This creates taxation without representation issues. Congress "reviews" Fed policy and "confirms" the appointment of the Fed Chairman, but it does not vote on and control money creation issues on a case by case basis the same way that the House Appropriations Committee reviews U.S. Government expenditures. Congress abdicated the direct money creation powers that it once had under the original Constitution when it created the Federal Reserve Banking System in that fateful year 1913, the same year, incidentally, that it created the permanent income tax. (24)

Gradually removing the lid on gold 

The fall in gold prices from around $380 in early 1996 down to lows around $252- $256 in the 1999- 2001 time frame was for many investors a complete enigma. Gold got so low it threatened to put half the gold mines in existence out of business. Here was a metal that had spiked to around $850 in Jan 1980 during the height of stagflation and Middle Eastern tensions. Since around 1990, global gold demand has exceeded mine and scrap supply. Since 1995, various charts of different forms of the U.S. money supply (M1, M2, and M3) have shown 25 to 35 degree upward trends. The steady slide in gold prices defied all of these bullish fundamentals for gold.  (25)

This episode was not only bad for mining companies, but it also helped to distort the markets. Gold has historically been a barometer of inflation. Downward sliding gold prices sent a false signal to the financial markets that inflation was no longer an issue. The message: Do not worry about dividend yield levels on stocks. (Indeed, dividend yields dropped to their lowest levels in American history, and are still at lows characteristic of historic bull market tops). We are in a new era. Bid up the internet and telecom stocks and S&P index funds, and let the good times roll!  (26)

To muscle down gold prices, the Fed has played a key role in orchestrating a global campaign to get central banks around the world to divest about half of their gold hoards to date, or about 16,000 tonnes. The Fed played this game once before beginning around 1960 when it orchestrated the sale of 3,000 tonnes through what was called the "London Gold Pool" until the program was officially disbanded in 1968. After the lid came off, gold began an irregular and ragged up trend that persisted for about 12 years until gold hit its spike peak at around $850 an oz. and Fed Chairman Paul Volcker finally turned the tide on double digit interest and inflation rates.  (27)

The anti-gold propaganda line has gone something like this: "Gold is a barbarous relic. Historically countries have hoarded it as a last ditch form of monetary `insurance' to defend their currencies or pay for defense in time of war. But in this new era, all it does is sit in the vault and do nothing. You can't eat it, and it does not "go to work" growing things like technology. It will never again be used as real money, particularly now that money is becoming increasingly "electronic." The European countries that have joined the EU no longer need to maintain their own gold hoards because they have "denationalized" and merged their currencies into the Euro and have opened their borders within the EU. Furthermore, today you can use derivatives to hedge currencies rather than rely on gold as a back-up. Derivatives are particularly necessary since the US went off the gold standard in the early 1970s. You can trust government to maintain the integrity of your fiat currencies without any backing to tangible assets."  (28)

When the dollar was backed by gold, it wound up being worth about 50% more in 1900 than in 1800, despite bursts of inflation typically generated by war-related spending during that period.   In his video "Money, Banking, and the Federal Reserve," Lew Rockwell, President of the Ludwig von Mises Institute, said that in addition to experiencing dollar value appreciation, the US economy grew quite nicely at about 4% a year on average for twenty years beginning in 1871 when the dollar was returned to the gold standard.  This took place in the wake of massive Civil War inflation that had nearly cut the value of the dollar in half.  When the Fed was created in 1913, the public expected it to help stabilize the currency. The opposite has happened. The dollar has lost over 95% of its value since the Fed's inception. In 1729, Voltaire observed that "Paper money eventually goes down to its intrinsic value --zero." Governments and central banks since his time have continued to prove that they can not discipline themselves. Gold can provide an important intangible form of "insurance" and "discipline" for the integrity of a nation's financial system. Gold has not only been used as a form of money, but has also been used for jewelry and for industrial applications.  (29)

Resistance to the anti-gold trend is growing. European central bank gold sales have been slowing as EU members focus on the problems of getting along with each other. Central banks in general tend to get nervous as their dollar reserves decline in value and their appreciating gold hoards dwindle. America's largest bullion dealer, Blanchard & Co. filed an anti-trust law suit against JP Morgan Chase and Barrick Gold in December 2002 alleging that the companies made $2 billion in short-selling profits by suppressing the price of gold, thereby victimizing individual investors.  Newmont mining, the largest gold mining company in the world, has been aggressively unwinding hedges, particularly in regard to various properties that came with its acquisition of Normandy Mining of Australia. One of these acquired companies shorted more gold than it could produce, creating a speculative over hedge to try to milk a little more profit out of declining gold prices. When gold prices moved back up, the hedge went under water and gave the company negative net worth. Some critics charge that since the banks egged on the over hedging problem, it served them right when Newmont threatened to abandon the problem back into their laps.  (30)

