Thread: Bernanke To Light the Fuse on Monetary Inflation Bomb

Bernanke To Light the Fuse on Monetary Inflation Bomb

Economics / Inflation
Oct 06, 2010 - 05:44 AM

By: Gary_North

It is always a good idea to pay attention to new words or phrases that seem to have no connection with any previous word or phrase, and which are not self-evident. Such a phrase these days is "quantitative easing." When we hear a phrase like this, we should think through the implications of what this phrase probably means.

The new phrase may be a euphemism. A euphemism is a substitute phrase for a practice that is considered questionable or even wrong. The new phrase is substituted in order to tone down the contrast between what people regard as right and what they regard as wrong. We used to have a phrase for such a concealed practice, but it fell out of favor over 70 years ago. A euphemism was substituted for it by W. C. Fields in the movie, My Little Chickadee. He called it "the Ethiopian in the fuel supply."

In the British sitcom, "Yes, Prime Minister," there is a delightful scene in which Humphrey explains to Prime Minister Hacker what "modernist" means. It's on YouTube.

Here is a popular phrase that we hear in the media from time to time: "undocumented worker." It is a euphemism for the better-known phrase, "illegal alien." We can be certain that a writer who adopts this euphemism, as well as the journal in which he publishes his phrase, is hostile to the idea of doing anything about illegal aliens. He is probably attached to a political party, or faction within a political party, that wants to avoid dealing with the question of illegal aliens.

Another phrase that we use to describe such euphemisms is "politically correct." Something that is politically incorrect is covered up by a phrase that is considered politically correct. Politics shapes the language of acceptable discourse. Many colleges and universities have anti-free speech codes that are examples of political correctness. Students are to avoid using certain phrases because of the emotional pain that these phrases have on the listeners or targets of the phrases. Note: the use of the term "you fascist" to identify a political conservative is not on most of these lists. I have not heard if "male chauvinist pig" is prohibited. Maybe it just got archaic.

This is why I am fascinated with the phrase, "quantitative easing." The first time I heard it, I had a mental image of a man suffering from an extreme case of diarrhea. I am sure that the person who came up with the phrase "quantitative easing" did not intend that it should have any such mental effect on the listeners. The reason why the phrase produced that response in my mind is simple to explain. Over half a century ago, there was a conference on inflation that was sponsored by a nonprofit research organization. One of the attendees was United States Senator Wallace Bennett. His son, Bob Bennett, recently lost the Republican Party's re-nomination for Senator. Unlike his son, Wallace Bennett was an astute businessman who understood economic theory. He provided the finest description of price controls that I have ever heard. He said that price controls are the equivalent of using adhesive tape to control diarrhea.

MONETARY INFLATION

The phrase "quantitative easing" is a euphemism for monetary inflation. We are told that the Federal Reserve System or some other central bank may soon adopt a policy of quantitative easing. Whoever says this does not want to use the words "monetary inflation." Why not? Because, when people hear the words "monetary inflation," they think that this sounds bad. They think that it means that the government or the central bank is about to indulge itself by expanding the money supply. This is exactly what it does mean.

Because of this politically negative connotation of the phrase "monetary inflation," those Keynesians who believe that monetary inflation is the only sure way of re-establishing economic growth have been in a quandary for a long time. They do not wish to convey the negative implications of the policy that they are recommending. They seek to find another way of justifying the policy, which means that they want to avoid the negative connotations of their policy.

The policy of quantitative easing, if extended long enough, moves from monetary inflation to monetary mass inflation, and from there to monetary hyperinflation. The outcome of monetary mass inflation is usually mass price inflation. I regard this as a rate of price inflation above 20% per year.

If a central bank indulges itself with monetary inflation, we can be certain that the policy will distort the allocation of resources. It may lead to an economic boom, but that boom will become an economic bust whenever the policy of monetary inflation is predicted widely by economic investors and consumers. They will begin to take steps to protect themselves against the effects of monetary inflation, and this creates the final bubble that precedes the economic crash. We saw this in 1978–80. We saw it again in 2004–7. This boom, bubble, crash sequence is the Austrian theory of the business cycle in action.

