Silver has returned to its rollercoaster ways. After a low of $7.42 in November, silver shot up to $9.22 intraday on December 12th. Since then it's had a two step correction, closing today at $8.31 an ounce. Silver may dip lower, but I think we've seen the worst of this correction already. Although it's difficult to predict, I expect silver will move above $9 again in a couple of months.

Crystal Clear, Part I

It seems that every time I read the news I see calls for greater transparency. Prestigious individuals from Wall Street, the Federal Reserve, and U.S. government agencies claim to support more open communication. Ironically, the more institutions announce their openness, the more cloudy the real condition of the economy becomes to the public.

When I speak to average stock market investors, they seem quite relaxed about the state of the U.S. economy. The Dow is approaching 11,000, and their real estate has appreciated sharply over the past five years. If they have no fear of a crash, it's due to the misinformation they receive every day. Wall Street, the Fed, and the government work together in a symbiotic relationship to obscure reality. Mass psychology tells Americans, "Don't worry, go shopping," and today's leaders don't try to change their minds.

Wall Street and the government cooperate to keep complacency high. Financial pundits often cite the BLS' Consumer Price Index as proof that price inflation is tame. However, under President Clinton's administration the method for calculating CPI changed. Through the use of hedonics, geometric weighting, and substitution, inflation has been understated by 2.7% according to Gillespie Research. This has secretly reduced seniors' Social Security checks by 43%, and caused many investments to have a negative real rate of return. Government officials point with pride to low "core" inflation which excludes energy and food, as if consumers don't spend much of their budgets on these items. If the pre-Clinton methodology is used, price inflation is over 7% this year.

Firms with government contracts indexed to CPI are very pleased with this downward adjustment which enhances their bottom line. Wall Street also hopes the reported price inflation stays low. If the Federal Reserve proclaims inflation "contained," they will stop the rate hikes that make short-term corporate borrowing more expensive. Understating inflation artificially boosts the GDP number. Wall Street interprets robust growth numbers as an indicator of higher corporate profits in the future. The pundits argue that stocks are "cheap," and investors should buy now before the shares appreciate.

Corporate scandals are the pebbles which disturb the pool of investor complacency. The Refco debacle is one of the most visible examples of deception and mismanagement on Wall Street today. Its former CEO, Phillip Bennett, was fired and charged with fraud when it was discovered that he had concealed $430 million in bad debts. Somehow, Credit Suisse First Boston, Bank of America and Goldman Sachs all missed this illegal activity when they underwrote Refco's IPO in August. Grant Thornton also audited Refco's books earlier this year, but didn't raise any warnings despite murky accounting.

Refco's problems have rippled through Wall Street. A month after Jim Rogers moved his commodity fund to Refco, $362 million of its assets were frozen. His lawsuit claims that segregated funds were shifted to an unregulated account without his knowledge. Investors in the Rogers Raw Materials Fund will probably never recover all their money, since Refco has already declared bankruptcy. Some assets were auctioned off without determining proper ownership, a task made more difficult by confusing and inadequate records. About 20 other customers have also filed suit in an attempt to recover nearly $2 billion in assets.

Laws that are supposed to protect the public aren't helping. The 2002 Sarbanes-Oxley law requires CEOs to endorse their company's accounting to prevent fraud, but it doesn't hold the auditors or underwriters responsible. The new bankruptcy law effective October 17 dictates that a trustee should be appointed to run a company if management is suspected of fraud. This didn't happen with Refco. Managers hired by Bennett are still directing the activities of the firm. On December 8, Refco announced that it shifted $170 million in assets from one subsidiary to another and sold over 68% of these securities in a breach of the bankruptcy code. To date, the authorities have taken no action. Despite all the government regulation, small investors were victimized once again.

The Federal Reserve may be involved in the Refco affair. Three weeks before its sudden implosion, Jim Sinclair notes that the Fed met with major banks on derivative issues, including Refco's major underwriters. This meeting was originally scheduled for December, then moved 3 months earlier even though the meeting was ostensibly focused on routine housekeeping issues.

Despite repeated Wall Street scandals, confidence remains high and volatility is low. Investors have faith the Federal Reserve will manage the economy smoothly, and stocks won't suffer a major correction. This phenomenon is so accepted that it's referred to as the Greenspan put.

I hope you enjoyed Part I of Crystal Clear. After the New Year, I will explain how the Federal Reserve and the U.S. Treasury Department collaborate to confuse the average investor, and how you can protect yourself from financial fraud.