From Jeffrey Snider first posted at RealClearMarkets
Bernanke Employs a Modified 'Pump and Dump'
Gold is not money, according to Federal Reserve Chairman Bernanke.
When pressed on the subject, he demurred that banks, including, I
presume, central banks, continue to hold gold due to nothing more than
"tradition". Thus, he feels there is a vast difference between dollars
and gold. It is curious word for him to choose because Mr. Bernanke is
actually correct, but probably not in the way he intended with his
unspoken pejorative connotation, politely dismissing any value for the
Value itself is nothing more than the outward expression of
individual faith. The traditional value of money is really just an
outgrowth of its historical reputation, earned through so many actions
and consequences. Money may seem to add a level of objectivity into the
discussion of value, but that is only because of a more universal
"faith" in the transactional price discovery process it allows.
This discussion of "tradition" in the context of "value" is the
central problem of our financial age. The question of faith in
valuations is at the very heart of the ongoing crisis, infecting all
facets of finance and economics. Almost three years after a major
banking panic, we are still wrestling with the idea of valuations, and
more innately, value itself. Economic and financial unease and
uncertainty trace their roots to the shaky valuations that have been
provided or interjected into every marketplace, keeping up with the
grand tradition of fiat currencies and centralized policy.
For example, U.S. treasuries are supposed to be, pardon the pun, the
gold standard of riskless assets. Yet they are increasingly questioned
(ask Bill Gross and China). The value of the paper is a derivative
function of the ability to tax, as in full faith and credit of the
United States. But the same is also true of Greek paper, as sovereign
Greek debt derives its value from the Greek government's ability to tax.
Yet U.S. debt is more "valuable", in money terms, than Greek debt
solely because the Greeks have a "tradition" of default while the U.S.
does not. Tradition matters.
By engaging in quantitative easing, the Fed is creating cash for
primary dealers that, it hopes, will be used to fund the purchases of
"riskier" assets. But those additional purchases only push up the
momentary price of the asset, so this flow needs to be ongoing otherwise
it is supremely susceptible to reversal. This means a constant state of
interference. After establishing such a flow and the follow-on
"favorable" price trend, the ensuing faith that higher prices are
supposed to generate is thought to lead directly to spending "velocity",
which yields economic flow and a healthy economy. That is the theory of
the "wealth effect". It is being practiced on both sides of the
Atlantic with equal fervor, though with slightly different mechanics.
If prices are the independent variable in the economic equation, that
is, the x-factor that needs to be manipulated, then why not just remove
the marketplace and mandate specific valuations? Why go through the
charade of "managing" a market-based price discovery process? Greece
would not need restructuring if the European Central Bank simply decreed
that it would convert all Greek debt at par, setting the universal
price. After all, Greek principal and interest payments are denominated
in euros, so the ECB can easily supply them.
The answer here is that value in any human economic system cannot be
directed by diktat or fiat order. If it could, central banks would have
done it by now. Instead, value is conferred by scarcity . In engaging in
market manipulations to create the appearance of monetary values for
financial and derivative financial assets, central banks have turned
value on its head by making money plentiful. Plentiful money has always
Anyone with the means, and that includes those that hold the power of
money printing, can pay $1 million for a stick of gum, but that only
establishes a price, not a wider acceptance of value. But that is what
central bank intervention is, the establishment of price in a narrow
way. Greek debt scarcity and its attendant real value are governed by
the perceived ability to repay, a direct link to the quantity of debt
for a given tax base. If the market perceives a stable or declining tax
base but the Greeks issue twice as much debt at a consistent price, the
level of scarcity falls in relation to repayment probabilities,
affecting the larger question of value.
It does not matter if the ECB buys a substantial portion at par; the
larger system is not fooled into blindly believing in scarcity, or that
price action equals true value. The marketplace will instead buy on the
foolishness and irresponsibility of the central bank, buying up all
Greek debt solely on the ability to pawn it off on taxpayers at an
unearned profit. But even here, it only works as far as faith in the ECB
and the euro is maintained, since value has not really changed. The
central bank interference is nothing more than a game of musical chairs,
with risk investors willing to play as long as they believe the music
will keep playing. The second the music stops, that entire intervention
and managed price discovery becomes irrelevant as the assets suddenly
This is the essence of central bank liquidity management: ensuring
that marketplace actors have enough money to prop up prices. But all
that liquidity fails if there is no implicit, sometimes explicit,
backstop of central bank guarantees. Moral hazard is fully acceptable
because without it many more markets will find themselves bidless. This
is the opposite of what investing is supposed to be - buying assets with
the hope that the rest of the world never finds out what they are truly
In fact, successful investment is predicated on buying something
valuable before the wider world recognizes that value, with the greatest
hope that the rest of the world will see that value. Investment scams
work because they get a small audience to believe that they are
discovering something valuable just before the rest of the world makes
the same realization, meaning the subject of the scam is presented as
undervalued by current prices.