It is bad enough that citizens of the US, UK, and other countries have allowed their central bankers to divest their national gold stocks at fire sale prices while manipulating the gold barometer downwards. But what is even worse is that banks have created a huge overhang of short and derivative positions to keep the price of gold smothered with "paper." Bill Murphy, Chairman of the Gold Anti-Trust Action Committee (GATA),  said that as major gold mining companies have unwound their hedges since November of last year, gold derivatives have gone up instead of down, growing from $279 billion to $315 billion today. In Mr. Murphy's opinion, this is a smoking gun that shows how big banks and Wall Street firms such as Goldman Sachs, Citibank, and JP Morgan Chase have stepped up their derivatives exposure to do the Fed's bidding to suppress gold, working in round robin tag teams.  (31)

The Fed has to ease out of a horrible problem of its own making. According to GATA, total global gold short positions stand at about 15,000 tonnes, six times annual mine and scrap supply, which run about 2,500 tonnes a year. Global demand for gold is about 3,900 tonnes a year, or 1,400 tonnes over mine and scrap supply. To keep gold prices from spiking up, the Fed has to find ways to fill that 1,400 tonne deficit every year, and it appears to be getting harder and harder. Bill Murphy said in his May 31, 2003 interview with James Puplava that he thinks the Fed may be arranging payments to foreign banks prices for gold that are way above current market prices in order to get them to disgorge more gold into the market at below market prices and keep the price of gold suppressed.  (32)

Many financial writers are nervous about JP Morgan Chase, one of America's three largest banks, which apparently has heavy exposure to unregulated gold derivatives. In addition, JP Morgan Chase has a total exposure to derivatives of all kinds of about $25 trillion, which is somewhere over six times its equity base. The total gold market capitalization is relatively small compared to other markets. A massive flood of capital into gold bullion and gold stocks might spark a sudden run up in prices, which in turn might threaten to serve as a "detonator" if any major banks with massive unregulated gold derivative exposure turn out to be "hedge funds" or "Enrons" in disguise.  (33)

Incidentally, there is evidence that the Fed has been involved with the suppression of silver, also known as the poor man's gold, but that is a topic for another article. (34)

Stock market intervention.

The Fed is linked to a "Plunge Protection Team" (PPT) that covertly creates sharp rallies to prevent market crashes.  Bob Pisanti on CNBC has talked about "Big buyers in the S&P futures pit that pulled this market higher." Index futures are a very efficient way to spark a rally because they have a lot of leverage, can be easily entered and exited without full ownership disclosure, and can move underlying stocks through the arbitrage programs of Wall Street firms.  (35)

As a possible real life behind-the-scenes example of the PPT in action, during his May 3, 2003 Financialsense News Hour interview with writer/investigator Nelson Hultberg, James Puplava said that earlier that week he had received an anonymous e-mail from an individual who claims to be a senior trader at a top three Wall Street firm who executes orders for large institutional clients. This person said that last summer he began to get abnormally large orders every few months that are quietly relayed by the senior manager of the entire department. No one is permitted to speak with the client, nor does this client have a name or letter code (typically used with clients who wish to remain anonymous), and at the end of the day the manager goes into the order management system and personally moves the client executions out of the desk accounts. The orders are executed at market without regard to price, they are notable for their size, are typically placed at technical market bottoms, and each time they have moved the market significantly. James Puplava noted that he has seen numerous V-shaped "flag pole rallies" over the last couple of years that seem decoupled from market news and fundamentals and this e-mail may provide some background regarding what he is seeing.  (36)

The article "Plunge Protection Team" by Brett Fromson, that appeared in the Feb 23, 1997 Washington Post, describes the Working Group on Financial Markets (WGFM), created by the Reagan administration in early 1988 in reaction to the 1987 crash. It consists of the Secretary of the Treasury, Fed Chairmen, and the heads of the SEC and Commodities Futures Trading Commission (CFTC). "[The] quiet meetings of the Working Group are the financial world's equivalent of the war room. The officials gather regularly to discuss options and review crisis scenarios because they know that the government's reaction to a crumbling stock market would have a critical impact on investor confidence around the world." According to E. Gerald Corrigan, former president of the NY Federal Reserve Bank who became an executive at Goldman Sachs & Co., "The first and most important question for the central bank is always, `Do you have credit problems? The minute some bank or investment firm says, `Hey, maybe I'm not going to get paid --maybe I ought to wait before I transfer these securities or make that payment,' then things get tricky. The central bank has to sense that before it happens and take steps to prevent it."  (37)

