Caution: Central Bankers at Work!

Founder Bill Bonner

The S&P is up 120% from its March 2009 low. The U.S. housing market is recovering too.

What's driving this market? A real recovery? Or central banks' fast and easy money?

We'll take a wild guess.

This week, the Bank of Japan promised to print more yen to buy bonds, joining the cabal of British, American and European central bankers. They'll keep at it until prices rise. They're aiming for inflation of 2%. Will they hit the mark?

All over the world, the central bankers are in charge. They're moving markets... they're changing economies... they're keeping companies alive that would have failed... and they're bailing out industries with nearly zero-cost credit.

Saving Civilization

The central bankers are credited with saving civilization... and now they are aiming to make it even better.

But who are they? With the fate of the world economy in their hands... do they know what they're doing? From Reuters:

As the United States teetered on the edge of financial crisis in 2007, one prescient voice within the Federal Reserve was all but silenced when he warned that problems at Wall Street bank Bear Stearns were not contained and posed "enormous risk."

It was at the U.S. central bank's policy meeting in June 2007, where policymakers discussed Bear Stearns' recent bailout of two of its hedge funds hit by losses on subprime mortgages.

Though the Wall Street bank would later prove among the first dominoes to drop in a brutal crisis and global recession, then-New York Fed President Timothy Geithner and others largely agreed that the situation was contained. It was far different, they said, than that of Long-Term Capital Management, the hedge fund that collapsed in 1998 and nearly caused a global crisis.

But Richard Fisher, the former hedge fund manager and then president of the Federal Reserve Bank of Dallas, challenged his colleagues around the table. He argued there were indeed worrying similarities between Bear Stearns and LTCM, including an over-reliance on computer-based stress tests and uncertainty around the true value of underlying securities.

"I would argue -- having been in the business, although the business wasn't as sophisticated when I used to be in it -- that this has broader dimensions than those we had before," Fisher said, according to a meeting transcript released on Friday.

"If you look at the growth rate of these instruments -- again, without any underlying sense of what you ultimately can cash in if you're pressed -- it has been a straight up-curve.

"The numbers are quite huge," Fisher added. "I don't think the issue is contained. I do think there is enormous risk."

Of course, it turned out Fisher was right. And now, after a five-year embargo, we're able to see the Fed's notes from that era. What we see is hardly surprising. The head honchos had no idea.

None of them understood what was going on. None of them realized that the whole world economy was about to get whacked.

"I will be the first to say that it is always difficult to get monetary policy just right," said another Fed authority, Janet Yellen (possibly the next Fed chairman, if Ben Bernanke gets hit by a bus or an idea).

"But the Fed's analytical prowess is top-notch and our forecasting record is second to none."

We hope she wasn't under oath. Or she might be facing a prison term. The Fed's prowess is nowhere close to No. 1. Many hedge funds, research outfits, banks and rogue economists, including yours truly, had a much clearer idea of how things might shake out.

Not that anyone knew exactly. Bear Stearns? It could have been one of the other major players. You never know the details or the timing. All you can know is that mistakes will be corrected. The longer they are allowed to go on... the greater the correction.

What's the big mistake that is being made now? Where's the bubble that will pop? What are Bernanke, Shirakawa, Carney, Draghi et al. missing this time?

Our guess is that they're missing the biggest bubble ever: the bubble they caused themselves. A bubble in government debt.

More to come...

Regards,

Bill


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