So, now that the economic recovery in the United States and Western Europe seems stalled, economists and central bankers are looking for a way to re-establish strong economic growth, which will lower the rate of unemployment, increase corporate profits, and increase tax revenues. The planners need revenue to alleviate the enormous budget deficits that Western governments are running. Keynesians believe that the expansion of the money supply will lower interest rates, and businesses will then borrow more money in order to increase the construction of buildings, buy more capital goods, and hire unemployed workers.

The problem Keynesian policy-makers face today in the United States and Western Europe is this: interest rates are at historic lows. In the United States, 90-day Treasury bill rates are in the range of 2/10 of one percent. This has not taken place since the darkest days of the Great Depression in the 1930s.

At present, the Federal Reserve System is not expanding the money supply. Monetary policy has been flat for almost a year. With monetary policy flat, there must be another reason why 90-day Treasury bills are at this low rate. Furthermore, 30-year Treasury bonds are at historic low rates. Low long-term rates are consistent with monetary stability or deflation.

There is great confusion about this in the financial press. Here is a recent example. The writer is summarizing remarks made by Paul Volcker regarding Federal Reserve policy. Volcker warned against new monetary policies, which are likely to produce price inflation. He said that he does not think price inflation is an immediate problem, but he worries about Federal Reserve monetary policies that would lead to price inflation. Obviously, he was talking about quantitative easing.

The author of the article pointed out that Volcker was in charge of the Federal Reserve during the period in which the Federal Reserve's policies produced double-digit interest rates: 1980–81. This in fact was the case. The Federal Reserve slowed what had been a double-digit inflationary expansion of the money supply. In slowing the rate of monetary inflation, the Federal Reserve produced high short-term rates and a major recession. Volcker was criticized at the time by businessmen, since his policy had produced the recession.

The author then contrasts today's policy of the Federal Reserve with Volcker's. "Today, Fed Chairman Bernanke is taking an exact opposite approach against a very different backdrop, using super low interest and asset purchases. . . ."

There is a major problem with this assessment. The Federal Reserve System over the past year has been even tighter with the monetary base than Volcker was in 1979 and 1980. The Federal Reserve doubled the monetary base exactly two years ago, and it did so in less than a month. But, since then, the Federal Reserve has adopted a relatively stable money policy. So, whoever wrote that article has not paid regular attention to the statistics and charts that are published by the New York Federal Reserve Bank and the St. Louis Federal Reserve Bank.

LOW INTEREST RATES

The low interest rates that we see today are the result of falling demand for loans on the part of businesses and also the unwillingness of local banks to lend to local businesses or even the United States government. Instead of buying Treasury bills, commercial banks are increasing their holdings of excess reserves at the Federal Reserve. Nevertheless, interest rates have fallen dramatically on Treasury debt. This is not because there has been quantitative easing; it is because there is enormous fear in the hearts of businessmen and bankers regarding the temporary nature of the present economic recovery. Investors buy T-debt for safety. They are scared.

The financial press rarely discusses this. You virtually never see an article in the mainstream financial press, or anywhere else, that talks about today's historically low interest rates in terms of the Federal Reserve's policies in 1931 and 1932. In those years, the Federal Reserve held the monetary base flat. It did not deflate. It simply stopped increasing its holdings of U.S. government debt. During that two-year period, which is comparable to the two years since October of 2008, the FED sat on its hands. This is basically what the FED has done over the last two years. The results in the 1930s were extremely low interest rates on Federal debt, and we see this again today.

The question then is this: What effect will an increase of purchases of Treasury debt by the Federal Reserve System have on Treasury interest rates specifically, and interest rates in general? Today, the answer is: nothing much. If businesses will not borrow much money at today's low rate of interest, and if bankers are unwilling to lend to businesses at these low rates of interest, but prefer to hold excess reserves at the Federal Reserve for almost 0% interest, then the Federal Reserve's increase of the money supply will have only short-term effects. The money will be spent by the Federal government, or by whichever owner of the debt sells to the Federal Reserve, but after the initial spending of this newly created money, the multiplying effects of the fractional reserve banking process will not take place. The Federal Reserve cannot change the minds of businessmen or commercial bankers merely by increasing its purchase of Treasury debt.

