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Bill Fleckenstein

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Posted 6/30/2003

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Read “Monetary Policy in a Zero-Interest-Rate Economy”

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Contrarian Chronicles
Fed's truly scary idea: tax you into spending
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It's positively diabolical. Some Dallas Fed economists suggest perking up the economy by taking a piece of every dollar you have the gall to save.

By Bill Fleckenstein

There's always a loss of pride involved when we own up to our mistakes. It's a moment in time, though. It passes. Then we are enriched for what those mistakes have taught us. But when pride turns into hubris, there's no learning from one's mistakes. In fact, hubris sometimes drives the need to actively cover them up. That is the story of our Fed.

A few weeks ago, I was sent a paper by Evan Koenig and Jim Dolmas of the Federal Reserve Bank of Dallas, titled "Monetary Policy in a Zero-Interest-Rate Economy." I started to write up my thoughts about it, but I was so incensed that I had to set them aside. I returned to the paper recently, only to feel the same sense of outrage. What it proposes is one of the most maniacal, diabolical ideas this group of idiots has come up with so far. I urge everyone to read this paper and consider what its implications are. This will be on the final, guaranteed. To read the text of the paper, click on the link at left.

Fed pens Frankensteinian nonfiction
Koenig and Dolmas start out by not understanding that deflation is a consequence of prior policy actions that create a bubble and have severe economic consequences. They fall into the trap that many people do, thinking that deflation is a disease, rather than the symptom of a previous disease -- wildly excessive monetary policy and the misallocation of capital associated with it. What they do is talk about how our experience in the 1930s and Japan's problems were a function of central banks not acting quickly enough. They fail to recognize that the problem is a function of the fact that the central banks acted like complete drunken fools in the first place. That precipitated the ensuing economic problems -- and today's environment that doesn't have enough inflation to suit the Fed.
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They then go on to talk about the challenges of, in essence, diddling the market in a near-zero-interest-rate environment. (In the past, I have likened this to the problems encountered by physicists near a black hole. Things are just different.) The Fed is so panicked about the stagnant economy that it's thinking about resorting to mad experiments to get its own way, i.e., make the economy do as it commands. Now as regular readers know, I don't really expect to see deflation. But the fact that the Fed would contemplate these measures is absolutely frightening.

Capital punishment for savers
There’s a lot of chatter in this paper about the Fed helping the economy by buying real goods and services, or other domestic securities, such as longer-term Treasurys. But here’s the most staggering idea in the paper: It contemplates taxing your savings.

Koenig and Dolmas propose what they admit is a radical idea: a "stamp tax." In this, a currency would have to be stamped periodically, and you would be charged for your currency, "in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative, nominal interest rate the central bank desired." They toss out a few numbers, say 1% a month, to validate your currency. In other words, it would cost you 12% a year to have the gall to save money.

So basically, these unelected morons are contemplating a new law -- "Thou shalt not save, thou shalt spend." And, if you don't, we're going to confiscate your money, via a tax, after we've already confiscated your money via debasement.

It is truly breathtaking to witness the measure of hubris, arrogance and wanton disrespect of people's money on the part of these idiots. That they would even entertain the idea of such a penalty (not that they will necessarily be able to get away with it) boggles the mind. That's the mindset of this group of lunatics, that it would cast itself as a dictator from ancient times, with the public there to do its bidding.

Meantime on Wall Street, the current mindset can best be described as remarkably bullish. Investors Intelligence recently reported that that its investor sentiment index indicated 60% bulls and just 16% bears -- a reading that has not been more lopsided since the spring of 1987, which I believe is saying something. I myself have not been operating bearishly, as I have been waiting for this rally to play itself out. I have a very dim outlook for the second half. Yet virtually no one seems to share that view, other than my good friend Fred Hickey, editor of the influential High-Tech Strategist newsletter, or Morgan Stanley chief economist Stephen Roach (more about him in a minute). As I continue to reappraise my assessment, I ask myself, what is it that these folks see that I do not see? Why is it that they are so lathered up about this particular moment in time?

A few things come to mind that separate the environment right now from other bear market rallies:
  • Many people were just tired of being bearish.
  • The market has been rallying for a time now, and it's currently up on the year.
  • In February and March, many folks feared terrorism and war. Those fears in particular made me nervous about being short back then (i.e., folks were bearish for the wrong reasons). But these reasons don't tempt me to change my view.

Lip service vs. embracing the bubble
More importantly, it strikes me that many people fail to understand that we had a bubble, and that it has created long-lasting, unavoidable repercussions. They can say the words, "We had a bubble," but they never get beyond that to accept the implications. So, when you put a summation sign in front of all this, it adds up to folks being particularly optimistic (more so than at any time in 16 years) about right here, right now, when in fact, it's just another bear market rally and rate cut.

Perhaps the cumulative effect of the previous 12 cuts will make the 13th magical. Perhaps the cumulative effect of what's gone on from a downsizing standpoint may matter. Perhaps the economy will see a bounce, but I find it unlikely that we will see anything more than that, if we even get that. To summarize, the bulls have yet to come up with a persuasive argument for their case. I still firmly believe that the second half is going to be a disappointment, both in the economy and the stock market.

Sentiment is getting set up for a letdown
Further, since so many people have swung their views around so hard, betting heavily on second-half wonders, I believe that sentiment is now more binary than ever. If disappointment starts to rear its ugly head, we will see a real wipeout in the equity market. That could happen later this year, even if the economy does better for a short period. (As an aside, and to repeat my recent comments, the Fed has now positioned itself so that in the event of an economic recovery, the law of unintended consequences might surface, in terms of a bond market wipeout -- especially if the Japanese bond market starts to decline.) And that's the situation in which we find ourselves, with very few skeptics remaining. Yet, the people making the bullish case, though they could possibly turn out to be right, have nothing new to bolster their prior arguments, which have not worked.

Click Here!
The only person who inhabits the Wall Street mainstream and has voiced concern about the bubble and its aftermath these past three to five years is Stephen Roach. In his piece titled "Endless Bubble," he paints the picture of a Fed in the serial bubble-blowing business. First, the Fed created the stock market bubble. Now, to try to solve the problems of the bust, it's creating a bubble in the bond market. "The result," he writes, "is a seemingly endless array of bubbles that only heightens the perils of the post-bubble endgame. . . . The legacy of these bubbles is a sad testament to the excesses of an increasingly wealth-dependent U.S. economy: Consumers have now become addicted to the 'extra' purchasing power they can extract from overvalued assets." This is as succinct and brilliant a discussion as you'll find on the subject.

Time to own up to the bubble
My favorite part, however, was his conclusion: "The biggest difference between my bearish view of the world and the more sanguine views of others can be traced to the bubble. More than three years after America's equity bubble popped, there is an understandable temptation to believe that it's time to move on. A massive dose of fiscal and monetary stimulus, in conjunction with a sharp rebound in the stock market, adds to that conviction.

"As I see it, however, the legacy of this monstrous bubble endures -- not just in financial markets but also in the form of the excesses that it has fostered in the real economy and in its balance-sheet underpinnings. Until those excesses are purged, I maintain my view that America still needs to be seen through the lens of a post-bubble workout. As one bubble morphs into the next one, the moral hazard dilemma only deepens. And the endgame -- including the risks of deflation and a dollar crisis -- appears all the more treacherous."

Editor's note: Last Wednesday, following the Fed's announcement that it would cut rates 25 basis points, Bill Fleckenstein weighed in with his comments. To read them, click here.

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for's RealMoney. At the time of publication, he had no positions in any securities mentioned in this article. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money.

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