In a way, central banks are engaged in nothing more than a modified
"pump and dump". They are attempting to create the illusion of value
through price action. By maintaining high valuations due almost solely
to their own purchases, they hope to "attract" additional investors into
the process. Whereas the exit plan of the traditional version seeks a
higher price to disgorge the schemer's original holdings, the legal,
central bank version is trying to buy public faith in order to disgorge a
larger acceptance of a return to normalcy. In both cases, the public
gets abused - suckered investors in the first, taxpayers in the second.
Contrary to Chairman Bernanke's meaning, in this vital respect
tradition and reputation are far more important, not less. The more
central banks fool investors into placing money into investments of ill
repute through these legal confidence schemes, the less faith about the
wider marketplace they will engender. There is already considerable
damage to reputation after the great pains the ECB took in 2010 to
repeatedly assure investors that Greek, Portuguese, Irish, Spanish, and
Italian debt were safe and secure. Any investors that committed to
purchasing such debt as a result of these assurances have fallen prey in
the same way stock investors are taken in by illegal "pump and dump"
Considering the potential losses that the ECB, now heavily assisted
by China, continues to create as all the PIIGS persist in issuing
billions of euros in new debt, central banks are building on their own
tradition of dishonor. Now the debate is about what kind of default
should be employed by Greece; essentially who should be identified as
the Greatest Fool.
The Federal Reserve, for its part, has added to its own fine
tradition. Before the crisis, the Fed used much of its credibility to
"assure" markets that everything was fine, right up and into a
full-blown panic. After the panic, the Fed lost still more credibility
on assurances of monetary efficacy with regard to the recovery, yet no
recovery exists. It proclaims a job well done in "saving" millions of
jobs, to the amazement of any impartial observer.
Trillions of dollars have been used on price discovery, especially in
the stock market, but 45 million people continue on food stamps and the
average duration of unemployment is now twice the previous record.
Banks are enjoying healthy profitability, assisted by loan loss
accounting, at the same time withholding credit from all but the largest
obligors. Individual American savers who are doing everything right are
bearing the brunt of all this monetary success, as zero interest rates
transfer money from them to the very banks that colluded in creating
this disaster in the first place.
Those that have the means will always dilute currencies. It is the
greatest temptation of any fiat regime - the easy answer to all the hard
problems. No one has to lose money if it can be created out of nothing.
It sounds like the path to financial and economic paradise but it is
the devil's bargain. No matter how much money they print, it will never
be circulated fairly enough.
Market discipline, no matter how brutal, is at least objective and
often meritorious, an acceptable condition to free people - free to
succeed, free to fail, all regardless of size or stature. General
interference, including fiscal interjections such as General Motors and
Chrysler, breeds distrust. Fiat is simply an invitation to chaos and
discord, so three years of ongoing uncertainty is wholly unsurprising.
Price discovery due to interference is not really price discovery at
all, meaning the larger class of investors will never fully commit or
regain faith. If the game is rigged, fewer and fewer will play.
The interbank money markets are now, invisible to the broader public,
tightly in the grips of amplifying turmoil because banks simply do not
believe in each other's prices. Banking rules allow German and French
banks, among others, to hold PIIGS debt at par on their books,
establishing a price for their credit portfolios that no one actually
believes (the very same problem as 2008, so much for progress).
Instead of transforming these artificial prices into increased faith
within the intercontinental banking system, especially the eurodollar
market, they have unleashed nothing but havoc. The mass of overnight
lending activity has shifted out of unsecured transactions into
collateralized loans whereby U.S. treasury bills are now the only
accepted collateral - fewer and fewer institutions are willing to play
the unsecured lending game. So we see the general collateral rate, for
the first time in history, fall below zero. Inspiring confidence is not
how I would describe this action.
For Mr. Bernanke and his contemporaries, gold's traditional value is
not in question, which is probably what Congressman Paul's query was
driving at. Rather, it was the value of fiat in light of its well-earned
and sordid reputation that was being indirectly questioned.
Ironically, it is the ongoing tradition of central bank intervention
and currency devaluation that is shining the brightest light on gold's
intrinsic value. You may not be able to eat gold, but it is a constant
reminder of the constraints that it places, even in our modern times, on
central bankers - earning their scorn and pejorative dismissal. There
is a reason that Americans' private gold holdings were confiscated by
executive decree in 1933; they offered actual protection against the
currency devaluation that was being planned. Gold is the foil, the
opt-out, of every central bank confidence scheme.
Central banks are betting the financial health of their constituents
on the theory that they can buy prosperity. Just like the eccentric art
collector that vastly overpays for some obscure artist's original work,
the Fed and its global counterparts are hoping that the rest of the
world comes to see what they see, to value what they have valued. They
are hoping that the prices they establish through narrow transactions
become universally accepted as true value. If not, then the central
banks will once again transfer to the rest of us the cost of eating