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Where's the Money?



Catherine Fitts was an undersecretary for HUD in 1990. At some point she noticed that there was a discrepancy between funds available and funds allocated. After investigating she found that several other divisions of the government were experiencing the same situation and that if one carefully compared the actual government receipts to government expenditures, the difference was around $1 trillion. She began to ask some tough questions.

Ms. Fitts no longer works for the government and now writes for ""; her own organization which has a short term goal of "illuminating the trillions of dollars in missing and mishandled government funds and corporate corruption and fraud."

Ms. Fitts does not seem to have any direct knowledge of the Federal Reserve; I bring her work up mainly to alert you to it. But her work on the federal government in general lends credence to the suspicion of extracurricular activity at the Fed as well.

The Fed had moved beyond - way beyond - their original charter during FDR's administration, and they have been drifting away from the strict definition of what they are "supposed" to do for decades. Even though the U.S. government and the Federal Reserve are two separate entities, they are born of the same bureaucratic culture, a culture of the means justifying the method.

We know this primarily through speeches given by governors over the years, and most recently by Bernanke in November 2002 where he said, "The U.S. government has a technology, called a printing press - or today, its electronic equivalent - that allows it to produce as many U.S. dollars as it wishes at essentially no cost", that the Fed also acts in non-sanctioned ways to accomplish short term objectives.

The Federal Reserve has never been audited. We believe that they did some fairly extraordinary things in order to inject liquidity into the markets in an attempt to "stabilize" the economy after 9/11. But they could still be doing them. To what degree is a matter of serious debate between serious people with serious implications.

The money supply has been growing at a very high rate of 12% since the beginning of the year and more so lately. I personally have little doubt that the Fed can behind the scenes be doing things without the general public realizing or understanding what they are doing.

One thing they might be doing right now is monetizing the debt: printing money to buy U.S. treasuries. Bonds have been performing rather poorly lately, but given the recent strength in economic statistics, we believe that long rates (the Fed has much more control over short rates) should even be much higher than they currently are.

A long bond rate of 6% could be disastrous for the U.S. economy. It would stifle growth being generated from the housing market. It would significantly reduce money currently being mis-allocated to risky assets in lieu of bonds, which would eliminate the positive wealth effect on consumers' balance sheets.

One way to keep foreigners from selling our bonds is to first convince buyers that there is no inflation while at the same time marginally support the market by monetizing it. This will on the margin put pressure on the dollar, which we are seeing now. We put the chance of the Fed doing this now at around 20%.

20% doesn't sound like much, but the important point is that it is not zero. This idea is a distinct possibility, a possibility that makes the pieces of the puzzle fit together.

The fact that it is a possibility at all indicates the dilemma the Fed is currently in and why they must at all costs keep interest rates artificially low.

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