The Fed discovers chicanery: James Saft … Acknowledging that sometimes banks chisel clients and bank employees chisel banks may sound obvious to you, but for the Federal Reserve this is a pretty big step forward. Jeremy Stein, a member of the Board of Governors of the Fed, gave a speech last week in which he said that sometimes it may be necessary for the fed to raise interest rates to control overheating in credit markets. While a lot was made about him being Wall Street's new bubble cop, I'd argue that actually the big step here was that he specifically and convincingly argued that you can't understand markets without understanding the way participants game the system to their own advantage. This is a huge change from the old Greenspan – and Bernanke – assumption, which was that the market was self-policing. – Reuters Opinion, James Saft

Dominant Social Theme: Federal Reserve officials come in from the cold and realize that free markets need a modicum of regulation.

Free-Market Analysis: According to this Reuters opinion article, Federal Reserve officials have finally realized that markets need common sense regulation – including bubble moderation when things seem to be getting out of hand. This is hailed as a positive first step to returning the West's financial market s to full functionality.

In this article, Saft, the editorialist, writes that "it makes good sense to make regulation as simple as possible, which in turn would lead to simplicity in financial products and minimize the potential for the abuse of clients by their advisers."

Saft points to Glass-Steagall as a good example of powerful, simple legislation that did "a good job."

In fact, the libertarian analysis of Glass-Steagall is that it was an attack launched by the Rockefellers at the Rothschild controlled JP Morgan, which had the most to lose by being split up into component banking and trading parts.

This little analysis – which probably has some truth to it – only goes to show how complex regulatory rationales really are. The bottom-line truth is that regulations are price fixes and price fixes never work out the way they are intended.

Not only that, but regulations are created by people with various agendas and competitive strategies. For many industry leaders, regulation is just competition via other means. They want the government to do to their competition what they have not been able to accomplish in the marketplace.

Perhaps Saft's point makes some sense: A few, overarching rules are better than a plethora of niggling ones. But either approach is probably going to distort the market and create other problems down the road. Here's more from the article:

Fear of the commercial consequences of bad actions would serve as an effective brake on fraud and abuse. That naïve view allowed the Fed to assume that markets would behave predictably and rationally. It helped to set the intellectual underpinnings that led to too-easy rates, further easings when things went bad and the rolling series of bubbles and panics we've seen over the last decade and a half. The truth, as we've seen, is that you can't understand financial markets without taking into account the fact that agents, like banks and fund managers, often put clients in bad but profitable products and that those same bankers and managers often do the same thing to their own institutions.

"The premise here is that since credit decisions are almost always delegated to agents inside banks, mutual funds, insurance companies, pension funds, hedge funds, and so forth, any effort to analyze the pricing of credit has to take into account not only household preferences and beliefs, but also the incentives facing the agents actually making the decisions," Stein said in a speech at a symposium sponsored by the St. Louis Fed. "And these incentives are in turn shaped by the rules of the game, which include regulations, accounting standards, and a range of performance measurement, governance, and compensation structures."

This, if accepted, could be a kind of Copernican revolution in Federal Reserve thinking, except that, rather than accepting that the earth revolves around the sun, the Fed would at last be acknowledging that banks do the dirty to their clients and bank employees do the same to their banks.

Accepting that human beings act in their own best interests, not those of their clients, is a crucial ingredient not only to running regulatory enforcement and policy but also to managing monetary policy. My guess is that Federal Reserve officials and other economists tended to ignore these issues because they make analysis so messy and difficult.

For academic purposes it is far easier, when trying to prove a theorem, to assume that markets are efficient and that people within them act in what they see as their own best interests. It is also true that this reflects a kind of market fundamentalism born out of a suspicion of the effectiveness of regulation and government intervention.

Okay, sure … Fed officials in years past held that competition would moderate the markets' behavior and that therefore the Fed did not have to intercede when it came to investment bubbles, etc. But this was always a flawed argument because of what Austrian business cycle analysis shows us – that it is central banking overprinting of monopoly fiat money that stimulated bubbles to begin with.

Simple, broad regulation is not what is needed to make markets more productive and efficient.

What is needed is to remove the function of monetary production from an entity that has a monopoly franchise granted to it by government.

That is the issue that Stein should be dealing with – and Saft should be analyzing, in our humble opinion. But, alas, it is an issue that as usual goes undiscussed.

It is not discussed because both Reuters and the Federal Reserve are mechanisms of elite control. One creates money and the other attempts to adjust public sentiment on the matter – but both are designed to promote the manufacture of currency under the watchful control of a designated few.

This is a power elite that is dedicated to world government and uses the awesome power of central banking to fund its gambits. It also uses dominant social themes to control the conversation about money creation and the privileges that it currently enjoys.

We can see in both Stein's speech and Saft's subsequent analysis that the conversation is indeed adequately controlled. There is no mention of the suitability of a single entity and a handful of men controlling trillions of dollars – as regards both value and price.

Instead, the concern is whether the Fed is doing an adequate job of regulating member banks and keeping them from abusing their powerful positions as sole distributors of the money created by the Fed.

Saft approves of the idea of a more active and powerful central bank. In fact, in an article just yesterday, we discussed how this seemed to be an expanding elite meme … that central banks, having failed to control various excesses in the past, now need to become more aggressive in terms of monetary policy and regulation.

This doesn't make much sense to us. Central banking simply doesn't work – on purpose, no doubt, as the elites need chaos to formulate world government. But purely from an intellectual standpoint one can easily argue that if a system is constantly failing it doesn't need yet more power.

A more important point when it comes to discussing these issues is that Saft does not mention the proverbial elephant in the room. What happens when central banks begin to raise rates because of increased economic activity?

Stein is arguing that the Fed needs to be more proactive to control bubble finance. But central banks around the world have dumped some US$50-100 trillion into the markets in the past five years to try to stimulate global economies.

This is actually unheard of and occurred only because the dollar reserve system basically died in 2007-2008.

When all this money does finally begin to move out of bank coffers and into the general economy, central banks will have to raise rates fast and hard, choking off the recovery once again.

In fact, it will likely prove impossible to control the surge of money that has already been printed. On the heels of this inflation will come terrible price inflation – inflation that can hardly be imagined now.

This is the real issue that Stein and Saft should be grappling with. Saft can comment approvingly about the idea that central banks need to regulate more proactively but, even assuming such an argument were accurate, it is too late for that remedy now.

Fifty to a hundred trillion dollars too late.