During the 1987 plunge, "A final critical moment came that day when the Fed decided not to shut down a subsidiary of the Continental Illinois Bank that was the largest lender to the commodity futures and options trading houses in Chicago. The subsidiary had run out of capital to provide financing to that market." According to Fromson, "The SEC, CFTC and Treasury have market surveillance units. They monitor not only the overall markets, but also the cash positions of all the major stock and commodity brokerages and large traders." In fact, in 1987 the Fed, "Encouraged big commercial banks not to pull loans to major Wall Street houses...flooded the banking system with money to meet financial obligations... announced it was ready to extend loans to important financial institutions."  (38)

Bill Murphy of GATA described in his May 31, 2003 interview with James Puplava why he believes the Fed and Wall Street firms are currently exercising the "PPT" on a continuing basis. The Fed has a repurchase agreement pool about $40 billion in size, to which it can add another $30 or $40 billion from an Exchange Stabilization Fund (created in the 1930s), totaling $80 billion. Major Wall Street firms such as Merrill Lynch, Goldman Sachs, JP Morgan Chase, and Citigroup (Salomon Smith Barney) have access to this money through the Fed's repurchase desk, in which they can borrow billions of dollars for up to 28 days, and then they have to return the money to the Fed. Sometimes the Fed is willing to keep rolling part of the money over, as if making a permanent loan. Although the Fed is restricted from buying stocks and index futures directly, the major investment houses are not, so Wall Street firms can use the repurchase money they borrow from the Fed to support the stock market any way they want, ranging from buying index futures to buying individual stocks. Mr. Murphy claims that when the repurchase agreement pool falls below $20 billion, that is a clue that the market is likely to fall, since so much of the market seems to be held up by liquidity pumps and media hype rather than US economic fundamentals. Once the markets keep falling to the point that fear begins to grip Wall Street, sudden spike ups in the amount of repurchase agreement money made available seems to be a tacit signal for one or more of the "PPTs" of major Wall Street firms to get into action. Hedge funds that engage in heavy short-selling have learned to quickly cover their positions and buy back, driving market rallies yet higher.  (39)

Fed research paper 641 written in 1999 discusses the possibility that policymakers could consider resorting to unconventional means such as buying stocks or real estate outright if lowering interest rates proves ineffective. The Fed seems to be one short step away from actually buying stocks itself, which is in fact a policy currently being openly practiced by the Bank of Japan to bolster the Japanese market. As long as CEOs of Wall Street firms and banks that form an axis with the Fed know that their plunge protection teams will always be supported by endless Fed liquidity pumps, that last step may not be necessary. That is, unless speculative excesses, supported by increasing moral hazard, create a rogue wave that is just too big for the financial system to contain. Put another way, while Fed intervention may effectively stave off or even help solve problems in the short run, its interventions are counterproductive if they support moral hazards that lead to overwhelming problems later on.  (40)

While the PPT is only a nickname and is not officially tied to the Working Group on Financial Markets, the ongoing "war room" meetings, scenario planning, and coordination efforts of the WGFM provide the perfect cover for banks and investment firms to talk to each other, collude, and cooperate. The banking industry is unique in America by the extent to which it routinely engages in behavior that would constitute clear antitrust law violations in other industries. The most extreme special privileges start with the Federal Reserve and its ability to create money.  (41)

