Siegfried & Roy & Bernanke

Siegfried & Roy were one of Las Vegas’s most popular acts until 2003, when Roy Horn, the trainer of big cats, was attacked by a tiger. He has still not recovered.

Siegfried was an illusionist. We call these people magicians, but the magic they employ is illusion.

The more I think of it, the more I see Ben Bernanke as the replacement for Siegfried & Roy. The show must go on.


The illusionist relies on his ability to get the audience to look at one thing while he manipulates something else.

The stage illusionist doesn’t harm anyone. Any illusionist who harmed people would be written out of the guild. That’s why the Federal Reserve has never been able to gain membership, despite its consummate mastery at getting the audience to look somewhere else than where the FED is doing the manipulating.

On Wednesday, April 30, the Federal Open Market Committee met to decide if it should announce another reduction in the target rate for Federal Funds, the rate at which American banks lend money overnight to each other.

Wall Street had predicted that the rate cut would be minimal: a quarter of a percentage point (25 basis points). All day, the Dow Jones Industrial Average slowly rose by 145 points. Then, as soon as the FOMC announced its expected reduction, the market fell. It closed down almost 12 points.

In previous sessions, the Dow had soared several hundred points upon the FOMC’s announcement, only to fall back the next day or by the end of the week. This time, sellers wasted no time. The shot in the arm didn’t work at all this time.

The FOMC published its usual press release. It admitted what everyone suspects: slow growth ahead.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

The FED’s approach has always been to accent the positive. When the positive is barely visible, the FED emphasizes as much of it as it can.

Economic growth never departs entirely in a FED announcement. Whenever economic growth plays hide and go seek, the FED announces, “We can see you! You can’t hide from us!”

Look at the words in the announcement: “weak,” “subdued,” “softened,” “considerable stress.” This is indicative of an economy under pressure, but not in recession today.

Then there is the familiar refrain, which is rarely absent from any FED announcement.

Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

Year after year, decade after decade, the FED continues to monitor price inflation. Price inflation does not go away. It seems to exist in order to make work for Federal Reserve statisticians. Entire careers are devoted to monitoring price inflation. “There’s always more where that came from!” And there almost always is.

The key to a successful illusion is the illusionist’s ability to get the audience to focus its attention on something peripheral. That’s why he uses a wand. Or he may wave his hands in some flashy way. “The action is over here.” No, it isn’t. Let me show you how this works.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity.

“Yes, sir, watch the easing of monetary policy.” They mean: “Watch our announcement that it’s there.”

I prefer to watch the FED’s figures on monetary policy rather than the FED’s official press releases. The FED can control only one monetary aggregate directly: the monetary base. It buys, sells, or holds assets that serve as a legal reserve for the nation’s commercial banks. I watch the St. Louis Federal Reserve Bank’s adjusted monetary base. I post a link to it on my website, It’s in the “Free Materials” section, listed under “Federal Reserve Charts.” Click the link: Adjusted Monetary Base: Short Term.”

Because the chart is revised every two weeks, I am providing here a permanent snapshot of the figures, as of April 24, 2008.

The adjusted monetary base comes closer than any other monetary aggregate to revealing Federal Reserve policy. Thus, as the grand master of American illusion, Chairman Bernanke wants the audience to pay no attention to it.

In March, 2007, Congressman Ron Paul sent a letter to the Federal Reserve asking three questions:

How can the money supply increase at a rate three times that of the monetary base?

What is the source of the additional reserves that do not show up in the monetary base figures?

Because this has happened, according to the data, how does FOMC policy affect the actual money supply today?

Federal Reserve Chairmen do not appreciate these sorts of direct questions. So, they employ various techniques of verbal evasion. In his reply of March 28, Chairman Bernanke adopted an academic variation of Alan Greenspan’s FedSpeak. You can read his reply. It is masterful. It does not answer the questions, of course. But is surely lets us see a master illusionist at work. See for yourself.

Every reporter in the financial press should read this letter. They should all press him:

What is the function of the monetary base, if not to control the legal reserves of the banking system?

Then they should ask this question:

Can the banking system as a whole create credit independently of the monetary base?

Then they should ask this question:

If the banking system can create credit independently of the monetary base, how can the Federal Reserve System control monetary policy?

They will not do this. Why not? Because (1) they do not understand money and banking; (2) they do not read my reports.

Without the widespread mystery of central banking, the illusion could not go on. The best cure for this illusion is the money and banking textbook by economist Murray Rothbard, The Mystery of Banking. You can download it for free here.

Let us return to the FOMC’s assertion:

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity. . . .

I ask: “What easing of monetary policy?” Where is the evidence of such easing? The adjusted monetary base figures reveal a year-to-year increase of less than 1%. This is tight money by any post-1932 definition of monetary policy.