PREPARING FOR MASS INFLATION

If the general investing public ever perceives that the Federal Reserve is about to launch a new program of mass inflation, one which is comparable to what it did in October of 2008, then investors will begin looking for historic inflation hedges. Commodities have historically increased in price during times of mass inflation. This especially includes gold and silver. It has also included oil.

We have seen increasing discussions of the possibility of quantitative easing by the Federal Reserve, and we have also seen rising prices for precious metals. Oil has not fallen significantly below $80 a barrel for any length of time. Yet there is not much of an economic recovery, so the demand for commodities appears to be based on a fear of quantitative easing.

Despite the fact that the Federal Reserve has not been expanding the monetary base over the last year, and despite the fact that commercial bankers have refused to increase lending, the commentators in the financial press continue to talk about the possibility of the restoration of the program of quantitative easing. No matter what Bernanke says, and no matter how the votes actually go in the Federal open market committee, commentators keep talking about quantitative easing.

I think this indicates a preference for the policy of inflation on the part of the major financial media. They do not like the results of the prevailing tight-money policy of the Federal Reserve. So, they call on it to loosen monetary policy. They indicate that recent supposedly loose monetary policy has driven down interest rates, and they suggest that an even looser monetary policy will drive them down even further.

The problem is, you cannot drive down Treasury bill rates below zero. You can drive down 30-year T-bond rates to under 1%, assuming you buy enough T-bonds, but if the fractional reserve process of multiplying deposits is no longer functioning, then the expansion of the monetary base will not have major repercussions in the increase of M1 or the increase of the M1 money multiplier.

The Federal Reserve can control directly the size of the monetary base, but it can only indirectly control what banks do with the monetary base. It has chosen to leave banks alone, other than for an occasional speech recommending that they start making loans again. The speeches have had zero effect on bankers, and I doubt seriously that they were ever intended to have any effect on bankers. The speeches simply indicate the kind of good faith promise on the part of officials with the Federal Reserve System. "We're doing all we can," officials tell the media.

When we hear of quantitative easing, we are not supposed to think mass inflation. Yet, if the effect of quantitative easing really is to restore confidence in the economic recovery, thereby encouraging businessmen to start borrowing again, and thereby also encouraging commercial bankers to start lending again, the built-in expansion of the monetary base that took place in October 2008 is sufficient, in and of itself, to create mass inflation. If the M1 money supply doubles, and if the money multiplier goes back to where it was in 2007, the money already created by the Federal Reserve will multiply rapidly through the fractional reserve banking system.

Paul Volcker has to know this. He knows enough about central banking to understand the function of the monetary base. He warns about future policies of quantitative easing that may produce inflation, but I am certain that he understands that the Ethiopian is already in the fuel supply. The existing monetary base, when coupled with increasing bank credit, is all it takes to double the operational money supply, thereby doubling prices as denominated in dollars.

Volcker is warning the Federal Reserve that any attempt to overcome the existing recession by another expansion of the monetary base by the purchase of Treasury debt or anything else may produce the negative effects in the economy. It is not simply that another round of monetary expansion will, in and of itself, produce inflation. The problem is more deep-seated. Any expansion of the money supply that has the effect of restoring confidence in the economic future will set off the inflation that Volcker fears.

A POWDER KEG

Let me use an analogy. The expansion of the monetary base that took place in October of 2008 was like filling a powder keg with new gunpowder. The keg did not blow, because the traditional response to added reserves, namely, the willingness of bankers to invest new deposits in the financial sector, did not prevail. Think of loans as a fuse. This was pulled out of the powder keg by commercial bankers.

Volcker is warning the Federal Reserve against adding more powder to the keg. But if nothing new is done, unemployment is going to stay high, commercial bankers are not going to lend, and businesses are not going to expand.

The premise of Keynesian economics is that large federal deficits, when accompanied by falling interest rates, will produce economic recovery. The Washington Establishment has bet the farm on the accuracy of Keynesian economics. So, for that matter, has the Wall Street Establishment. But, so far, all that the deficits have accomplished, and all that the expanded monetary base has accomplished, is to halt the rate of economic decline. It has not restored confidence, and it has not restored long-term economic growth.

This is not just true in the United States. This is true all over the West. Western central banks expanded their monetary bases in 2008 and 2009. In other words, they brought in the kegs and filled them with powder. Their commercial banks have also pulled the fuse out of the new, vastly expanded powder kegs. This has kept a great explosion of prices from taking place. For this, we should be grateful. But it does no good to tell an unemployed man that he ought to be grateful.