Morphogenesis of the Fed Axis

Subterfuge and collusion are an old story regarding the Fed axis. In his book The Creature from Jekyll Island, G. Edward Griffin describes how financiers representing Rockefeller, JP Morgan, and Rothschild interests, which directly or indirectly controlled about 25% of the world's wealth, agreed to congregate on Jekyll Island, Georgia in 1910 to put the final touches on their plan for the Federal Reserve Act that got passed by Congress in 1913. At that time, Jekyll Island was a privately owned resort community in which many "Robber Barons" of the era maintained vacation mansions. Later, after the Fed had achieved enough public acceptance to feel safely institutionalized, many participants and their descendants wrote books with revelations about the Jekyll Island conference. The Federal Reserve, which in actuality is a private banking cartel, was sold to the public as a way to curtail the money trusts, stabilize the currency, avoid panics, and solve many of the problems that fractional reserve banking systems had shown on a state level. (Critics charge that the Fed's track record since inception belies all of this). Certain politicians felt that the currency needed to become more "elastic" because money grounded on gold made credit too tight, particularly for farmers who at that time still represented the majority of America's population. One example was populist leader William Jennings Bryan who once gave his famous "crucified on a cross of gold" speech in which he advocated linking currency to silver rather than gold to provide more liquidity. (In the original "The Wonderful Wizard of Oz," in which "Oz" originated as the abbreviation for "Ounce," the "yellow brick road" and Dorothy's silver slippers symbolized a gold and silver standard respectively) The "money trust" saw the change coming, and figured it was better to create their own Trojan Horse opposition rather than confront the changes recommended by genuine reformers and risk a defeat. But they were concerned that if the public found out that it was the money trust itself that was behind the Congressional legislation that was supposed to curtail the powers of the money trust, in other words, that it was the foxes who were designing the security system for the chicken house, their plan would blow up. For security reasons, the financiers agreed to arrive one at a time under the cover of darkness to ride in a private rail car from a NJ station to Jekyll Island and only refer to each other by either their first names or assumed names so that loose lips from attendants may not be so likely to make connections. One participant was Paul M. Warburg, a partner of the investment house Kuhn, Loeb and Co. and a representative of Rothschild financial interests in England and France. He carried a big black shot gun case to give the appearance that he was going on a duck hunting trip, even though he never owned or fired a gun in his life. Many sources consider him the principal architect of the Federal Reserve Banking System.  (42)

Are we heading into a box canyon?

One gets the sense that we may be approaching some endgames, or as James Puplava puts it, "storm fronts" are converging on us. For one thing, from the sharp upward angle on graphs of monetary expansion and credit creation, he thinks we could eventually see a hyperinflation rate as bad if not worse than what we had in the 1970's. After all, inflation is ultimately a money supply phenomenon, and as mentioned earlier, it is possible to see a simultaneous deflation in major assets combined with inflation in consumer goods and stagnation in the overall economy. (43) 

The ultimate endgame may lie more with foreigners than with the Fed. With America's continuing massive balance of trade deficits and dollar slide, foreigners are in essence accepting depreciating America paper in return for their goods. The dollar has declined around 30% in the last eighteen months, wiping out any gains foreigners have made in their US bond positions as interest rates have come down. Imagine the disaster if US interest rates start heading back up, causing the value of bonds to go down and the stock market to go down further, and on top of that foreigners continue to lose from a sliding dollar. Foreigners have owned as much as 45% of US Treasuries, and since the US government is so dependent on their purchases to fund its ever growing debt, the Fed may be forced to hike rates to continue to attract their capital. This would be similar to the desperate interest rate hikes used by various Latin American countries to keep attracting capital and slow down their sliding exchange rates after they have debauched their currencies with massive spending and have distorted their economies with massive malinvestments. Currently Japanese and Chinese central banks are buying US dollars to arrest the dollar slide. They are trying to keep their currencies relatively cheap to help maintain the competitiveness of their exports. How long they will be willing to continue doing this is anyone's guess. But the unfortunate trend is that Americans are becoming ever more dependent on the "charity of strangers" and less and less capable of determining their own destiny.  (44)

The ultimate endgame may also involve massive social and political upheaval within America. Michael Bolser, a protégé of Bill Murphy at GATA, hardly pulled his punches during his May 31, 2003 interview with James Puplava, "We are looking at a situation now that Bank of England President Sir Eddie George referred to as an abyss. He said in his own words, "We were staring into an abyss as the price of gold rose in September 1999." He wasn't talking about a temporary abyss, Jim Puplava, he was talking about the permanent destruction of the value of the United States dollar. It doesn't come back. You do not come back from where the Argentina peso has fallen. But it is worse than that, because you have a situation where not only is the present value of investors funds diluted down towards zero, and their current present life is taken away from them; their future is also taken away from them. The social security promise evaporates. And all the military retirement promises evaporate. This is a nation breaking event that the Federal Reserve is trying desperately to stop. And of course they have created the conditions to get us into this jam. And it has taken them since 1987 when Alan Greenspan was first appointed to do it. He has been on the wrong path for that long. And he has refused to get off this path. His answer to every single problem was to print more money. And here we are at the end game of a one way box canyon, at the end of which is a financial disaster."  (45) 

