This week the Federal Reserve took a step closer to acknowledging reality. Unfortunately it didn’t let that admission move it from a policy course firmly guided by fantasy. In its policy statement, Bernanke & Co. took the important step in noting that inflation expectations had taken hold in the country at large. However, in asserting that it expects inflation to moderate this year and next, the Fed gave no indications that these heightened expectations are gaining traction within the Open Market Committee itself. As a result, it signaled no likelihood that it was actually prepared to do something to fight a problem which it doesn’t really believe exists in the first place.

In fact, by indicating that they expect inflation to moderate, the Fed is saying that elevated expectations are unwarranted. In other words, Bernanke claims that despite the fact that so many people are carrying umbrellas, he still believes it will be a sunny day. The takeaway from the statement is that no rate hike is forthcoming. The markets saw this position for what it is… capitulation to inflation and a weakening dollar. No surprise then that the gold responded with the biggest single day gain in more than 20 years!

With the ensuing carnage on Wall Street, many Thursday morning quarterbacks claimed the Fed missed an opportunity to reverse the dollar’s slide by either talking tougher or perhaps actually raising rates a quarter point. If the Fed really believed it could talk the dollar up, or that a small rate hike would do the trick, they would have given it a try. I believe they chose a dovish route because of a greater fear of having their hawkish stance casually disregarded. Imagine what would happen if the Fed raised rates and the dollar kept falling? It would be like one of those horror movies where someone holds a cross up to a vampire, and the Count tosses it aside with nary a cringe.

Others claim that now is the time for coordinated central bank intervention to reverse the dollar’s decline. Those who place their faith in such a plan, overlook the fact that Asian and Middle East central banks have been unsuccessfully intervening on the dollar’s behalf for years. Those nations maintaining dollar pegs must constantly intervene in the foreign exchange markets by buying dollars to keep their own currencies from rising in value. Over the past few years the scope of this intervention has been unprecedented, with foreign central banks accumulating trillions of excess dollar reserves. Yet despite these Herculean and misguided efforts, the dollar has fallen drastically.

Intervention advocates must believe that if the ECB and a few other central banks joined the fray, that a better outcome would be achieved. However any additional efforts to artificially prop up the ailing dollar will be equally ineffective. Even if ECB intervention could slow the dollar’s decent, what possible reason would they have for doing so? The ECB is already concerned about inflation and is preparing to raise rates as a result. Intervention to support the dollar will only worsen Europe’s inflation problem and run counter to these efforts. This is because to buy dollars the ECB must increase its own money supply. That is exactly what is happening in countries like China and Saudi Arabia, which is why inflation in those nations is already much higher than it is in Europe.

Further, since the ECB is asking Europeans to endure higher interest rates to fight their inflation battle, why should they have to make additional sacrifices to help Americans fight their own inflation? Especially when our own central bank has held interest rates at the ridiculously low level of 2%, and has effectively excused Americans from the conflict.

Since we can’t count on any help from our friends, the only option would be for the Treasury to intervene unilaterally. However, the U.S. government should think twice about bringing a knife to a gunfight. The Treasury only has about $75 billion in foreign currency reserves with which to intervene. The war chest is just a spit in the ocean. To put this number in perspective, Poland has $77 billion, Turkey has $78 billion, and Libya has $79 billion. On the other end of the spectrum, China has $1.7 trillion (not counting Honk Kong’s 150 billion) Japan has $1 trillion, Russia has $550 billion, India and Taiwan each have about $300 billion. Singapore, a nation with fewer than 5 million people, has $175 billion. In fact, the United States holds just about 1% of the world’s $7.6 trillion of foreign currency reserves, and our total position amounts to just 2.5% of the total daily volume of foreign exchange trading. Talk about Bambi vs. Godzilla! In other words, if the dollar is going to fall, the Treasury is completely powerless to do anything to stop it

Those blindsided by the recent financial meltdown are now loudly blaming the free market for its failure to police its own excesses, and are calling for greater regulation to prevent future disasters. But for those who clearly observed the problems developing (in high definition slow motion) the blame can be directed squarely at the policies of the Greenspan/Bernanke Federal Reserve. As has been the case countless times in history, the free market will now pay the price for government incompetence.

In Senate hearings this week, all parties involved completely ignored the Fed’s own culpability in igniting the speculative fever. It’s as if a senior prom had turned into a wild bacchanalia, and angry parents now question why the chaperones failed to notice the disrobing or why the DJ played provocative music, all the while ignoring the bearded gentleman pouring grain alcohol into the punch bowl.