A STALLED RECOVERY

Politicians, Wall Street promoters, and the Establishment financial press all agree that the recovery is stalled. There is disagreement as to exactly how the American economy can begin growing again. The vast majority of those establishment members who are in a position to influence public opinion have been telling us that we should expect an increase in quantitative easing, because this is the only way the Federal Reserve will be able to overcome high unemployment and sluggish economic growth. Whether these people are trying to influence the Federal Reserve, I do not know. They are certainly preparing the public for a reversal of Federal Reserve policy. I see it as a reversal of policy over the last two years, which means policy change that took place in October 2008. I believe that the Federal Reserve at some point will return, like a dog to its vomit, to its purchase of long-term Federal debt, paying for these purchases by the expansion of the monetary base. I think we are going to get quantitative easing, although I do not know when this will begin. I think it will begin if the economy falls into a double dip recession.

The big question then will be whether commercial bankers will play their traditional role and lend money to businesses. It will also depend on whether businessmen are equally confident that this expansion of the monetary base will result in a restoration of confidence in the economy. These days, the decision-makers remain skeptical. We may hear talk about the recovery, but commercial bankers and businessmen are hesitant to believe the hype.

There is no doubt in my mind that the Establishment press wants quantitative easing, which is why the press adopted the euphemism in the first place. I do not think the financial press understands the implications of a doubled monetary base. I do not think it regards the doubling of the powder keg as a threat to price stability in the United States. I do not think the financial press understands that this threat exists in Europe.

There is a kind of tacit assumption that the expansion that took place in 2008 was neutral, having no effect on the money supply. Because it was neutral in 2008, they expect it to remain neutral in the future, despite the effects of quantitative easing. In other words, they assume that the 2008 doubling of the monetary base is irrelevant today and in the future. They do not see it as a powder keg. They do not see quantitative easing in the future as the equivalent of reinserting a fuse into the powder keg and getting bankers to light it. They assume that bygones are bygones. Monetary bygones are never bygones. They are powder kegs.

PUTTING THE SHUCK ON THE RUBES

The financial press directs itself to the 20% of Americans who are active investors in the stock market. It does not direct itself to the vast majority of Americans, who are living hand-to-mouth or month-to-month. This means that, when the financial press adopts the euphemism like quantitative easing, it is doing so in order to confuse the educated 20% of the country. It means the press believes that investors, though a minority of the general public, can be as easily manipulated by euphemisms as the average reader can. It means that the financial press regards its readers as rubes. By adopting the euphemisms, the press is attempting, in a familiar phrase of the South, to put the shuck on the rubes.

Because most investors have learned economics from Keynesians, they really are rubes. They are intelligent, but they have bought into a system of economic analysis that was deliberately designed by a master of rhetoric to muddy the waters. Keynes self-consciously created a system to justify what basic economics had taught was false for over 100 years before he wrote. He wrote in order to justify huge government deficits, which he said were needed to substitute for the lost spending of the general public.

Most academic economists have accepted this logic, and they have for over half a century. Keynes did indeed put the shuck on the rubes. His intellectual heirs are still following his model. I do not mean just his economic model. I mean his model of deception.

The very phrase, "quantitative easing," indicates that the financial press has adopted Keynesianism, and it assumes that its readers have also adopted Keynesianism. Keynesianism has always relied on deception. It has always relied on the use of terminology defined in ways different from classical economics. It has relied on the tactic of keeping people from asking obvious questions. One of these questions is this: "Where does the government get the money to spend into the economy in order to compensate for the refusal of consumers to spend money?" When you ask this question, you become alert to the two possible answers: the government either taxes the money that would have been spent by consumers, or else it borrows the money that would have been invested by investors. In other words, the policy of deficit spending does not change the fundamental spending patterns of the society; it just shifts money from one group of investors to another. This should be obvious to anybody with even a minimal understanding of economics, but it is not understood by the vast majority of those scholars with Ph.D.'s in economics.

