- Analytical, Socio-Political Market Commentary -

November 10, 2010 (FinancialWire) (http://www.financialwire.net/) (By Dr. Joe Duarte) (Entire article at http://www.investrendsyndications.net/12-content/manl/duarte/2010/11/php/10.php) – The S&P 500 SPDR ETF (AMEX: SPY) may take a breather as money moves into the U.S. Dollar Bull ETF (AMEX: UUP) and other places, perhaps the sidelines.

Much of what is going on in the markets now, has to do with the Fed’s quantitative easing moves, better known as QE 2 where the central bank will be printing money in order to buy treasury bonds and replace lost cash in the banking system and the economy.

The Federal Reserve is taking a lot of heat for its latest round of quantitative easing. Critics ranging from the least likely, Sarah Palin, to the most predictable, all the governments who want to replace the U.S. as the world's number one economy are weighing in negatively against Mr. Bernanke's latest attempt to keep the U.S. from falling into an economic abyss.

Let's set the record straight before anyone gets all worked up about this. We were one of the first services to report on the inside activity that was taking place on Wall Street and have consistently expanded the theme of what "structural" means to the economy. So, we're not exactly applauding the Fed for printing money. Yet, it seems a bit disingenuous for the entire world, which bases its financial house on Fiat money, just like the U.S., to balk at another round of money coming hot off the presses in Washington.

And we are not beating up on the increasingly popular Ms. Palin. Yet, Ms. Palin, doesn't seem to be looking at all sides of what's at stake here, although she seems to have good intentions, when she chides the Fed for printing money out of "thin air" in order to accomplish the quantitative easing. Where does all money in the world come from anyway? Thin air. That means that for the last thirty years, every Dollar, D-Mark, Peso, Peseta, and lately Euro, Yen, and oh yeah, the Yuan, is just paper that comes out of thin air. That's why it's called a Fiat monetary system. And it's been around since the gold standard was abolished.

That means that Ms. Palin, and everyone else who uses money has been passing paper backed by air from one place to another for decades. So forgive us for wondering why suddenly, it's chic to moan and groan about the Fed printing money, especially when it actually makes sense to do so.

Fiat money is responsible for the huge economic advances in the world over the last several decades. As money exchanges hands, it multiplies. And the more it changes hands, the more of it that seems to be available, which eventually leads to the so called wealth effect. It feels good to be wealthy and secure.

Unfortunately, Fiat money is also responsible for the rise in financial engineering, fraud, bubbles, and just about every negative event that has to do with finance, since its inception. But make no mistake about it. All money, not just the stuff that the Fed is about to print, but every Ruble, Euro, and so on, is Fiat money, and is backed only by the "legal tender" promise of the issuer, and the faith of the people who use the paper on that promise. As long as the issuer says that it's "legal tender" and those who use the currency believe that, it's good, and commerce continues.

Fiat money is all there is, other than gold, which has a certain mystique and perceived reliability as a store of value when Fiat money fails. Yet, no one knows how gold would serve as a currency in the current economy, which is based on the implied "legal tender" pact between governments and people.

So, Ms. Palin has her political motivations, and perhaps presidential aspirations, and likely good intentions when she beats up on the Fed. And, no the Fed isn't perfect. Greenspan missed the bubble's existence until it was too late. And yes, Greenspan helped to create the bubble, backing subprime mortgages, and lowering interest rates to zero after 9/11. So did George Bush, and so did Bill Clinton, who started the whole thing rolling along with Barney Frank, Christopher Dodd, and a whole host of others who are both in and out of Congress and public life now with their push for everyone to own their own home.

But what's really crummy is that Europe, China, and others are beating up on the Fed, especially when their economies are benefitting from the economic decline in America. Sure, their beef is that a falling dollar, which is not a good thing for America, is fueling U.S. exports to their countries, and by Gosh, competing against their domestic goods. That's not good is it? No. They want their own currencies devalued so that Americans can buy their goods.

What they don't realize, is how precarious their situation would be if the U.S. economy, as many secretly or not so secretly hope for, totally collapses, a development that could occurr if the Fed doesn't act, via its only unused tool, the printing presses.

Left out of the discourse by China, Europe, and Ms. Palin is the fact that bad policy for the last three decades, ie. deficit spending, and a lack of foresight toward education, manufacturing, and job creation in the U.S. have contributed significantly to the current mess.

The bottom line is that the Fed, has little in the way of options but to print money, close its eyes, and hope for the best, because the policy machine in Washington isn't going to crank out anything useful for the long term and because the "sructural" problems are so huge and ingrained into the system that it will take decades for them to be corrected to the point where America is once again functional.