A perfect illustration of the Fed’s failure to take responsibility can be found in Bernanke’s explanations regarding inflation, which he solely attributes to the effects of the rapid increase in global commodity prices. He failed to mention that commodity prices are rising as a direct consequence of his monetary policy, which is debasing not just the U.S. dollar, but currencies around the world. Rather than accepting the blame for creating inflation, Bernanke is shifting the blame to the free market. The Senators are happy to let him get away with it as it provides more evidence to support the “need “ for more government to save the economy from the disastrous effects of unbridled capitalism.

When asked how we got into this mess, Bernanke replied that our problems resulted from an excessive credit bubble characterized by aggressive leverage, reckless lending, and extreme risk taking. Absent from his explanation was the Fed’s role in irresponsibly setting interest rates below market levels, which mispriced risk, got the party started and kept it raging into the wee hours of the morning. The expressed goal of the Fed for much of this decade was, and is, to encourage and facilitate borrowing and lending.

During his testimony, Bernanke continued to claim that Bear Steams was not bailed out as shareholders only received about $10 per share. Of course, $10 is better than zero, which is what they surely would have received if the Fed hadn’t thrown taxpayer money around. What about Bear’s creditors though? Although the collapse of Bear Stearns would have cost bond holders dearly, the bailout essentially makes them whole. Here again, the Fed creates even greater moral hazards by encouraging excessive risk taking. By bailing out lenders who extend excessive credit, the Fed simply invites more of that behavior. The free market must be allowed to properly price risk. Lenders need to know that when they lend money, whether to highly leveraged investment banks and hedge funds, or to over-stretched homebuyers or credit card users, they risk not getting paid back. By interfering with this process the Fed simply guarantees more losses and even bigger bailouts in the future.

Also, leveraged speculators need to know that it is not “heads they win, tails the taxpayers lose”. Wall Street executives amassed fortunes by making extremely risky bets. Now that those bets have soured, why is it taxpayers that have to swallow the losses? Wall Street billionaires earn their bucks on the backs of the middle class, who made little on the way up, but foot the entire bill on the way down.

While Bernanke talked about the underlying strength of our economy, he claimed necessity in saving Bear Stearns from bankruptcy as it would have brought down our entire financial system. How sound can our economy be if the failure of one investment bank could topple it? Does this now mean that no more major banks or brokerage firms will be allowed to fail? Since we routinely accused Japan of practicing “crony capitalism” what do you suppose we should call our version?

Not to be outdone in rewarding reckless behavior, earlier in the week Congress passed $15 billion in tax breaks for homebuilders, who had made their fortunes overbuilding during the bubble and unloading their shares to a gullible public. By threatening to hold back on their political contributions, these same homebuilders are awarded still more billions. The last ones we should be subsidizing are homebuilders. After all, the last thing we need right now is more homes.

The legislation also contained a provision that offers generous tax credits to individuals who buy homes out of foreclosure. While this is billed as a benefit to homebuyers, it is just another hand out to lenders, as those qualifying for the tax breaks will simply pay more at auctions as the tax breaks subsidize higher bids. The real winners are the creditors who get more in foreclosure than would have been the case had buyers not had their bids subsidized by the government.

Of course, for all the talk about taxpayer bailouts, none of the senators bothered to mention that, for the moment, no tax increases are actually on the table. Instead, the bailouts are being financed by savers, pensioners, wage earners, investors and the elderly on fixed incomes, who all suffer staggering increases in their costs of living, as the Fed uses inflation to rob Main Street to pay off Wall Street.

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This week, as the financial sector began to give way under the unbearable weight of bad mortgage debt, the Federal Reserve stepped in to save the day. At least that’s what it says in the script.

In a surprise move, the Federal Reserve announced its intention to swap $200 billion of treasury debt for $200 billion of potentially worthless mortgage-backed securities. The Fed may have been partially spurred to take the step as a result of the rapid collapse of Carlyle Capital Corp. a publicly traded private equity firm that is a subsidiary of the Carlyle Group. The Dutch firm could not meet margin calls on its depreciating collateral of AAA-rated mortgaged-backed securities guaranteed by Fannie Mae and Freddie Mac. On Friday, the Fed then took the unusual step of providing emergency “non-recourse” funding to Bear Stearns, collateralized by that firm’s similarly worthless mortgage debt. Apparently the Fed now stands willing to assume any mortgage-related risk that no other private entity would touch.

