Page 2 of 2 SPEAKING FREELY They dare not speak its name
By Antal E Fekete
possible to predict whether bond prices go to zero as they would under
hyperinflation, or whether they go sky high as they would under hyperdeflation.
This problem is crucial and it can be approached only through understanding
bond speculation, especially as it is helped by tail-winds provided by the
central bank.
The following facts are either not widely known or not well-understood. Open
market operations of the US Federal Reserve (Fed) were introduced in the 1920s
in violation of the Federal Reserve Act of 1913. They were legalized
retroactively in the 1930s. There was hardly any public discussion of the
wisdom of the move or the stakes involved. Pre-1936 economics was categorical
in its condemnation of the monetization of government
debt. Introducing the catchy name "open market operations" has made it possible
to monetize government debt through the back door.
Economists failed to predict the disastrous consequences of this ex post facto
legislation. Bond speculators were given a risk-free opportunity to profit. In
pre-empting the Fed, they would buy the bonds beforehand, dumping them after
the Fed had completed the purchase of its quota. Risk-free speculation imparted
a bias to the market favoring rising bond prices or, what is the same to say,
falling interest rates.
It speaks volumes about the degradation of economics in the wake of the
Keynesian revolution that an illegal trick could be elevated to the holiest of
gestures whereby high-powered money is created, and nobody points to the
downside of the prestidigitation.
Revisionist theory of the Great Depression
Most importantly, economists have also failed to identify falling interest
rates as the main cause of the Great Depression. They have concentrated on
falling prices, not realizing that in doing so they are confusing cause and
effect. The true chain of causation is as follows.
Persistently falling interest rates result in the erosion (ultimately,
destruction) of capital deployed by the producing sector. In effect, bond
speculators siphon off money stealthily from the capital accounts of the
producers. The latter are unaware of being victimized by this vampirism of the
financial sector. But they are, whether they recognize it or not.
Profits of the bond speculators do not come out of nowhere. They are the
flipside of the opportunity loss suffered by the producers, who have to
continue financing their capital at the higher rate. Unable to escape from the
clutches of debt, the producers are squeezed. They scramble to sell more of
their product at fire-sale prices in order to fend off bankruptcy. In this way
a downward spiral of prices is created.
The prevailing optical illusion suggests that money is scarce. Everybody cries
out for the Fed to create more money. The Fed complies and enters the open
market to purchase more bonds. In doing so it provides bond speculators with
another opportunity to make risk-free profits. Interest rates fall further and
producers are squeezed more. A vicious circle is activated. At the end of the
spiral producers go bankrupt in droves.
According to my revisionist theory the Great Depression, far from being caused
by overproduction as suggested by Keynes, was caused by wholesale destruction
of capital. The ultimate cause was risk-free profits granted to bond
speculators through the Fed’s open market operations.
This is a serious challenge with which the prevailing orthodoxy is confronted.
The weakness of its position is shown by the unwillingness to take it up and
have an open debate. It is with regret that Gold Standard University Live has
to suspend its operation to let Keynesian orthodoxy win by default.
Witch-hunt in Washington
High energy and food prices have given occasion for a witch hunt in Washington.
Politicians are trying to push the blame on speculators, calling for
legislation to limit long positions in the futures markets. These laws, if
enacted, would be counter-productive. All this goes to show that economics is a
complete ignoramus when it comes to speculation.
Speculating in crude oil and in grains is not risk-free. Profits are the
incentive for speculators to lend liquidity to the markets and to temper price
swings. Indeed, speculation stimulates production or retrenchment according as
the threat is scarcity or overproduction.
It is a blunder to regulate speculators out of the commodity markets. The
result is predictable: illiquidity, more volatility, more scarcity. Consumers
would end up paying even more for energy and food.
So much for commodity speculation. Bond speculation is another matter. As
explained, bond trading does not address risks that exist in nature. It
addresses risks created artificially by the government. Worse still, instead of
promoting stability, it destabilizes the interest rate structure further. Worst
of all, bond speculation is made risk-free by the open market operations of the
Fed. The cap on bond prices has been removed, and continually falling interest
rates may push the world into another Great Depression, possibly worse than the
last one in the 1930s.
These are just some of the questions GSUL has set out to investigate in depth.
Mainstream economics avoids these topics like the devil avoids holy water.
Other schools such as the Austrian, for example, appear to be more interested
in cultism and in regurgitating old tenets than in new research of new problems
to which mainstream economics turns a blind eye.
It is with regret that GSUL gives up its plans to discuss these burning issues
in public just at a time when the need for such debate appears to be the
greatest.
I take this opportunity to thank everybody, participants as well as sponsors,
for their support of our cause. I wish everybody a prosperous journey through
what promises to be truly hard times.
Reference: A E Fekete, Fiat Currency, Destroyer of Capital,
www.financialsense.com, December 5, 2007.
Antal E Fekete has since 2001 been consulting professor at Sapientia
University, Cluj-Napoca, Romania. In 1996 Professor Fekete won the first prize
in the International Currency Essay contest sponsored by Bank Lips of
Switzerland. He also runs the Gold Standard University. Gold Standard
University session four will be be held in Hungary in July, and session five in
Canberra, Australia in November. These will be the last GUSL sessions.
(Copyright 2008 Antal E Fekete.)
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