What are the structural problems that Ms. Palin may not have counted on? On September 29, in this space, we enumerated them as follows:

"First, automation has replaced human labor for the last twenty years. And those human jobs are gone, forever. That means that high numbers of unemployed people are a permanent part of the landscape. The global governments have set up a welfare system to pick up the slack for the joblessness. But that's not good enough. What was required was the establishment of a new job paradigm, where the displaced would become the safety net by providing services to help others in need as the automation wave killed more and more jobs."

"Second, the maldistribution of wealth has finally hit the point of no return at the same time that funny accounting perfected the art of graft and corruption. The subprime mortgage crisis sold worthless bonds backed by empty houses and mortgages that could never be paid for to unsuspecting investors. They packaged those loans into CDOs, and sold them as AAA rated bonds. What's more is that investors counted the packages of air as real assets on their balance sheets. And they are still counting them as assets. Now they are known as toxic assets. But they are still worth nothing. And they will never be worth anything because the houses are still empty, the people who bought the mortgages can't be found, and the mortgages are just dead paper."

"And third, the smart guys who pocketed the money from their bets against the subprime mortgages, aren't going to give up the money or use it frivolously. That means that those billions of short selling profits are off the table. That's money that could have made its way into investments and into the coffers of pension funds, as well as fund innovation and create jobs."

Our conclusion, which is fairly irrefutable is: "what the phrase structural problem means, that there is something really wrong with the system, like the system has no money, or more specifically, not enough money to fund all of the promises that it has made," because the money was never really there, and the portion that truly existed is now in the pockets of the smart guys who bet against the mortgages that were created by crooks and bought into by not so bright people.

Finally, those who are railing against quantitative easing should consider this, which we also noted on 9-29: "The U.S. government is broke, as are most of the major Eurozone countries. There is no way to tell whether China is also blowing smoke, because they lie about everything, and no one wants to challenge them right now. Corporations and the truly wealthy don't want to spend any significant amount of money, because they know how messed up the system really is" and they want to have reserves around in case the whole system implodes.

The Fed may well stoke inflation, and the dollar may indeed collapse as a result of the quantitative easing. But, there is a chance that if the Fed plays its cards right, the quantitative easing may actually do a lot more good than people expect.

Will that cure America's ills? Will that right the ship of state in Washington? No, at least not completely. The culture of greed, fraud, and self-interest is too broadly entrenched now. But it if works, it could restore America's economy enough to keep the barbarians at the gate back long enough to make life hard and to delay, and perhaps thwart what some are calling inevitable, China's ascension to the number one economy in the world.

To be sure, this is a risky strategy. And it is one that could backfire. But, at the end of the day, by burning the proverbial ships, Bernanke has drawn a line in the sand. The U.S. is still, until proven otherwise, the financial leader of the world, albeit a battered and bruised one. If it weren’t, then why would everyone be complaining?

Yes, the bruises and the bleeding are mostly self-inflicted. And yes, given what took place, conceptually deserved, although no one should suffer what some innocents have suffered during this economic contraction.

But at the end of the day, Bernanke is doing all that he can. He may be too late. But it's the fear that he may get lucky that is bringing out all the boo birds. The fact is that lots of people would like to see the U.S. fail at this point, for various and self-centered political reasons.

We'd like to see the quantitative easing work. The world's financial system is based on thin air anyway. Why change it now? What's the hurry?

What we would like to see is that people have learned their lessons. It would be nice to see politicians tell the truth and for the White House to understand that a Capitalist country wants to remain Capitalist, not some weird social hybridization laboratory. It would be nice to have the education system teach kids about what money really is, paper backed by promises. It would be nice to see people live within their means, pay their taxes, and love thy neighbor.

Call us naive, or even stupid. But at least we can see that the issue is complex, that the damage to the system is both ingrained and not easily reversible, and that the alternative to quantitative easing, would likely be economic stagnation, or even the collapse of the world economy.

Inflation happens when there is too much money chasing too few goods. Right now, there isn't enough money and too many goods, the opposite. If you want a view into the future without quantitative easing, look at Japan, the land of no demand, oversupply, and never ending stimulus packages.

Think of it this way. Bernanke is not inflating the system. He's actually putting money into circulation that evaporated during the crisis and that is never coming back. He's actually bringing the system back to even. In other words, the reason that the crisis has been so bad is that money that was supposed to be there, never was, and will never be there again, unless Bernanke prints it.

Pardon us for expressing our opinion, but oblivion is not a good alternative, no matter what your politics are. So, go ahead Ben, print away. You and your predecessors have been doing it for a long time and no one ever complains while the piles of worthless paper are pushing up asset prices and creating bubbles.

(Go to http://www.financialwire.net/?s=drtjby to see more commentaries by Dr. Joe Duarte, and go to http://www.financialwire.net/2010/05/01/about-duarte/ for more about Dr. Duarte.)

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