That the Fed would take such extreme measures, which would have been considered unthinkable even a few months ago, followed a few notable media events that may have affected their thinking. On Monday, Wall Street was rocked by an article in Barron’s that suggested that government sponsored lenders Fannie Mae and Freddie Mac lacked sufficient capital to cover the likely losses on the $5 trillion in mortgages they insure (a position that I have taken for years) and raised the possibility of either bankruptcy or a government bailout. On CNBC the next day, Paul McCulley, the managing director at Pimco, the world’s largest bond fund, publicly called for the Fed to use it balance sheet and its printing press to buy mortgages.

According to the Fed, its new plan does not amount to buying mortgages but simply accepting them as collateral for 28-day loans. However, will the Fed really return these ticking time bombs to their true owners in 28 days, inciting the very collapse its actions were originally designed to postpone? Why does the Fed believe that the mortgages will be marketable next month; or the month after that? Nor can we believe that such “loans” will be restricted to only $200 billion. Bear Stearns and Carlyle are certainly not alone in massive exposure to bad debt. Given the unprecedented leverage that many of the biggest financial firms used to play in this market, there will be many more failures to come. Does the Fed stand ready to bail out all comers? Based on this course of action, the Fed, or more precisely American citizens, will end up with trillions, not billions, of such securities on its books.

The problem with these mortgages (other than the borrowers lacking any means or desire to repay them) is that the underlying collateral is worth a fraction of the face amount. With recent foreclosure recovery rates amounting to less than 50 cents on the dollar, it is no wonder that no one wants them. The real estate bubble allowed borrowers to leverage themselves to the hilt using inflated home values as collateral. However, now that the bubble has burst, mortgage balances far exceed current property values. It is a trillion dollar time bomb that no one can possible defuse.

Paper dollars are technically Federal Reserve Notes, which means they are liabilities of the Fed. When it puts newly minted notes into circulation it does so by buying assets, usually U.S. treasuries, which it then holds on its balance sheet to offset that liability. By swapping treasuries for mortgages, the Fed effectively alters the compilation of its balance sheet and the backing of its notes.

However, backing paper money with mortgages is nothing new. The French tried it in the late 18th Century, and it lead to hyperinflation. Assignats, which were first issued in 1790 to help finance the French revolution, were backed by mortgages on confiscated church properties. Although the stolen underlying collateral did have some value, the revolutionaries saw no reason to limit how many Assignats were printed, which resulted in massive depreciation. Within three years, price controls were introduced and failure to accept Assignats, initially an offence subject to six years in prison, was made a capital crime. By 1799 the currency was completely worthless.

If even the threat of death could not prop up the Assignat, does anyone believe that the currency could have been saved if Robespierre had forcefully mouthed a “strong Assignat policy” as President Bush is now doing with the dollar? Rather than repeating the mistakes of history we should learn from them. Our own failed experiment with the Continental currency as well as the Great Depression should prove conclusively that it is Austrian, and not French, economics we should be following.

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Despite the fact that the Fed still believes that a recession is unlikely to occur, Bernanke & Co. followed up on last week’s emergency 75 basis point rate cut with a 50 basis point kicker on Wednesday. Not to be outdone by the Fed’s generosity, the House of Representatives and the Bush Administration slapped together a $150 billion “stimulus package”, which can only be delayed by the Senate’s desire to join in the bead throwing. On Wall Street these actions were cheered as heroic, with praise and accolades for all (what could be more politically courageous than handing out free money in an election year.) In a recent poll, fully 78% of economists thought these policies were appropriate…while 18% thought that they were not aggressive enough.

A common definition of insanity is the act of repeating the same activity while expecting a different result. Bernanke is now repeating the same mistakes made by Greenspan, yet he and almost everyone on Wall Street expect a different result. The stock market bubble of the 1990s resulted from interest rates being too low, which sent false signals to businesses, causing them to over-invest in information technology, telecom, and dot coms. When that bubble burst, rather than allowing the corrective recession to run its course, the Fed responded by slashing interest rates. The result was an even larger bubble in real estate; causing consumers too borrow far too much money to buy houses and other goodies.

