It seems that every time I read the news, I see calls for greater transparency. Prestigious individuals from Wall Street, the Federal Reserve, and U.S. government agencies claim to support more open communication. Ironically, the more institutions announce their openness, the more cloudy the real condition of the economy becomes to the public.
When I speak to average stock market investors, they seem quite relaxed about the state of the U.S. economy. The Dow is near 11,000, and their real estate has appreciated sharply over the past five years. If they have no fear of a crash, it's due to the misinformation they receive every day. Wall Street, the Fed, and the government work together in a symbiotic relationship to obscure reality. Mass psychology leads most Americans to complacency. "Don't worry, go shopping," is the cry, and today's leaders don't try to change their minds.
Wall Street and the government cooperate to keep complacency high.
Financial pundits often cite the BLS' Consumer Price Index as proof that price inflation is tame. However, under President Clinton's administration, the method for calculating CPI changed. Through the use of hedonics, geometric weighting, and substitution, inflation has been understated by 2.7% according to Gillespie Research. This has secretly reduced seniors' Social Security checks by 43%, and caused many investments to have a negative real rate of return. Government officials point with pride to low "core" inflation which excludes energy and food, as if consumers don't spend much of their budgets on these items. If the pre-Clinton methodology is used, price inflation was over 7% last year.
Firms with labor contracts indexed to CPI are very pleased with this downward adjustment which enhances their bottom line. Wall Street also hopes the reported price inflation stays low. If the Federal Reserve proclaims inflation "contained," they will stop the rate hikes that make short-term corporate borrowing more expensive. Understating inflation artificially boosts the GDP number, as well. Wall Street interprets robust growth numbers as an indicator of higher corporate profits in the future. The pundits argue that stocks are "cheap," and investors should buy now before the shares appreciate.
Corporate scandals are the pebbles which disturb the pool of investor complacency. The Refco debacle is one of the most visible examples of deception and mismanagement on Wall Street today. Its former CEO, Phillip Bennett, was fired and charged with fraud when it was discovered that he had concealed $430 million in bad debts. Somehow, Credit Suisse First Boston, Bank of America and Goldman Sachs all missed this illegal activity when they underwrote Refco's IPO in August. Grant Thornton also audited Refco's books in 2005, but didn't raise any warnings despite murky accounting.
Refco's problems have rippled through Wall Street. A month after Jim Rogers moved his commodity fund to Refco, $362 million of its assets were frozen. His lawsuit claims that segregated funds were shifted to an unregulated account without his knowledge. Investors in the Rogers Raw Materials Fund will probably never recover all their money, since Refco has already declared bankruptcy. Some assets were auctioned off without determining proper ownership, a task made more difficult by confusing and inadequate records. So far 22, class-action lawsuits have been filed in an attempt to recover nearly $2 billion in assets.
Laws that are supposed to protect the public aren't helping. The 2002 Sarbanes-Oxley law requires CEOs to endorse their company's accounting to prevent fraud, but it doesn't hold the auditors or underwriters responsible. The new bankruptcy law effective October 17 dictates that a trustee should be appointed to run a company if management is suspected of fraud. This didn't happen with Refco. Managers hired by Bennett are still directing the activities of the firm, and Bennett himself still sits on the board of directors.
On December 8, Refco announced that it shifted $170 million in assets from one subsidiary to another and sold over 68% of these securities in a breach of the bankruptcy code. To date, the authorities have taken no action. Despite all the government regulation, small investors were victimized once again.
The Federal Reserve may be involved in the Refco affair. Three weeks before its sudden implosion, Jim Sinclair notes that the Fed met with major banks on derivative issues, including Refco's major underwriters.
This meeting was originally scheduled for December, then moved 3 months earlier even though the meeting was ostensibly focused on routine housekeeping issues.
A Free Market Economy?
Despite repeated Wall Street scandals, confidence remains high and volatility is low. Investors have faith the Federal Reserve will manage the economy smoothly, and stocks won't suffer a major correction. This phenomenon is so accepted that it's referred to as the Greenspan put.
Most Americans live in a state of economic cognitive dissonance. They are told that the U.S. has a free market system, yet they are encouraged to trust the Federal Reserve's steering of the economy. Most Americans believe that the Fed only manages the markets indirectly, through credit and interest rates.
However, there is credible evidence that the Federal Reserve in conjunction with the Treasury Department covertly intervenes in the stock market. Under the Reagan Administration, the Plunge Protection Team, or PPT, was formed to prevent crashes like the stock collapse in October 1987. As former Federal Reserve Governor Heller outlined in 1989, the Fed directs major financial institutions to purchase stock index futures on its behalf when the markets start to drop. Advance knowledge of market moves allows these firms to make incredible profits.
Small traders without inside information are repeatedly fleeced.
Another way the Federal Reserve intervenes in the markets is through the use of repurchase agreements, or repos. The Fed buys U.S. Treasuries from a dealer who contracts to repurchase them, usually within a week.
