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2 SPEAKING
FREELY Uncle Sam can avoid dire
strait By Antal E
Fekete
Speaking Freely is an Asia
Times Online feature that allows guest writers to
have their say. Pleas e click hereif you are interested in
contributing.
People tend to think
in terms of black-and-white. Many think that
either hyperinflation or deflation is in store for
the dollar; tertium non datur (no third
possibility given). I would say tertium
datur. The third possibility is a hybrid of
hyperinflation and deflation. I described this
scenario in my previous article (Dollar needs mint
freshener, Asia Times Online, February
7, 2008). It is possible, even probable, that we
shall witness collapsing world trade and
collapsing world employment together with
competitive currency
devaluations, as the three
superpowers - the US, China and Russia - compete
in trying to corner gold. The lure of gold is very
strong. "There is no fever like gold fever" and,
contrary to conventional wisdom, governments are
especially susceptible.
A large part of
the problem is that the central bank is helpless
in the face of bond speculation. The Fed is no
sorcerer. It is the sorcerer’s apprentice. It can
pump unlimited amounts of "liquidity" into the
system but cannot make it flow uphill. As we shall
see, new dollars flow to the bond market causing a
lot of mischief there, instead of flowing to the
commodity market as hoped by the Fed.
Up
to now, leading commodities have outperformed
gold. That could change. A select few commodities
might continue in the bull-mode for a time,
although gold could easily beat them. Most other
commodities might go into a bear-mode similar to
that of the commodity markets of the 1930’s. If
that’s what was in store, then most investors
would be totally lost. They would be navigating
without a compass. There would be endless debates
whether the country is experiencing deflation of
hyperinflation. Your motto in this hybrid scenario
should be: "expect the unexpected".
Of
course, the Fed will keep printing dollars like
crazy. Few of them, if any, will go into
commodities. Indeed, most of the newly created
dollars will go into bond speculation. Why?
Because commodity bulls are running into headwind
and face grave risks. By contrast, bond bulls
enjoy a pleasant tailwind. Bond speculation is
virtually risk-free. Under our irredeemable
dollar, bond bulls have a built-in advantage. The
Fed has to make periodic trips to the bond market
in order to make its regular open-market purchases
of bonds to augment the money supply. In order to
win, all the bond speculator has to do is to stalk
the Fed and forestall its bond purchases. This is
the Achillean heel of Keynesianism: it makes bond
speculation inherently asymmetric favoring the
bulls, and that will ultimately derail the economy
on the deflation-side of the track.
Uncle Sam in agony Russia is not as
enigmatic as China. The Russians’ game is gold.
China is the big unknown. It looks as if China
prepares to corner silver. Will the Chinese force
a silver standard on their trading partners? It is
quite possible that their pile of paper profits in
silver is already so huge that they can well
afford to gamble. They find trading Treasury bonds
most profitable. Indeed, theirs is the greatest US
T-bond portfolio ever, anywhere. They can
overwhelm any opponent bidding against them.
Just think about it. The financial destiny
of the US is in China’s hand. The good news is
that the Chinese have a vested interest in keeping
the bond bull charging. They also have a vested
interest in keeping the dollar on the life-support
system. The bad news is that the Chinese insist
that it is their finger that must be on the
switch. Here is an incredible sight, the US being
under the thumb of China. Not because the Red Army
is a match for the US military, but because Uncle
Sam has voluntarily put his head into the noose.
The Chinese ask: why fight shooting wars
when you know that your antagonist is painting
himself into a corner anyhow? They know that Uncle
Sam will sooner or later start crying: "Uncle!" in
agony. They have all the marbles. The marbles of
saving. The marbles of producing. The marbles of
silver. Maybe, one day, they will also have the
marbles of gold.
The logarithmic law of
deflation Most economists are ignorant of
the mathematics of depressions. They have
certainly never heard of what I call the
Logarithmic Law of Deflation. It states that
halving interest rates brings about the same
proportional increases in bond prices, regardless
at what level the halving takes place. It makes no
difference whether you go from 16% to 8% or from
2% to 1%, the value of long-term bonds will
increase by about the same factor. It can be seen
that a much smaller drop in interest rates could
bring about the same proportional increase in bond
prices, provided that the rates are low enough.
Why is this important? Because it gives
away the secret of the deadly deflationary spiral.
It is wrong to describe Fed action as cutting
interest rates. We should think in terms of the
Fed halving them. The bull market in bonds can go
on indefinitely under the regime of the fiat
currency. People assume, wrongly, that the Fed
will run out of ammunition when the rate of
interest is approaching zero. The bond-bull will
run out of breath. Not so. The Fed will never run
out of ammunition. The lower the rate, the smaller
cut will do. The Fed can halve interest rates any
number of times without ever reducing them to
zero. The bond-bull will never run out of breath.
The trouble is that the bond-bull is the
root cause of depressions. Falling interest rates
create capital gains for bondholders, yes, but
these gains do not come out of nowhere. They come
right out of the capital losses of producers. They
are the very stuff out of which depressions are
made. The serial cutting of interest rates by the
Fed is the grave-digger of the economy: it causes
wholesale bankruptcies in the producing sector.
The large-scale dismantling of the producing
sector in America during the past 25 years is a
direct consequence of the regime of falling
interest rates.
Production stopped as a
result of the financial sector siphoning off
capital from the producing sector. Industrial jobs
were exported as there was no capital left to
support them at home. This shocking truth was
never investigated by mainstream economists,
sycophants of Keynes. They did not want to expose
the gravest error of their idol in confusing a low
interest-rate structure with a falling one.
Keynesianism is the gigolo of science (Ayn Rand).
Moral cannibalism As the example of
Japan shows, we are not looking at a ditch into
which the Japanese economy has stumbled. We are
staring a black hole in the face, the black hole
of zero interest. It can suck in the Japanese
economy. It can suck in the economy of the United
States. It can even suck in the entire world
economy. It is powered by the regime of the
irredeemable dollar, and the Fed’s policy of
serial interest-rate cuts.
Ayn Rand called
the confiscation of gold in 1933 by F D Roosevelt
"moral cannibalism". As I have shown elsewhere,
the epithet is apt. The removal of gold as the
chief competitor of government bonds was one of
the main causes of the Great Depression in
triggering, as it did, a protracted fall in
interest rates. (The other cause was the
deliberate manipulation of interest rates lower by
the Fed.)
The latter-day equivalent of
moral cannibalism is risk-free bond speculation by
the banks, perpetuating the bull market in bonds.
It is made possible by the open-market operations
of the Fed that have been clandestinely and
illegally introduced and, by now, have become the
mainstay of the management of fiat currencies. The
result is another protracted fall in interest
rates. Could they herald another Great Depression?
There is an historical lesson to learn
here. The twentieth century was not the "American
Century" as advertised. The sun started setting on
America as early as 1913 when, in imitation of the
Europeans, Americans embraced the idea of a
central bank. An earlier attempt to establish a
central bank in the United States was found
contrary to the Constitution, and the Bank’s
charter was not renewed. But by 1913 the visionary
admonition of Thomas Jefferson was totally
forgotten.
If the American people ever allow
the banks to control the issuance of their
currency, first by inflation, and then by
deflation, the banks and corporations that will
grow up around them will deprive the people of
all property, until their children wake up
homeless on the continent their fathers
conquered. The issuing power of money should be
taken from banks and restored to Congress and
the people to whom it belongs. I sincerely
believe that the banking institutions having the
issuing power of money are more dangerous to
liberty than standing armies.
In less
than a generation after 1913 adventurers invaded
America’s institutes of higher learning and exiled
monetary
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