Now that the housing bubble has burst, the Fed is once again slashing interest rates to postpone the pain. However, in order to correct for years of extravagant borrowing and spending, the country is in desperate need of a period of saving and economizing. But by rewarding debtors and punishing savers, lower interest rates actually encourage the opposite behavior. Given how much harm this strategy has already done in the past why should we assume it will work any better now?

Consider a real world example. Suppose your spendthrift neighbor, maxed out on credit card and home equity debt, no savings in the bank, struggling to make ends meet and one paycheck away from foreclosure and personal bankruptcy, comes to you for financial advice regarding what to do with the $1,200 he received in the Federal Stimulus Lottery? Would your advice be to “go out and buy yourself a brand new plasma T.V.”? My guess is that you would suggest he pay down his debts. If you were a good friend you might help him devise a budget to put his financial house back in order. Such a plan might include trading in his Mercedes SUV for a more fuel efficient Honda, brown bag lunches instead of expensive restaurants, tearing up department store charge cards, cancelling vacations, cutting back premium cable channels, etc. When you are neck deep in debt, the solution is to economize, ratchet down your lifestyle and repair your personal balance sheet. In other words, you go though your own personal recession.

Would your advice be any different if it was not just one neighbor asking but 300 million? If it’s wrong for an overly-indebted individual to blow a windfall, it’s just as wrong if millions of us do it collectively. If our economy is already suffering from too much debt, think of how much worse off we will be after we blow thought these rebate checks.

Or think about it this way — Imagine an obese individual showing up at a Weight Watchers meeting and his counselor handing him a box of Twinkies? How much weight do you think would be lost on the “Twinkie diet?” American consumers have basically stuffed themselves almost to the point of explosion. What is needed is salad; not more Twinkies.

Ironically of course, by blowing up both the stock market bubble in the 1990s and the real estate bubble that followed, Greenspan actually repeated the same mistakes that previous Fed chairmen Benjamin Strong and William McChensey Martin made in the 1920s and the 1960s respectively. It seems sanity is a major disqualification for central bankers.

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For members of Congress desperate to avoid recession, the takeaway message that Fed Chairman Bernanke delivered in his testimony this week was that a successful stimulus package needs to be rapid and targeted. By this he meant that money would need to be delivered quickly to those individuals who would be most likely to spend, and withdrawn when and if the need for stimulus ebbs.

For those who believe that this strategy is prudent and effective, the debate now becomes choosing the most effective technique to deliver the cash. Proposals include middle class tax cuts or rebates, extension of unemployment benefits and expansion of funding for public works. However, for those who want to engineer spending, the problem with these ideas is that the people who receive the funds may not decide to spend it immediately, if at all. They may, god forbid, elect to pay down existing debt or most perniciously, actually save it instead.

Fortunately, the government has very modern and effective tools available to deliver funds and micromanage spending. Just recently, the Treasury Department launched a program to streamline Social Security payments through the use of debit cards. The same idea could be used for fiscal stimulus. The Government could distribute millions of “Economic Stimulus Cards” to citizens, which could function more like retailer gift cards rather than debit or credit cards. Here’s how they would work:

When the government wants a quick, fast stimulus, it authorizes expenditures on the cards which can only be used for consumer purchases and only for a set time frame. Knowing that they must use or lose their newly authorized funds, Americans will run to their nearest retail outlet and spend, spend, spend. The beauty of the system is that the consumers will spend exactly how much the Government deems necessary. What’s more, the government could decide to direct the spending to specific areas of the economy that it deemed particularly strapped. For example, it might target specific types of merchandise that may be purchased or particular retailers where those expenditures would be authorized, with the political benefits being the icing on the cake.

When the economy has been sufficiently stimulated, the government could leave the cards idle with no purchasing power. Better economic micro-management through technology! The minute consumers seemed to be running out of purchasing power we could have a quick fix simply by pushing a few buttons. No need to waste all that money on paper or ink, or fuel for the helicopters!

The only downside to the plan is that it will completely clarify the fundamental component of any and all fiscal stimuli, namely the government creating money out of thin air and giving it away. Of course, the other negative effect would be higher consumer prices with price spikes particularly pronounced immediately following any additional government authorized spending. After all, what rational retailer would not raise prices during those times in which the new consumers were holding exploding gift cards? However, a few more adjustments to the CPI should take care of that problem lickety-split! As Richard Nixon once said, “No politician ever lost an election by creating inflation.”