It may be that the use of a phrase like "quantitative easing" really does conceal from investors the implications of what is really being recommended. But it does not conceal it from all investors. Some investors do recognize the threat that such a policy will have on the purchasing power of the national monetary unit. They begin to look for alternative investments that will enable them to escape the depreciation of money that will inevitably result from a successful policy of monetary inflation.

There can be an unsuccessful policy of monetary inflation. From the point of view of those who recommend such a policy, an unsuccessful result would be a continuation of the existing skepticism regarding the recovery, an unwillingness of businesses to borrow money, and an unwillingness on the part of commercial bankers to lend money. An unsuccessful policy will therefore not reduce the high unemployment rate, and it will not goose the economy back into strong growth mode. But it will also have the positive effect of not producing mass price inflation.

Those who are buying gold, silver, and oil are convinced that, at some point, a policy of quantitative easing will get the bankers to light the fuse. They are getting out of range of that explosion. They are shielding themselves from the effects of that explosion as best they can. How? By buying commodities. They may be premature in their entrepreneurial decision to get out of digital money while the getting is good. It may turn out that there will not be quantitative easing, or that there will not be enough of it to get bankers to light the fuse. It may turn out that, for a time, commodity investments will fall back to lower levels, because the economy itself loses steam, and falls back into recession.

This is an entrepreneurial decision. A few investors believe that quantitative easing really is mass monetary inflation, and the mass monetary inflation will eventually produce mass price inflation. They want to position their investments in advance, so that they are not wiped out, as the common man will be wiped out, when the results of prior monetary inflation are translated into mass inflation by means of the next round of monetary inflation. In other words, they think that the Federal Reserve eventually will persuade the commercial bankers to light the fuse.

CONCLUSION

Nobody knows if the FED will do this, and nobody knows if commercial bankers will once again pull the fuse out of the powder keg. But anyone who does not pay attention to the existence of that powder keg is putting his economic future on the line. The powder keg is real. All it will take to produce the explosion of digital money and consumer prices is the willingness of commercial bankers to light the fuse by decreasing their holdings of excess reserves at the Federal Reserve System.

I suggest that you take seriously the euphemism, "quantitative easing." The opinion-makers are attempting to change the opinions of the 20% of Americans who are active investors in the stock market. When the powers that be adopt a euphemism, we can be sure that this is part of a program to persuade the public to accept a policy decision on the part of the Federal Reserve that threatens to become the negative result known as mass inflation.

Gary North

http://www.marketoracle.co.uk/Article23277.html

Commodities and QE2 Buoys Stock Markets

Stock-Markets / Stock Markets 2010
Oct 06, 2010 - 07:00 AM

By: PaddyPowerTrader

Tuesday was turnaround day – markets began to rally over lunchtime in a move that would last until the end of the session. There was no concrete explanation as to what started the move, though some cited positive Meredith Whitney comments while others suggested it was on the back of whispers the ISM number would be much better than consensus. In the event the services ISM number printed 53.2 v a 52 consensus, allowing markets to push on. S&P 500 traded through the key 1150 level. Europe finished near the days highs, with banks the biggest gainers as those with peripheral exposure gained on the back of Moody’s saying they are ‘impressed’ with Greek government actions.

Stateside, banks benefitted from positive comments from JP Morgan saying their were likely to top Q3 estimates , miners followed commodities higher, and energy stock rallied as Crude (+1.75%) prices rose and Chevron announced a buyback. Gold continued its recent stellar run as the potential for additional quantitative easing and the likelihood of continued fiat currency weakness bolstered the desire to own gold,

Mining names are bid today in Europe again with BHP Billiton, the world’s biggest mining company, up 2.4% and Rio Tinto, the third-largest, better by 2.3% as Aluminum, copper, lead, nickel, tin and zinc all increased on the London Metal Exchange. Separately Antofagasta , the copper producer controlled by Chile’s Luksic family, soared 5.2%, the highest price since it first sold shares to the public.

