Eric Fry

According to the financial commentary of the moment, Federal Reserve Chairman, Ben Bernanke is either a genius or a moron. But your California editor would offer a slightly different perspective; he believes Bernanke to be a genius…engaged in moronic behavior.

He is “too clever by half,” as the old saying goes.

The erudite Federal Reserve Chairman is an accomplished academic in possession of a 99th percentile vocabulary. He knows his way around a thesaurus as well as he knows his way around the esteemed monetary theories of past and present. But therein lies the problem. When a refined vernacular cavorts with monetarist musings they produce a bastard child like “quantitative easing.”

Chairman Bernanke portrays quantitative easing (QE) as, “just monetary policy. Monetary policy [always] involves the swapping of assets – essentially, the acquisition of Treasuries and swapping those for other kinds of assets.” Not so, counters James Grant, editor of Grant’s Interest Rate Observer. “The truth is that QE isn’t about asset swapping but, rather, dollar conjuring.” Your editor sides with Grant on this one.

Quantitative easing is “just monetary policy” like pornography is “just cinema.” QE and pornography both utilize the conventions of mainstream activities in order to conduct and legitimize questionable activities. Chairman Bernanke considers quantitative easing to be an oeuvre d’art – a monetary masterpiece. But to most of the outside world, QE looks like nothing more than monetary porn.

The Chinese ratings agency, Dagong, scorned QE as “a practice resembling drinking poison to quench thirst… In essence the depreciation of the US dollar adopted by the US government indicates that its solvency is on the brink of collapse.”

Undeterred, Chairman Bernanke clings to his theories and his highfalutin euphemisms. Even though quantitative easing, at core, is nothing more than “dollar conjuring,” Chairman Bernanke continuously portrays it as a highly sophisticated monetary tactic. To hear him tell the story, QE is the latest and greatest monetary invention – it is good for what ails you and producers no side effects…or at least none that we know about.

From Bernanke’s perspective, QE bestows all the sweetness and none of the calories of a legitimate monetary policy. And he is so sure of himself that he conducts his money-printing operation shamelessly – out in the open where everyone can see. Never has a genius behaved so moronically.

In bygone eras, James Grant observes, the issuers of sovereign currency would “debase surreptitiously, as if [they] were ashamed of [themselves]…Bernanke, in contrast, is out in the open, as transparent as Facebook.”

Bernanke’s proposed QE2 campaign is not merely transparent; it is audacious. The Fed plans to purchase almost 100% of the total net Treasury issuance. “For the next five months,” Stone & McCarthy Research Associates observes, “Fed buying of $550 billion would be the equivalent of 94.2% of net Treasury issuance of $584 billion.”

Treasury Coupon Supply vs. Fed Purchases

By conducting such transparent and audacious money-printing, Bernanke seems to be daring America’s creditors to blink. For the moment, most creditors are simply rubbing their eyes in disbelief. “Hearing Bernanke, but not, at first, believing him,” writes Grant, “America’s creditors have just now come around to accepting the astonishing fact that the steward of the currency in which they denominate a substantial portion of their national wealth is bent on inflation (only a little, he says).”

But America’s creditors are not accepting this astonishing fact with resignation; rather, with rebellion. They are lightening up on dollar-denominated assets and they are tiptoeing away from the long end of the US Treasury market. Apparently, many investors are beginning to fear that the unknown side effects of Bernanke’s QE2 will be fully known by the time a 30-year Treasury bond matures.

Long-dated bond yields have been rising rather sharply during the last three months, even though short-dated bond yields have not. As a result, the yield curve is “steepening” and the yield spread between the 30-year Treasury bond and the 5-year Treasury note has reached the highest level in more than three decades.

To be sure, a variety of trends and influences could be contributing to this phenomenon. The QE process itself is helping to suppress yields at the short end of the yield curve, thereby skewing the connection between short-term and long-term yields. Nevertheless, the recent, sharp rise in long-term Treasury yields seems to be sending a very clear message: Inflation is coming.

The soaring commodity markets and the slumping dollar corroborate this message.

“It isn’t just the paper dollar from which the gold buyers are fleeing,” Grant asserts. “[They] are in flight from modern monetary doctrine, too… By exchanging currencies for Krugerrands or shares in a gold exchange-traded fund, individuals are implementing their own personal gold standards…

“In our view,” Grant concludes, “the rush to gold is a flight from bad ideas. The gold price is soaring – i.e., the value of the dollar is plunging – because central bankers have lost their bearings.”

Net-net, Bernanke’s marvelous monetary sweetener may turn out to be as marvelous as cyclamates. To repeat a phrase that bears repeating, “If something sounds too good to be true, it usually is.”

Eric Fry
for The Daily Reckoning

Eric Fry

Eric J. Fry, Agora Financial's Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling.  Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling. 

Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry  supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts.  His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.

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