Connecting the Dots

By: Tony Sagami | Wed, Oct 26, 2005
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William Jennings Bryan, a young lawyer from a small town in Nebraska, committed himself to a lifetime of public service. Even though he had a law degree, Bryan felt he could do more to help the ordinary folks -- the farmers and laborers -- that he grew up with as a politician than as a lawyer.

Bryan was a powerful speaker and handsome man who at only 32 years of age got himself elected to the U.S. House of Representatives in 1892.

At the time, our country was still feeling the ill effects of a depression caused by the great drought of the 1880s. The wheat farmers of the Great Plains and cotton growers of the South were failing and the country slipped from a recession into a painful depression.

By the early 1890s, the depression worsened and most Americans found themselves deeply in debt and mired in poverty. The country was ripe for a messenger of hope.

Bryan quickly made a name for himself by championing farmer and labor rights, and at 36 years of age, became the youngest person to ever run for President in the United States in 1896.

A key cornerstone of Bryan's campaign was his free coinage platform, in which he wanted to convert the U.S. from the gold standard to a sliver standard.

"We demand the free and unlimited coinage of both silver and gold at the present legal ratio of 16 to 1, without waiting for the aid or consent of any other nation. We demand that the standard silver dollar shall be a full legal tender, equally with gold, for all debts, public and private, and we favor such legislation as will prevent for the future the demonetization of any kind of legal-tender money by private contract."

For the desperate farmers and laborers, Bryan's free coinage proposal was an appealing way to pay off their debts for pennies on the dollar.

Bryan attacked the campaign trail with a new but very effective campaign strategy -- he toured the country by train and speaking from the back of railroad cars to promote his new economic policy. Bryan became the populist candidate and appeared destined for the White House.

However, "Boy Bryan" as he was called, lost a close race to Republican William McKinley in an election that historians have largely agreed was fraudulently manipulated by the rich industrialists of the time, such as J.P. Morgan and John D. Rockefeller.

Undeterred, Bryan ran for President two more times in 1900 and 1908 but lost each time.

Had Bryan been successful, a conversion to a silver standard would have been indeed given some sort term relief to ordinary Americans, but it would have flooded the economy with millions of new dollars and been the modern day equivalent of turning on the printing press.

While the concept of free coinage or otherwise turning on the monetary printing presses may have some immediate appeal to people at the bottom of the economic ladder, flooding the economy with massive doses of monetary steroids is massively inflationary and causes more long-term problems than it solves.

It has been more than a century since Williams Jennings Bryan ran for office, but thanks to the retirement of Alan Greenspan, one of the most important offices in the world will soon be filled by someone just as eager to pump the economy full of inflation as Bryan.

Bye bye Alan.

Four Presidents and 18 years. That's how long Alan Greenspan, a Ronald Reagan appointee, has been Chairman of the Federal Reserve Bank.

His long tenure will end on January 31 and President Bush announced that Ben Bernake, a current White House economic adviser, will succeed Alan Greenspan as the Chairman of the Federal Reserve Bank.

On paper, Bernanke appears very qualified for the job. He received a B.A. in economics from Harvard in 1975 and a Ph.D. in economics from Massachusetts Institute of Technology in 1979.

Bernake then taught at Princeton for 17 years before joining the Federal Reserve Board as a Fed Governor in 2002. Bernanke was named chairman of the President's Council of Economic Advisors in June 2005.

The Wall Street crowd loved the news and sent the Dow Jones up by 169 points on Monday. Hip hip hooray!

Helicopter Ben

While I'm not surprised at the appointment, I believe that Bernake's appointment is going to be like pouring gasoline onto an already too-hot inflation fire.

Plain and simple, I think Bernake is possibly the worst choice that President Bush could have made and has doomed our economy for a return to a return to the painful 1970's era of inflation.

I say that because Bernake has left a long and clear paper trail that proves that he will be inflation's best friend.

The best example what in November of 2002 in a speech titled, "Deflation: Making Sure It Doesn't Happen Here," that Bernake gave a telling glimpse of how he will handle periods of financial stress.

"The U.S. Government has a technology, called a printing press...The Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter."

Worse yet, Bernanke has close to zero clue that inflation is even a problem. In a recent congressional testimony, Bernake said that the threat of inflation "remain low and stable based on measures of inflation compensation derived from inflation-indexed Treasury securities."

Yes, Bernanke thinks that the government-manipulated inflation numbers are a valid measure of inflation.

On October 18, the Labor Department reported that inflation at the wholesale level -- the Producer Price Index or PPI -- jumped by 1.9% in September. That is the biggest single-month jump in the Producer Price Index in 31 years and on an annualized basis it pencils out to a 22% inflation rate!

Oh, and if those massaged numbers get too big...just close your eyes and wait for them to go away.

"The stability in core inflation and inflation expectations does suggest overall inflation is likely to return to levels consistent with price stability in coming quarters."

What worries me the most is that Bernanke thinks he is as powerful as the man behind the curtain in the Wizard of Oz.

"If all goes as planned, the changes in financial asset prices and returns induced by the actions of monetary policymakers lead to the changes in economic behavior that the policy was trying to achieve."

Bernanke actually thinks that the function of the Federal Reserve Bank is to manage asset -- stock and real estate -- prices and that central planning works.

"The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost...Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost."

The Goldilocks Economy
July 27, 2005; Page A12

"The central bank has a very important obligation to maintain the stability of the underlying institutions. To the extent that there are large movements in asset prices that threaten the stability or functioning of exchanges or other institutions, the central bank may have to play a role to try to stabilize those institutions, as the Fed did in October 1987 for example."