Follow up to last week’s commentary:

Last week, I mentioned an old commentary of mine that referenced an advisor who had promised to “eat his hat” if the precious metals markets were not experiencing a blow-off top back in April of 2006. As it turned out, the author of that quote once again took the opportunity to falsely pat himself on the back for having written it.

By claiming credit for what may have appeared to have been a timely call, he conveniently omitted the fact that he wrote a follow up commentary about three weeks later, after one of the biggest one-day drops in the price of silver ever (within days of the absolute bottom and one of best buying opportunity in years), in which he urged investors to sell as in his opinion, “A significant correction in gold and silver had begun.” In fact, the correction had basically ended before the ink on his quotation even had a chance to dry!

While it is true that silver did return to single digits (spiking to a low of $9.50 per oz) as his original piece correctly suggested, it only remained there for perhaps two trading days. However, as this advisor never publicly recommended buying that dip it is highly unlikely that either he or any of his clients actually did. Having just forecast a significant correction within days of the bottom he most likely expected silver prices to fall much lower. Further, he never authored a subsequent commentary proclaiming an end to the precious metal’s correction or recommending that investors buy back into the market. In fact, since this particular advisor had been relatively bearish on precious metals since December of 2004, and remained so throughout most of the bull market, it is unlikely that any of his clients actually had any silver to sell back in April of 2006, let alone buy any back on the dip.

However, it now appears that after years of being a short-term precious metals bear while simultaneously professing to be a long-term precious metals bull, this commentator is finally unequivocally in the bullish camp. I guess it is better late than never, but given his repeated and often scathing criticism of those of us who had it right all along, a bit more candor and humility would be appreciated. In fact, an outright apology would be more appropriate, but I won’t hold my breath.

For a more in depth analysis of inflation and the inherent dangers it poses for the U.S. economy and U.S. dollar denominated investments, read my new book Crash Proof: How to Profit from the Coming Economic Collapse.

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As a contrarian, it is my nature to worry when too many people start agreeing with me. Currently, many of my most vocal critics, who had previously ridiculed my warnings about the dollar, now concede that it will continue to decline. With so many people now on the bandwagon, some currency watchers have asserted that sentiment now has nowhere to go but up, and that the stage is set for a dollar rally. Although I am unnerved by the company, I take solace in the fact that the conclusions that many of these nouveau-dollar bears draw are completely off the mark.

The group is united by two basic assumptions. First is that the dollar’s decline will be orderly, and second is that the decline will actually be positive for both the U.S. economy and the stock market. Therefore, other ways to confound the consensus would be for the dollar’s decline to be disorderly or for it to be negative for both the U.S. economy and the stock market.

For the dollar to register a significant short-term bottom based on negative sentiment, I feel there would have to be a much greater sense of panic associated with its weakness. However such is clearly not the case. The overwhelming consensus is that a weak dollar is good for America. Ironically there is more worry in Europe over the strong euro than there is in America over the weak dollar. My prediction is that before we get any significant dollar bounce this complacency will need to be replaced by outright fear, and that the dollar needs to fall more sharply as investors actually act on those fears by dumping dollars.

Of course should such a run on the dollar commence, it will not be the orderly decline everyone seems to expect. However, I am still not sure why so many feel a declining dollar is not a problem so long as it does so in an orderly manner. If you’re headed to the poor house what difference does it make how you get there? Whichever road you travel, you’re just as broke when you arrive!

In addition to being wrong about how quickly the dollar will decline and how it will impact the economy, most dollar bears are also wrong when it comes to their explanations as to why the dollar is falling in the first place. Whenever benign inflation statistics are released, ensuing dollar weakness is always explained as resulting from increased expectation that the Fed will cut rates. Lower interest rates are seen as dollar bearish as they reduce the returns on holding dollars, making dollars less attractive relative to other currencies.

In actuality, officially benign inflation statistics (which are coming at a time when actual inflation is getting worse) give the Fed further cover to create even more inflation. So the dollar is not weak because inflation is under control as the consensus believes, but because the opposite is true. Inflation is completely out of control and the Fed, hiding behind phony government numbers that purport otherwise, has the green light to add additional fuel to inflation’s fire. It’s the ultimate irony that the lower the official preferred measures of inflation are (core CPI or the core Personal Consumption Expenditure Index,) the worse inflation actually gets.