Now let us look at the “ongoing measures to foster market liquidity.” These policies are (1) swapping marketable assets in the FED’s portfolio for less marketable assets in the largest banks and brokerage firms’ portfolios; (2) announcing an implied promise to provide liquidity — fiat money — by announcing reductions in the FedFunds target rate.

The illiquidity in the system comes from the banks’ distrust of each other’s solvency. The problem is looming insolvency, not illiquidity.

This leads us to the second aspect of the performance: the big cats.


Roy Horn suffered from an illusion. He thought he was in charge of his tigers. Most of the time, he seemed to be in charge. This illusion ended in a spectacular fashion.

The trouble with wild animals is that they are wild. They may cooperate with a trainer for a time. The trainer provides tasty rewards. For a time, the animals figure that the treats taste better than the trainer. Then, without warning, one of them changes its mind.

All central bankers go on stage and perform just as Roy Horn performed. They snap their whips. They develop entertaining patter. They provide the sense of being in control.

They are dealing with wild animals: entrepreneurs. Entrepreneurs try to forecast future market conditions. They make money when they forecast correctly. They lose money when they don’t. Unlike central bankers, they put their money, or their clients’ money, where their mouths are.

As capital markets grow more complex, central bankers are like wild animal trainers who keep adding wild cats to the line-up. They snap their whips, but all it takes is one big cat — or fat cat — to gobble them up. George Soros is such a big cat. He called the joint bluffs of the Bank of England and the Bank of Malaysia in 1992 and made an estimated $4 billion at their expense.

The complexity of today’s international capital markets is beyond the ability of any computer program, committee, or central banker to understand. Central bankers call meetings, issue press releases, and announce non-existent policies, and they expect the markets to fall in line.

One of these days, the chairman of the Federal Reserve System is going to get mauled. So are all those investors who put their money where the Chairman’s mouth is.

The press release also assured us that “The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.” When a press release includes such meaningless, self-serving bluster as this, think of Roy Horn on-stage, going “Nice kitty. Nice kitty.”

The tiger got a grip on Roy Horn’s head and dragged him around the stage. I predict that someday, the capital markets are going to grab Ben Bernanke by the beard and drag him around the stage.


Franklin Sanders says that the Federal Reserve has only two tools: inflation and blarney. Bernanke has added another: asset swaps.

William Poole, the recently retired president of the St. Louis Federal Reserve, made this statement before he retired. “As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues.”

Under Bernanke, the FED has had to deal with insolvency issues. He has convinced his peers to adopt a policy of asset swaps. The Federal Reserve System exchanges low-risk Treasury debt to struggling large banks and large financial institutions in exchange for AAA-rated assets that no one believes are AAA-safe. This keeps the borrowing institutions from having to reveal on their accounting sheets that they are holding capital of less than book value.

This practice is legal. It is short-term. It doesn’t yet have answers to these questions:

What will happen if the AAA-rated paper doesn’t recover, because the capital markets for these assets do not recover?

How long can these 28-day swaps go on, when the borrowing institutions must pay interest to the FED for the swap?

What markets will the FED-borrowing institutions lend to in order to get enough profit to keep paying the FED?

What happens when the FED at last inflates, Treasury rates rise, and the FED-borrowing institutions owe higher interest payments to the FED for the borrowed Treasury debt?

The policy can continue for as long as (1) The FED has Treasury debt to swap (about $540 billion remaining), and (2) Treasury interest rates remain low.

The FED is dealing with insolvency directly. It is not dealing with illiquidity directly. It has intervened to convince those banks with more solid balance sheets to lend overnight to banks with questionable balance sheets.

The bankers know the score. They know that American major banks are on the edge of bankruptcy, just as British banks are. (This is why all information on which banks are involved in the Bank of England’s $100 billion asset swaps is locked up for the next 30 years.) They don’t want to lend to these banks.

The FED is not supplying the banking system with liquidity. It is instead providing public band-aids for banks facing insolvency or at least a contraction of their lending ability due to reduced balance sheets. The FED is trying to persuade decision-makers in an illiquid commercial banking system that the FED stands ready to bail out any toppling firm whose bankruptcy threatens the entire payments system with gridlock. This is what Greenspan a decade ago called cascading cross defaults.

Almost ten years ago to the day, Alan Greenspan gave a speech before the 34th Annual Conference on Bank Structure and Competition of the Federal Reserve Bank of Chicago. He warned:

To be sure, we should recognize that if we choose to have the advantages of a leveraged system of financial intermediaries, the burden of managing risk in the financial system will not lie with the private sector alone. As I noted, with leveraging there will always exist a possibility, however remote, of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked.

That was the threat in 1998. It remains an even greater threat today. So, how can society deal with this threat?

Only a central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks will of necessity be drawn into becoming lenders of last resort.

In short, “Nice kitty. Nice kitty.”


We are all riding on the back of a highly leveraged, debt-ridden tiger. We hope that Chairman Bernanke doesn’t get eaten alive. Why? Because the tiger will maul us first.

May 3, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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