The United States Federal Reserve delivered another handsome gift to the bond
bulls on Wednesday, March 18, with the announcement that the Fed's Open Market
Committee has made a unanimous decision for the US central bank to buy US$300
billion in long-term Treasury bonds and notes over the next six months.
The yield on the 30-year Treasury bond immediately fell from 3.8% to 3.5%,
while the yield on the benchmark 10-year Treasury note fell more, from 3% to
2.53%, increasing the price of the note by 42/32, the biggest one-day rise in
years. The gift of risk-free
profits is granted to the bond bulls courtesy of the Fed, in telling them in
advance about its intention of buying long-dated government debt.
Note that in the past, Fed purchases of long-term Treasuries have been
exceedingly rare. The last time the Fed resorted to it was in 1959. But half a
century ago it was not meant to be a permanent fixture of monetary policy. This
time is different. Last Wednesday's announcement is the opening salvo in a
brand new game of serial interest-rate cuts in the high-end of the yield-curve
now that the Fed has chewed up the low end. It has used up all its ammunition
in the short-term T-bill market where the rate is only microscopically greater
than zero, rendering the Fed helpless and impotent.
A new bag of tricks is coming into play: the monetization of long-term
government debt. The market tells it all. The dollar index fell 3%, the biggest
drop in more than two decades.
Actually, as I have suggested in several earlier articles, "serial cutting of
interest rates" is a misnomer. The correct phrase is "serial halving of
interest rates". The nuance is important. Serial cutting comes to an end when
you have cut it to the bare bones: all the way back to zero. Not so serial
halving. which can be fine-tuned like water torture. It can continue
indefinitely, while each halving causes the same devastation in the economic
landscape as it doubles the liquidation value of total debt.
Central banks in Japan and the United Kingdom have announced similar monetary
policies. The Bank of Japan has said that it will increase its volume of bond
purchases by 30%. According to Masaaki Shirakawa, the governor of the bank,
"bond purchases are not intended to finance the Japanese government's spending.
That would be too dangerous." Who is the governor kidding? As long as the
Japanese government spends more than its revenue from taxes, every act of
buying a government bond is an act of financing the government.
Even in Switzerland, the paragon of monetary and fiscal rectitude, where the
Swiss National Bank is hard put to find a government bond it can buy, they have
to do something to enter the mad race to find out which country can increase
the money supply at the fastest rate. The Swiss are resourceful: since they
cannot increase the money supply through purchases of bonds, they will increase
it through sales of Swiss francs. All masks are off. The Swiss will not let
others outbid them in the game of bidding down the value of national currencies
around the globe. This is competitive currency debasement at its most vicious.
It is a cover-up for the underlying trade war.
Why should we worry about a monetary policy that depends on risk-free profits
offered to speculators betting on higher bond values? Because it reflects the
utter corruption of the profit-and-loss system on which capitalist production
is based. It makes the businessman appear foolish who takes risks in the
producing sector while trying to satisfy the needs of the consumers - when
risk-free profits are available in the financial sector. As a matter of fact,
the risk-free profits of the bond bulls do not come out of nowhere. They come
right out of the capital accounts of the producers. These gains are the flip
side of the capital losses suffered by the real risk-takers, the sitting ducks
in this shoot-out.
The single cause of the present economic disaster is the Fed's deliberate
policy to drive down interest rates through serial halving. This policy is
animated by the economic theories of John Maynard Keynes, according to which
interest ought to be abolished so that the stone can be turned into bread and
water into wine. The miracle is worked by a central bank well equipped with
printing presses and a factory to produce green cheese in unlimited quantities,
to shove it down the throats of savers who are trying to provide for their
twilight years, or for the education of their offspring, or just for a rainy
day.
Continuing or even accelerating that disastrous monetary policy of unlimited
green cheese production will not alleviate the crisis. It will make it worse.
Much worse.
Look at it this way. The present contraction of the world economy is not due to
a glut in global savings for which businessmen can find no good use, and which
consequently have to be mopped up through expanding the balance sheet of the
central banks all over the world, as "explained" by Paul Krugman and his
friend, mentor, and former boss Ben Bernanke.
The contraction is due to the lethargy of businessmen who see their past
investments turn sour one after another at each interest-rate cut. Businessmen
will not make new investments, no matter how badly central bankers want to
force-feed them at the trough of newly created money, as long as the mad
driving-down of interest rates continues. Would you buy a car today if you were
told that its price will be cut tomorrow? Of course you wouldn't. Well, it is
the same with businessmen. They would not make an investment today if they were
told that tomorrow they could finance it at a cheaper rate and, the day after
tomorrow at a rate cheaper still. It is as simple as that.
Now the Fed is saying that it has got a new toy grenade to try on the economy:
the T-bond purchase plan. Businessmen conclude that this is time to go into
hibernation mode. They just want to survive with their remaining capital intact
until this madness runs its full course. They will come back and start
investing again in saner times, when interest rates are stabilized at their
natural level. Those who listen to the siren song from the Fed and other
central banks, and invest at today's teaser rate will get massacred at the next
halving, when even lower teaser rates will be offered.