For a more in depth analysis of the tenuous position of the Americana economy and U.S. dollar denominated investments, read my new book Crash Proof: How to Profit From the Coming Economic Collapse (Lynn Sonberg Books)

Coming at a time when rate increases were needed to combat the sinking dollar and surging gold, oil and other commodity prices, Ben Bernanke’s 50 basis point cuts in the Fed funds and discount rates this week may go down as the most irresponsible move in Fed history.

To America’s creditors around the world, whose mountains of dollar reserves will be debased by lower rates in the U.S., this action amounts to the monetary equivalent of “let them eat cake.” My prediction is that rather than doing so, they will just throw it back in our faces, and refuse to continue funding our deficits.

Wall Street bulls have heaped praise on the Fed, at times calling the rate cuts courageous and brilliant. From their response, you would have thought that Bernanke’s solution was akin to Einstein’s breakthroughs on relativity. In the first place, what is so brilliant about cutting rates? My five year old could do it and would gladly accept payment for his service in popsicles.

Furthermore, a fifty basis point cut was not an act of bravery but one of cowardice. The brave thing to do would have been to raise rates and allow market forces to purge the economy of the imbalances built up during the Greenspan bubbles. It would have taken some real courage to level with the American public and let them know that our profligacy has consequences, rather than pretending it can ride to the rescue with a wave of its magic wand and a crank of the printing press.

If Bernanke really had any guts he would have assured our creditors that they will be repaid with real purchasing power, and that the Fed was willing to put some teeth in our alleged “strong dollar policy”. His capitulation proves that this phony policy was pure propaganda all along, merely designed to fool foreign creditors into holding our paper.

Those who believe the Fed should reduce interest rates to ward off a recession or stabilize home prices simply do not understand the situation. More credit is not the solution: it is part of the problem. Our economy is on the brink of disaster because irresponsible Fed policy encouraged Americans to borrow and spend too much and created an unprecedented national real estate bubble. The last thing the Fed should do is entice Americans to borrow more money they cannot repay, buy more imported products they cannot afford, and attempt to blow more air into the deflating real estate bubble.

Bernanke’s attempt to circumvent the free market forces that are bringing on a long overdo recession (which is necessary to purge our economy of unsustainable imbalances) will lead to an even greater disaster. Make no mistake about it; had the Fed done nothing, or raised rates as I would have preferred, the economy would have clearly tipped toward a severe recession. However, by “coming to the rescue” with rate cuts, the Fed assures us that we will experience something far worse.

Again, the coming recession is not the problem but the solution. Painful as it will be, a recession is the only way to cure our sick economy and we will need to grin and bear it. When it ends, our nation will be a lot poorer, but at least we will be clawing our way out of this gigantic hole. Cutting rates now only assures that we will dig ourselves into an even deeper hole. In the end, it will be that much harder for us to get out, and we will be that much worse off when we finally do.

Although they may slow the process down for a few quarters, the rate cuts will neither prevent the recession nor keep house prices from collapsing. But they will cost us dearly. The dollar’s fall, which had been held somewhat in check by the possibility of a hawkish Fed, has accelerated in earnest now that the curtain has been pulled back.

Unlike previous bouts of Fed easing, this time any additional liquidity will not artificially pump up the economy or the housing market, but merely accelerate the rise in consumer prices and eventually push up long-term interest rates as well. If Americans are having problems making mortgage payments now, think of how much more difficult the task will become when food and energy prices double. If you think mortgage rates are high now, wait to you see how much higher they rise after a few rate cuts. After all, with the dollar in free-fall, will foreign savers really want to buy our mortgage backed securities, or lend us any more money at single digit interest rates?

For some reason everyone seems to think the Fed can bail out homeowners and mortgage lenders without anyone picking up the tab. There is no such thing as free lunch, especially if served by the Fed. If Congress does not raise taxes to fund a legitimate, although ill-advised bailout, then the Fed can not perform the same task for nothing. As the additional dollars the Fed creates reduce the value of all other dollars already in circulation, the cost for the “bailout” is simply borne by all holders of U.S. dollars.

The irony of the situation is that on September 11th, while in Germany, Bernanke delivered a speech in which he admitted that we need to increase our savings and declared that the inevitable adjustment to our current account deficit would have both real and financial consequences. Bernanke’s actions, which reward borrowers and punish savers, merely exacerbate those imbalances, ensuring even greater consequences when the inevitable adjustment finally occurs.