One of the ironies used in ancient Greek tragedy was the concept that they who the gods would destroy, the gods would first grant their wishes. America's representatives asked for some extra intervention and safety by voting in a central bank in 1913. What they got has taken on a life of its own --and has been able to get its own way. Would we be Pollyannaish to hope that our central bank wizards know what they are doing, are somehow working for our best interests, and are somehow different in character from hedge fund managers? Or have things become so totally out of control that we are now forced to stand by and watch a financial system geared towards the endless creation of what David Korten calls "money without value" hang itself the same way that the Russian people were forced to ride through the last self-destructive phases of communism? If nothing else, the analyses of individuals such as Messrs Bolser, Korten, Murphy, Puplava, and Rogers lead me to think that Americans should have stayed with the original Constitution and the advice of Thomas Jefferson, Andrew Jackson, John Adams, and other early American leaders. They admonished us to maintain a fully transparent and decentralized financial system with a currency backed by hard assets. The Founding Fathers put the power to create money in the hands of Congress in the original Constitution, so quite frankly, I think that is where they really felt it should be. For over ninety years we have disregarded their sage advice. We now find ourselves way off the yellow brick road, hallucinating on poppies (that is, disinformation disseminated by the Federal Reserve and the national media), and in danger of attack by wicked witches and flying monkeys.(46)

© 2003 Bill Fox All rights reserved.

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  • McCoy, Andrew P. "Louis Rukeyser: Is This Rally for Real? Fidelity Investor's Weekly, June 13, 2003, click on market commentary and Expert analysis in left tool bar, and scroll down to McCoy article.  Also, McCoy posted another June 27th article with Rukeyser comments.

  • Fisher, Kenneth L., "Dumb Bears II," Forbes, July 21, 2003

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  • James Puplava interview with Richard Russell  June 28, 2003.  Russell stated:  “Actually one of the big questions I am asking myself is I am beginning to think the consumer is finally starting to cut back. I felt all along that the one thing that would scare consumers even more than a market going down is unemployment, you losing a job or your neighbor losing a job. Here in La Jolla I noticed just recently that the restaurants are emptying out, all the storekeepers are complaining. It does seem to be slowing down, at least here. The other thing I am watching is the almost collapse of the transportation average, and this tells me that what we are probably seeing now is the manufacturing going on, inventories building and so forth, but the goods are not being shipped out.   I think that this is the beginning of a real slowdown in the economy. And I am convinced that Greenspan sees this and it is really scaring him. That is why he continues to drop the rates and that is why he continues to surge the liquidity and the money supply.”  The Dow Transports started to rebound back above the 50 day moving average a week after this interview, clouding this indicator in the near term, but the longer term dollar slide and rising gold and commodity price trends appear to remain in tact.

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  • Baker, Dean, "The U.S. Wage Gap and the Decline of Manufacturing," Economic Policy Institute, Washington, DC, discusses decrease of manufacturing employment from 30% to less than 15% and declining in productivity growth from 2.5% to 1% a year

  • "How Does Uncle Sam (tentatively) Plan to Spend Your Tax Dollar in 2003"; Tax Foundation, discussion of 60% of US Government budget that goes to entitlements.

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  • Rose, Judy, "House Prices Out Jump Income," Detroit Free Press, July 5, 2002. Discusses how home prices and equity has a greater impact on consumer spending than the stock market, and how housing price gains have exceeded income gains

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  • James Puplava has mentioned the case of the Executive Life Insurance Company that got hit with the tail end of a recessionary market in 1991 and could only get 50 cents on the dollar in its junk bond portfolio, causing it to go bankrupt.

  • AIMR Advocacy, ”Corporate Risk Management:  The Financial Analyst’s Challenge” Discusses Proctor and Gamble, Air Products and Chemicals, Gibson Greetings

  • Stanko, Brian B.  A discussion of derivatives-related losses.  Includes State of Wisconsin, Metelsgesellshaft, and Showa Shell Sekiyu.

  • Korten, David "When Corporations Rule the World" description of the PaineWebber, Piper losses in 1994 and Barings Bank disaster at: pages 185-247

  • Wilmotte magazine, discussion of losses by Vairocano and Fenchurch Capital.

