That liquidation and the formation of real savings are required for the economy to return to real growth is fundamental, but of course not an expedient policy for a bureaucrat or elected official.
How can liquidation be avoided? Mr. Bernanke knows! During TARP mania, the Federal Reserve purchased a major portion of the toxic assets from the six megabanks in order to save the financial system. Of course they refer to these assets as "illiquid assets" ... and of course they purchased them at their "full" value. This was not expansionary monetary policy because they would simply sell the assets back once the market had recovered, thus removing the temporary injection of liquidity. But of course, an asset that has already gone to zero, a mortgage that has already defaulted (some sold on 100:1 leverage no less) is not illiquid in the sense that it has low value due to uncertainty. It is straight up worthless and can never be sold.
By swapping dollars for worthless assets, they have not avoided the liquidation phase of the business cycle, they have simply kicked the can down the road ... avoiding what should have been a short lived but very sharp correction in real estate, and turning it into a future currency crisis. Liquidation still must happen, it will simply happen in a different (and much more widely felt) sector.
This is what gold is telling us. Mr. Greenspan admitted as much in his speech before the CFR last week. He called the gold price rise "a canary in the coal mine." Liquidation of worthless assets is being avoided in the short term at the cost of a currency crisis. Gold has been telling the market this for ten years. Those who are apologists for Keynsian policy missed out on the best performing asset class of the last decade. They said not to buy gold at 250, 300, 400, 600, 800, 1000, and definitely not now. They see the canary die (gold prices rising 20% year over year). They blame the canary for dying. "The air is fine, who needs the canary anyway!" Recovery is just around the corner! But those who ascribe to the ABCT know that recovery cannot and will not happen until there is liquidation and a return to savings as the modus operandi of the public.
One thing about the ABCT that I was initially reluctant to buy into and some have blogged about, is the idea that investors are stupid enough not to realize what artificially low interest rates mean in the long run. Of course, this is where the madness of crowds comes into play. Most investors do not have the time or motivation to look at market fundamentals day in and day out. They use market signals like interest rates to make quick decisions. In the U.S. in particular, it's a mess. Market analysts in the media boiled investment trends down to statements like "markets go up 5-10% per year in a normal environment" ... and "housing growth is unsustainable now, but will probably settle into to a normal 10% annual growth rate in the near future." Market cap? P/E? Dividend yield? Who cares! Markets "go up" 5-10% (stock price appreciation) and interest rates are lower than that. You'd be stupid not to "be in the market!" Hell, buy financials that are leveraged 10:1 to 100:1 and make 50-500% annually!
As to investors not identifying low interest rates as temporary (thus borrowing cheap money and using it with little discretion)...
Exhibit B: (3:14 till the end)
"As a general rule, the most successful man in life is the man who has the best information."
Gold is talking. Keynsians and Monetarists are losing their shirts in the market. Those investing based on an understanding of ABCT are preserving their wealth ... and even growing it. What did it take to bury Marxism? Massive poverty and wealth destruction. What will it take to bury Keynsianism? Probably 5-10 more years.