What we are witnessing is the closing of Keynes' system. This system is based
on the worst fallacy ever embraced by pretenders and impostors in science: the
fallacy, inspired by Karl Marx, of over-saving and under-consumption. It was
under this banner that the Fed introduced its illegal policy of open market
purchases of government bonds that would be legalized retroactively later. But
with this coup d'etat the Fed shot itself in the foot. It has forgotten to take
the reaction of bond speculators into account.
Speculators will not sit idly by when they are told that, as a matter of high
monetary policy, the Fed will have to make periodic trips to the bond market to
purchase its quota of government bonds. Of course, speculators will want to
pre-empt the Fed. Of course they wanted to buy first so that they could dump
their bonds on the Fed at a profit later. Of course bond speculators would lie
in wait for the Fed and ambush it at the moment it was ready to pick up its
next quota of government bonds in the open market.
The present monetary system promises risk-free profits to bond speculators.
This guarantees that the interest rate structure will keep falling
indefinitely. Astute businessmen who understand the interaction between finance
and production will stay on the sidelines. They will not join the mad tea party
of teaser rates whether offered in the subprime mortgage market or whether
offered on loans to finance future production. Teaser rates are there to tempt
individuals and businesses to commit hara-kiri.
This raises the question just how sound a monetary system is that wants to
create money, lots of it, but can only do it through bribes and blackmails.
This also raises the question how it is possible to treat Keynes' system with
respect.
You had thought that the political system was rotten as it was a system of
bribes, blackmails and vote-buying facilitated by irredeemable currency. You
had thought that the judiciary was rotten as no complaint about the fraud
involved in the check-kiting conspiracy between the Treasury and the Fed would
ever be heard in a court. You had thought that victims of the Ponzi-scheme
whereby the government would sell bonds, which it had neither the means nor the
intention to pay off, could have their day in court.
But look: the educational system, our only hope for the future, is equally
rotten. Its faculties of criticism are so badly disabled that one can no longer
hope for an open discussion of burning issues. Keynesians, in concert with
their Friedmanite comrades, control everything: monetary policy, fiscal policy,
the judiciary, appointments and the research agenda at universities and other
think-tanks, the publication programs in the editorial offices of scholarly
journals.
Keynesians and Friedmanites want to control the rescue effort and they
certainly do not want to see their past errors and misdeeds, which lie at the
root of the problem, exposed to public scrutiny.
The economic and financial crisis that is plaguing the world is extremely
serious. Damage to the social fabric could be even greater than that during the
Great Depression. But a reasoned, high-level discussion on the genesis of the
crisis is ruled out. You have to buy the official line on the global savings
glut. You are not allowed to challenge the official dogma of under-consumption,
even after the most wasteful episode of over-consumption in history, running up
private and public debt to stratospheric heights.
The present crisis is about past, present and future destruction of capital due
to the Keynesians' deliberate policy of driving down interest rates. Education
of public opinion about these matters is sorely needed. Keynesians have been
successful in convincing the public that their monetary policy to drive down
interest rates is a blessing. But the truth is that falling interest rates
erode capital, because the return from earlier investments proves insufficient
to amortize debt contracted at higher rates. At the end of the capital erosion
road comes the realization that production and finance stands bereft of any
capital. The result is a credit collapse that can no longer be covered up with
the usual Keynesian nostrums.
My conclusion is that the latest move of the Fed is going to entrench deflation
through entrenching the trend of falling interest rates. The mechanism works
through bond speculation, making risk-free capital gains available to
speculators, who will then bid up bond prices unopposed to any high level.
Other observers may violently disagree with this view. For example Clive Maund
had this to say: "So Treasuries spiked yesterday [on March 18], but the large
gains were almost entirely erased by the drop in the dollar ... So in an
environment where the Fed and the Treasury are going to have to create dollars,
ie, to dilute the currency, to prop up financial instruments ... who but a
complete imbecile is going to buy them? ... The Treasury market will collapse
in due course anyway despite, and perhaps even because of, the Fed's desperate
and reckless attempts to backstop it."
Not so fast, please. Ultimately the market for Treasury bonds will collapse in
a hyper-inflationary scenario, but this may be years down the road. In the
meantime, we have to face the music that keeps the game of musical chairs
going: the serial halving of interest rates to enable bond speculators to earn
risk-free profits. This stokes the fires of deflation, not the fires of
inflation. Obituaries of the dollar are written prematurely. The death throes
of the dollar almighty, as the US currency was known not so long ago, will
continue for quite a while yet and, unfortunately, will cause a lot more damage
to the world economy, and a lot more economic pain to ordinary people.
It is an inane and Keynesian propaganda that falling interest rates are good
for the economy, for you, for me, for business. On the contrary, they are
lethal. Only low and stable interest rates can help us to get out of the
present mess an unachievable goal under the regime of irredeemable currency.
Reference:By the same author: That Accursed Propensity To Save,
March 9, 2009, www.professorfekete.com.
Antal E Fekete is Professor of Money and Banking, San Francisco School of
Economics. E-mail: aefekete@hotmail.com
(Copyright 2009 Antal E Fekete).
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