Of course, the most comical spectacle of all was Alan Greenspan’s attempt to steal the spotlight. During his media blitz to promote his new book, he simultaneously disclaimed any responsibility for the problems we are now facing while forecasting that both inflation and interest rates would eventually rise to double digit levels. He even admitted on “60 Minutes” that he personally had already diversified his own assets out of the U.S. dollar. I guess it’s fairly easy to read the writing on the wall when you are the one with the spray paint. Greenspan sowed the wind. Unfortunately the entire nation is about to reap the whirlwind.

For a more in depth analysis of the tenuous position of the American economy, the housing and mortgage markets, and U.S. dollar denominated investments, read my new book “Crash Proof: How to Profit from the Coming Economic Collapse.” Order Crash Proof: How to Profit From the Coming Economic Collapse (Lynn Sonberg Books)“today.

During his testimony before Congress this week, Ben Bernanke didn’t hesitate to opine on a number of topics that had very little to do with his mandate as Fed Chairman. The wealth gap, racial factors in income inequality, and the impact of capital gains tax policy were all fair game.  But when queried about the one issue where his impact is unrivaled, the value of the U.S. dollar, the Chairman quickly passed the buck to the Secretary of the Treasury. Conveniently, the Secretary was nowhere in sight.
 
This should come as a surprise to no one, but the Fed sets monetary policy in the United States. The last time I checked, money in the United States is the dollar. Therefore monetary policy is in fact dollar policy. The supply of dollars is regulated by the Federal Reserve, with ostensibly no interference by the Federal government. The Fed also independently sets short-term interest rates, which are a huge factor in determining the dollar’s value. In other words, the Fed controls both the supply of and yield on dollars. Bernanke claims to be worried about inflation, yet will say nothing about the value of the dollar. Prices rise as a result of the dollar losing value. How then can he ignore the persistent weakness in the dollar and refuse to comment on its effects on domestic inflation?

Why defer to the Secretary of the Treasury? Other than signing the bills, what does he have to do with monetary policy? As a member of the Cabinet, the Secretary’s job is to advise the President on economic matters, manage the finances of the United States, help plan the budget and oversee appropriations. He has no control over either money supply or interest rates. That power was delegated to the Fed in 1913. Potentially, the Treasury Secretary could authorize using our meager foreign exchange reserves to buy dollars, but given our limited bank account of foreign currency, such intervention would be more embarrassing than effective. There is literally nothing the Secretary can do except repeat the useless mantra “A strong dollar is in our national interest.” 
 
Another interesting exchange occurred when a Congressman asked Bernanke what he would tell his Chinese counterpart in order to help convince the Chinese government that an appreciated yuan was in China’s interest. First, Bernanke noted that a free-floating yuan would enable China to pursue an independent monetary policy. Unburdened by the need to print yuan to buy U.S. dollars, China could end the domestic inflation which is now causing Chinese consumer prices to rise and which has caused the formation of asset bubbles. The Chairman neglected to mention that if this were to occur, China’s retreat from the U.S. Treasury bond market would send interest rates in this country significantly higher.

Second, Bernanke correctly stated that a higher yuan would create additional purchasing power in China, resulting in a higher percentage of China’s resources being devoted toward satisfying domestic rather than foreign demand. The Chairman neglected to mention however, that such a re-allocation would result in fewer exports to the United States and higher prices for American consumers.

So if China actually adopted Bernanke’s suggestions, the result in America would be that both consumer prices and interest rates would rise. For someone who claims to be worried that inflation will fail to moderate or that the subprime problems might spread to the overall housing market and the economy, it seems odd that Bernanke would encourage China to take steps that significantly raise the likelihood that both scenarios occur simultaneously.

Finally, Bernanke dismissed concerns about the wisdom of favoring core inflation over headline by asserting that oil prices will soon moderate. Considering that oil prices rose another 2% during his two-day testimony, and that he and his predecessor have consistently underestimated oil prices for years, what now makes his crystal ball any clearer? Also during his two-day testimony the dollar fell to new lows against most currencies and gold prices rose $15 dollar per ounce. Bernanke may claim that inflation is under control, but $76 dollar oil and $670 gold suggest otherwise.

For a more in depth analysis of the tenuous position of the American economy and U.S. dollar denominated investments, read my new book Crash Proof: How to Profit From the Coming Economic Collapse (Lynn Sonberg Books)”

Visit Peter Schiff’s Website