"The three stages of magic:

First, there is the setup, or the "Pledge," where the magician shows the audience something that appears ordinary but is probably not, making use of misdirection.

Next is the performance, or the "Turn," where the magician makes the ordinary act extraordinary.

Lastly, there is the "Prestige," where the effect of the illusion is produced. There are "twists and turns, where lives hang in the balance and you see something shocking you've never seen before."[

From the movie “The Prestige”.


Bernanke is the illusionist.

We are the audience.

We must be willing to suspend disbelief. We paid for the ticket. We know that a railroad car or the Statue of Liberty cannot disappear. But we want to believe they can. We want to be entertained.

The setup, or the “Pledge”, is a fair market and real, inflation adjusted growth. It seems normal and fair but all is not what it seems.

The “Turn” is the illusion of exceptional economic growth and prosperity beyond all rational expectations. Interest rates are low, zero down, cash back financing, asset values increasing far in excess of any wage and earnings growth. People making $50,000 per year are buying houses for $500,000. Houses are “flipped” for huge profits. Assets sell for more than the asking price. Wages increasing faster than prices. Security of social contracts (social security, etc.). $700T worth of derivatives that are perfectly hedged. Banks with sufficient reserves. Solvent muni bond insurers. Sufficient equity and cash flow for the debt load.

The “Prestige” is the appearance of real growth of your wealth and the financial stability of the US, all the while the “lives hanging in the balance” are real estate crashes, massive bank write-offs, increasing unemployment, historic rise in prices of oil, unimaginable federal budget deficits, a war in Iraq, prescription drugs, Medicare, Medicaid, Social Security, trade deficits, Sovereign Wealth Funds moral authority via their investments, complete lack of wage pricing power, record foreclosures, negative savings rates, increasing bank failures.

All of these are mis-directions. All real and, yet, you WANT to believe that these problems are solvable at the wave of a wand by the Illusionist.

You walk away from the event knowing what you saw can’t be real yet you still believe.

The only problem is that when you leave the theatre, the Pledge, the Turn and the Prestige, the entire illusion, stay in the theatre. You don’t have to go back and your memory of the illusion grows richer over time.

In the real world, you pay for that Illusionist each and every day with your tax dollars, your depreciating disposable income and your diminishing asset values. You feel richer but you are not.

Inflation erodes your purchasing power, deflation diminishes the value of your home. Your net worth increases BUT your real value, in terms of purchasing power, decreases.

The FED CANNOT raise interest rates and have economic growth. The FED CANNOT lower rates and stop inflation. They have finally reached their “Hobson’s Choice”…a choice that is really no choice at all.

We have no wage pricing power in a globalized world. We have no pent-up demand to drive a recovery via new jobs in manufacturing or service. Our real savings are decreasing.

To raise interest rates, oil must come down, thereby freeing up disposable income to pay the higher interest rates. But if rates increase, housing dies, more mortgage and credit losses, more FED lending to banks and investment banks, the FED runs out of balance sheet (about $1T total to work with but having used about $500B already), the FED goes to the Treasury for re-funding, that means more federal debt, higher federal interest costs, bigger budget deficits.

This is the quintessential “Hobson’s Choice” and the greatest illusion ever attempted.

The FED will not raise rates in this election year, no matter what the “Pledge” is.

And our audience will not suspend disbelief. Therefore, the illusion is no illusion at all.

Fade to black…