Hey, if the Federal Reserve Bank thing doesn't work out, Bernanke can always get a job with the Russian Politburo.

The result for investors is pretty obvious.

1. Bond Investors: All you have to do is take a look at how the bond market reacted to the news of Bernanke's appointment. While the Dow Jones soared by 169 points, the bond market got clobbered. The 10-year Treasury note lost 15/32, watching its yield rise from 4.39% to 4.45% and the 30-year bond climbed from 4.61% to 4.67%. The bond crowd is clearly sending a message to anybody willing to hear it.

If you own bonds, keep your maturities very short because interest rates are headed much higher.

2. Gold Investors: Inflation is already high, but it will take off like a rocket under Helicopter Ben. I've never been much of a gold bug, but I am confident that gold bullion and mining shares will do very well under Bernanke's leadership.

3. Other hard assets. If I'm right about inflation, hard assets of all kinds should perform very well. Copper (Phelps Dodge), oil (Exxon Mobile), and timber (Plum Creek) could be huge winners along with real estate of all kinds.

In fact, the biggest winners of all under Bernanke's leadership will likely be real estate investors, who were headed for a big fall when the bubble popped. Bernanke will do whatever it takes to keep real estate prices from falling, including lowering interest rates, increasing money supply, and encouraging relaxed lending standards.

4. Stock investors. The stock market shot up by 169 points for a reason: they're counting on Bernanke to do whatever it takes to keep stock prices from falling.

I suspect they're right...for a while. But like any government intervention, the effects are short-lived because central planning cannot dam up the forces of free markets and capitalism for very long. And when that dam does break, the losses will be even worse than if the nosy bureaucrats had left things alone.

Even Bernanke understands the risks of too much meddling.

"If monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield and a tendency to respond unpredictably."

5.Savers. The biggest losers under Bernanke will be the savers that keep their money in T-bills, short-term CDs, and money funds. Inflation is called the cruelest tax of all because it erodes the purchasing power of people that are conscientious enough to save money. Instead of getting rich slowly, savers will find themselves getting poor slowing under Bernanke.

Williams Jennings Bryan may have been the first American politician to think a country could inflate its way out of trouble, but the appointment of Ben Bernanke to head the Federal Reserve Bank shows that his spendthrift spirit is alive and well today.

INFLATION TARGETING a central bank should publicly establish a preferred rate of inflation and adjust monetary policy to achieve it.

"Currently, the FOMC makes its decisions without an agreed-upon definition of price stability or of the inflation objective, and one wonders how oarsmen pulling in different directions can get the boat to go in a straight line,"

"It's true that the Federal Reserve is already practicing something close to de facto inflation targeting, and I think we've seen many benefits from that. My main suggestion is to take the natural next step and to give an explicit objective, that is, to provide the public with a working definition of price stability in the form of a number or a numerical range for inflation. I think the FOMC's decision-making process would be improved if members shared a collective view of where we want the inflation rate to be once the economy is on a steady expansion path.

"Currently, the FOMC makes its decisions without an agreed-upon definition of price stability or of the inflation objective, and one wonders how oarsmen pulling in different directions can get the boat to go in a straight line."

"I think the FOMC's decision-making process would be improved if members shared a collective view of where we want the inflation rate to be once the economy is on a steady expansion path."

FED COMMUNICATION . He argued at the Fed that central bankers could improve the effectiveness of interest-rate policy by offering more information on their economic and policy views.

"From a communications viewpoint, financial markets would be well served by knowing the medium to long-term inflation objective of the Fed. An explicit inflation objective would help market participants accurately price long-term assets, both by anchoring long-term inflation expectations and by giving the market better information about the likely path of short-term policy as the Fed moves toward its long-term target."

In a January 2000 Wall Street Journal opinion column titled "What Happens When Greenspan is Gone?" Bernanke and two coauthors stressed the importance of continuity at the end of the Greenspann's term, and argued that inflation targets would promote it.

"Inflation targeting is a monetary-policy framework that commits the central bank to a forward-looking pursuit of low inflation -- the source of the Fed's current great performance -- but also promotes a more open and accountable policy-making process. More transparency and accountability would help keep the Fed on track, and a more open Fed would be good for financial markets."


Tony Sagami

Author: Tony Sagami

Tony Sagami
Harvest Advisors.

Tony Sagami

Tony Sagami is the owner and founder of Harvest Advisors, an investment research and money management company. Sagami has been managing money for more than 20 years and is one of the early pioneers in the application of technical and quantitative analysis to mutual funds and stocks.

Tony is a man that wears several hats. In addition to Harvest Advisors, he has launched several successful technology companies. Tony is the owner of Monocle Systems, a popular investment analytical software program that has been used by thousands of professional money managers and sophisticated individual investors. Tony is also co-owner of AdvisorSquare, one of the largest web design and hosting companies in the world.

Tony is a frequently quoted expert, appreciated for his frank and unconventional view. Tony has appeared in publications such as the Wall Street Jouranl, Barrons, Kiplingers, Smart Money, Business Week, New York Times, Washington Post, Investors Business Daily, Bloomberg, Financial Planning Times, Mutual Funds Magazine, Chicago Tribune, LA Times, and many others.

A graduate of the University of Washington, Tony enjoys coaching youth sports, serving his community as an active Rotarian, and exploring the all the beauty that Montana has to offer. Tony is a Paul Harris Fellow, an Eagle Scout, and married to his first-and-only wife and father of 4 wonderful kids.

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