  • Cash, James M. "No Hedging Here," Forbes, April 6, 2001: Quote of Vanguard manager John Bogle reading from a UBS Warburg booklet: "Let me comment on Long-Term Capital Management. Isolated is not the right word. UBS-Warburg has this wonderful book I read from cover to cover, and they're promoting hedge funds in it. They have a list of losses. Askin Capital Management, 1994, $420 million; Argonaut Capital Management, 1994, $110 million. Vairocana Limited, 1994, $700 million. By the way, they have the reasons the funds went wrong. In Askin's case, "Hedge did not work. Liquidity squeeze. Could not meet margin calls. Did not inform investors." Vairocana: "Change of strategy from duration neutral to directional plays on falling interest rates." Global Systems, Victor Niederhoffer, 1997: "Market losses. Short puts in market correction. Margin calls." Long-Term Capital management, $3.6 billion loss: "Market losses. Excess leverage. Margin calls. Fund was under funded (or over-leveraged)." Manhattan Investment Fund: "Managers sent fictitious statements for three years." Tiger Management, loss unknown. Soros Fund, loss unknown. Ballybunion Capital Partners, long-short equities, 2000 failure. Only cost $7 million of somebody else's money. A lot of money to somebody. "Reporting of false performance figures, wrong information on Web." These are, together, not isolated instances."

  • Pramik, Mike, ”Hedging Their Bets:  Universities Ivy-Covered Endowments Clipped by Fund Debacle, Market Dip” Columbus Dispatch, October 11, 1998.  Everest lost half its funds or over $1 billion.

  • Galts, Chad “The Long Haul,” Brown Alumni Magazine, Nov/Dec 1998. Yale, Brown and Emory listed as victims of 1.3 billion Everest Capital loss.

  • Hunter, Robert, “Victor Niederhoffer’s Garage Sale”  DerivativesStrategy.com, Feb 1999.

  • Task, Aaron L., “Requiem for a Heavyweight  Street.com, March 29, 2000.  discusses how Julian Robertson’s Tiger Management dropped from $22 billion to $6 billion

  • Karchmer, Jennifer, "Tiger Management Closes"  CNNfn, March 30, 2000.

  • Tilson, Whitney, “Should Warren Buffett Call It Quits”  Fool.com, April 3, 2000, about Robertson decision to retire.

  • Lopez, Joe, “Soros Withdrawal, A Sign of Things to Come”   World Socialist Web, 5 May 2000, Soros loss estimated close to $3 billion due to decline in tech stocks.

  • Max, Kevin and Brett Fromson:   Multibillionaire Speculator Soros Exiting the Risk Business,” The Street.com, April 28, 2000.   Estimate of $5 billion in losses of Soros Fund management.

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  • Clash, James, "No Hedging Here," Forbes, April 6, 2001.  The 20% survival statistic for hedge funds in 7 years.

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  • Quotes from David Korten's book "When Corporations Rule the World"

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  • McDonald, Joe, “China Faces Heat Over Currency Controls,”  Associated Press, Newsday.com, July 3, 2003.   According to McDonald, “Even though the Chinese Yaun has been pegged at 8.28 Yuan to the dollar since 1994, "The state newspaper 21st Century Business Herald reported on June 30 that China's central bank, even with currency controls, has to buy huge amounts of dollars every day to stabilize the yuan, though the report didn't disclose how much it has to purchase."


© 2003 Bill Fox
Editorial Archive

Contact Information
Bill Fox

VP, Investment Strategist
America First Trust Financial Services
Vancouver, WA, USA

Bill welcomes phones calls and other responses to this article. His address is VP, America First Trust Financial Services, Registered Rep., Sammons Securities Co., LLC, PO Box 820669, Vancouver, WA 98682, telephone: 360-882-5369, toll free: 866-945-5369 (866-WILL FOX), email. Securities offered through Sammons Securities Co. LLC, member NASD and SIPC.

DISCLAIMER: Not all views referenced in this report are necessarily those of the author, America First Trust Financial Services, or Sammons Securities Co., LLC.  Sometimes the author provides opposing viewpoints to give the reader a greater sense of perspective. This report is intended for informational purposes only and should not be considered specific investment advice. It is not intended to be a recommendation to buy or sell securities in the absence of specific knowledge regarding the financial situation and suitability requirements of a reader. The information has been obtained from sources believed to be reliable but whose accuracy can not be guaranteed. Past performance is no guarantee of future results. There can be no guarantee that the market will perform according to the author's opinion or that his investment ideas will be effective under all market conditions. His opinion can change without notice. Investment returns will fluctuate and the value of an investor's shares may be worth more or less than the original cost when redeemed. Market data presented here is subject to change daily. Sammons Securities Co., LLC is a member of the National Association of Securities Dealers (NASD) and the Securities Investor Protection Corporation (SIPC).

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