Today’s Market Moving Stories

The world is clearly still gripped by QE2 fever. And finally stocks respond, with the S&P500 +2.1% (Tuesday with a intraday high was highest in almost 4 months (May 13)). The Nikkei rallied +1.5%.overnight after the BoJ fired the starting pistol Monday (or at least the gun is now loaded, waiting to be fired). The RBA also unexpectedly sat on its hands when it had every justification to hike. Then Fed’s Evans came out in favour of asset purchases overnight (see below for more on this). He favours “much more accommodation than we’ve put in placeâ€

Bank of Japan Goes "All In" To Stem Deflation

Interest-Rates / Japanese Interest Rates
Oct 06, 2010 - 04:55 AM

By: James_Pressler

In an attempt to fight off worsening deflation and prevent the economy from falling into another recession, the Bank of Japan (BoJ) announced its largest foray yet into the realm of quantitative easing (QE). It lowered its benchmark interest rate to between zero and 0.1% (effectively 0%), set up a ¥5 trillion ($59.7 billion) fund to purchase government and corporate bonds, and also created a ¥30 trillion lending facility using those assets as collateral. The breadth of such QE measures caught the market off-guard and dispelled most concerns about the BoJ being too timid in the face of another economic downturn. And yet, even though the BoJ seems to be placing its largest wager ever on the table, we cannot help but ask: Is it enough?

By enough, we wonder whether QE alone is the answer. Japan is no stranger to these operations - its last QE program was implemented midway through the 2000-03 recession and lasted for over four years. But its intention - to flood the market with more than ample liquidity - is limited by the amount of demand in the market. Strictly from a financial perspective, lending conditions are ideal. Money is all but free to borrow, banks have plenty of access to funds and the labor market is as loose as it has been in a generation. But weak demand indicators suggest a poor outlook going forward, offering businesses little incentive to do anything more than save those yen for another day. All the QE in the world will not change that situation.

In Tokyo, hints are coming out about a $55 billion (1.1% of GDP) stimulus package being discussed, supposedly to be paid for through unexpected tax revenues accumulated through the first six months of the April-March fiscal year. Depending on how this stimulus is targeted, it could provide enough of a gain to stem off another prolonged recession. Incentives to private consumption - the laggard of the GDP accounts - could provide some benefit and raise confidence, but it would hardly be a fix for flagging demand.

The government and the BoJ have been trying to stimulate exports by intervening to drive down the yen, but like other measures this only provides artificial relief while doing little to get the economy back on a self-sustaining growth track. Even if the Bank wages an extended currency intervention campaign similar to that in 2003-04, it will only offer a brief respite before the country's longstanding imbalances force the yen higher.

The only cure for what is ailing the Japanese economy is a good dose of inflation, which is hard to come by when the globe is concerned about deflation. Even with interest rates as low as possible, real interest rates are at five-year highs, giving strong incentive for foreign investors to flock to the yen and drive its exchange rate ever-higher under the assumption of continued deflation. A burst of higher prices could break that cycle, and the sooner the better as far as the Japanese economy is concerned.

But creating inflation is easier said than done when it comes to Japan. Ultra-loose monetary policy has failed to spur price pressures, and heavy deficit spending has only generated temporary growth and a lasting mountain of debt. The usual vehicles for heating up the economy are no longer adequate, leaving policymakers with the daunting challenge of heating up an economy that refuses to thaw. Creative and possibly counterintuitive policies are required - incentives to encourage spending but not saving, and to rekindle domestic demand in a sustainable manner. Most of the countries throughout the industrialized world are pondering this riddle for their own recoveries, but considering the dire state of the Japanese economy, Tokyo is the one most in need of a solution.

James Pressler — Associate International Economist

http://www.northerntrust.com

http://www.marketoracle.co.uk/Article23274.html

Will the Fed’s Spending Drive Stocks Back Up to Pre Credit Crash levels?

Stock-Markets / Stock Markets 2010
Oct 06, 2010 - 06:51 AM

By: Money_Morning

Jon D. Markman writes: The Standard & Poor's 500 Index is up more than 10% in the past month, and it finally looks like all of the thin threads of strength we've seen over the past few months are starting to twine together into a single rope that may be strong enough to pull stocks back up to pre-crisis levels.

The key threads are:

•The ECRI Weekly Leading Index has stabilized and turned higher.
•The U.S. Federal Reserve announced that it had made an epic change in its outlook, targeting deflation instead of inflation.
•Emerging markets and commodities are leading other markets higher, as we have seen for two months.
•Demand for stocks has increased while supply has decreased.
Even if you are skeptical of these developments, remember one thing: The Fed has absolutely flooded the financial system with money.