This is one of the data points contained in the M3 series, which the Federal Reserve will stop publishing in March 2006. M3 also includes M2, all other CDs over $100,000, and deposits of Eurodollars. If the Fed needs to print a huge amount of dollars to buy U.S. bonds that are dumped by foreign governments, M3 will no longer alert investors or other central banks. It becomes very difficult for investors to protect themselves from a hyperinflation of the currency if they can't even see it coming.
Some critics assert that if there were serious problems in the U.S. economy, some government official would speak up. However, individuals who want to sweep away the veil of confusion are silenced or discredited. Treasury Secretary Paul O'Neill tried to find out the extent of America's obligations under the Social Security and Medicare programs in 2002. He was soon fired and his report detailing the $44 trillion liability was buried. After the Medicare prescription bill was passed in 2003, that figure ballooned to $51 trillion, but you won't hear O'Neill's replacement John Snow or your senator talking about it.
Similarly, when White House economic adviser Lawrence Lindsay stated that the Iraq War could cost $200 billion, he was marginalized and later forced to leave his post.
The Gold Anti-Trust Action Committee (https://www.gata.org) has produced reams of evidence suggesting that the Fed and the U.S. Treasury Department collude to suppress the gold market and prop up the dollar.
Why would governments want to keep the price of gold down? Economists frequently use gold to assess the financial health of a country, so a low gold price would inspire confidence in the currency. In fact, the dollar usually has an inverse relationship with gold.
When one of GATA's members sued Barrick Gold, one of the largest gold hedgers, the miner claimed sovereign immunity in federal court. The company stated it was borrowing gold on behalf of the central banks.
Since these banks are agents of government and can't be sued, Barrick claimed it was similarly immune.
Alan Greenspan himself stated in 1998 that central banks would lease gold as necessary if the price rose. He later claimed his testimony was misinterpreted, as the Federal Reserve owns no gold. However, he did not answer the question on whether the Fed was in charge of the disposition of the U.S. Treasury's gold. We know that other central banks manage the gold market, since they announced their intentions to sell 2,000 metric tons of gold in the Washington Agreement of 1999. The price of gold later bottomed at $252 per ounce, while the dollar index peaked around 120. It closed below 90 today, while gold was over $540.
Greenspan Sleight of Hand
Alan Greenspan repeatedly advocates for transparency, yet his official statements are known for their ambiguous and confusing nature. Fed meeting notes, which are released five years after the fact, often prove that Greenspan's public pronouncements were very different from his private beliefs. He questioned out loud in 1996 if "irrational exuberance" was at work in the markets, causing sharp drops in stocks around the world. He then minimized the importance of that statement in public, while continuing to debate it in closed door sessions. Afraid to deflate investor confidence and trigger a recession, the Federal Reserve Governors waited for the stock bubble to pop while denying its existence.
Greenspan said in February 2004 that consumers should take out adjustable rate mortgages as they are a great value. However, these mortgages are only a good idea if the rates will stay low for an extended period. He made this statement knowing that the Federal Reserve was planning to embark on a long rate-raising cycle! Then in September 2005, he hypocritically expressed his concern on the amount of "exotic" home financing options and lowered standards in the mortgage industry.
Mr. Greenspan often endorses talking about a problem in order to influence the markets, even if the Fed doesn't carry through on the threat. He also discusses containing inflation expectations, as if inflation is caused by public misperceptions. In fact, price inflation is caused by too much liquidity eventually seeping into the retail sector, which in turn is caused by excessive money printing by central banks! The Federal Reserve continually debases the dollar with this torrent of liquidity.
The Fed was originally chartered to stabilize the U.S. currency, but the dollar has lost 95% of its value according to its own inflation calculator. Mark Faber wryly observes, "If it were a crime for central bankers to destroy the value of money, Mr. Greenspan and all the Board Members of the Fed would be sentenced to death."
Ben Bernanke promises to continue Greenspan's legacy if he is confirmed as Federal Reserve Chairman. He has been even more strident in his commitment to fight deflation by printing money. Bernanke also has endorsed "unconventional measures," going so far as to suggest dropping dollar bills out of helicopters to prevent deflation. He states that he values open communication, yet his plans include more regulation behind the scenes.
With all this veiled intervention in the markets, what's the small investor to do? It's clear that the neither the Federal Reserve nor the federal government is going to make things simpler for the public.
Fortunately, you don't have to trust regulators if you own tangible assets. Buy precious metals and store them yourself. You don't need to put your entire net worth into the metals, but purchase enough to hedge against a sudden loss in your other assets. Just because you can't see the risk, doesn't mean it's non-existent. Refco's creditors didn't expect the company to implode, either.
A precious metal portfolio has its upside, too. Silver, gold, and platinum have doubled in price since their lows of 2001. This year should see continued gains, as the second phase of the commodities bull market speeds up. There will be corrections along the way, so expect a bumpy ride. If you avoid leveraged positions, you don't have to feel stressed by the volatility. You can view the dips as fresh buying opportunities.
Copyright © 2006 Jennifer Barry