Banks and large companies have hoarded most of those funds so far, leading gross domestic product (GDP) growth to stall. But the Fed essentially said last week that it is going to double down. The central bank has never had a $1 trillion balance sheet, but it could have a balance sheet twice that size by this time next year if it goes through with its plan.

This money ultimately will be put to productive use, and eventually, it will leak out into the stock market as speculative investment and nurture inflation.

My guess is that any decline from here will be shallow because the central bank has issued what traders are calling a "Bernanke put" - a takeoff on the "Greenspan put" that was believed to underlie the market in the 2000s.

A put is a derivative that swells in value if its underlying instrument goes lower in value. So the idea is that if the economy goes lower, Bernanke's efforts to save it will get larger. This should create a cushion of safety - real or imagined - especially if it is increasingly seen to be "at the money," or triggered by near-term events.

We can mutter about it under our breath and wonder if it's the right thing to do, but it's happening nonetheless. So what I want you to grasp is that the greatest financial bubble in the history of mankind is being formed right in front of our eyes. And the only sensible thing to do is take advantage.

The prospects for the S&P 500 to return to its pre-crisis levels above 1,200 - its level prior to the September 2008 Lehman Brothers Holdings Inc. bankruptcy - are better than ever. In fact, it would not surprise me in the least to see the entire U.S. bear market repealed by the end of 2012. It already has been swept away in many overseas markets, so it's just a matter of time before it happens here.

Skeptics say that the Fed is "pushing on a string" with its plan to flood the system with money because there is not enough demand. But that concern ultimately will vanish as entrepreneurs - enticed by reward and propelled by ambition - will find ways to put the money to work.

It happened in the 1990s, when the Fed flooded the system with money in the wake of the late-1980s savings-and-loan crisis and 1990 recession. Investors were skeptical in the first few years, but the markets ultimately increased five-fold by 2000.

You may recall that period began with the Internet being strictly used by academics and the military, and ended with an incredible boom of the consumer web, which led to billions of dollars in wealth creation and tens of thousands of jobs. However, we are currently in the midst of a commodities bubble that is similar in scale.

Just to get an idea of what I'm talking about consider this anecdote: One of my hosts in Pittsburgh told me about the business of his son-in-law in Lansing, Michigan. The young man graduated from high school a dozen years ago and went to work for his father's tool-and-dye business as an apprentice. Before long he was a master toolmaker and took over the business.

When the recession and credit crisis hit, his local bank was taken over by a larger national bank that decided to pull his line of credit. That would have been fatal to a small company that often had to buy equipment before it could bill for the products that it would create. But the young man didn't fold; he was resilient. He persuaded another local bank to give him credit, and after several lean months discovered that one of his biggest customers, Pratt & Whitney, had won major new bids of its own to supply engines for jets that were sold to Asian and Persian Gulf customers suddenly flush with money from the commodities boom.

That small business is now on track to hire a new employee a month, and expects to be able to more than double its business next year.

So you can see where I'm going: Rise in commodity value = more money for commercial airliners in under-served emerging markets = demand for more engines = demand for more parts = improvement in financial condition of a Michigan manufacturer = more skilled jobs in Lansing = more money to buy houses and cars and spend in restaurants. Several major industrial manufacturers, like The Timken Co. (NYSE: TKR), are already at new highs.

I realize that this may be overly simplistic, but it's real.

Sometimes investing decisions are hard, and sometimes they are not so hard. Right now it's the latter. The Fed sees weakness in the economy and employment, and has vowed to fight them. It has never lost such a battle, though sometimes the effort is prolonged.

More simply, the price/earnings (P/E) multiple for companies in the S&P 500, such as Johnson & Johnson (NYSE: JNJ), is around 13. Given the current level of inflation and interest rates, the average PE of the average large company should be 20-times, and some sober, veteran investors and academics argued over the weekend at a major economics conference organized at Princeton University that it should be 25-times.

This means that prices should be twice as high right now, all other things being equal. That's a bit extreme, but you get the point. All that is missing is a return in confidence - and that should not remain scarce for long.

Source : http://moneymorning.com/2010/10/06/stocks-3/

Money Morning/The Money Map Report

http://www.marketoracle.co.uk/Article23283.html