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“Heads — you win; tails — I lose.” Such is the message the Fed sends to bond
speculators. But why would the Fed offer such a stupid wager? Read on.
The
Fed is trying to bribe bond speculators with risk-free profits. That’s
how the Treasury/Fed check-kiting conspiracy makes sure that there will
always be plenty of buyers for government debt, regardless of the size of
offering.
Ten
years ago I started writing about my theory that, wittingly or unwittingly,
the Fed has become the quartermaster general of the coming deflation and
depression. I offered a logical, closely argued reasoning for this thesis. My
argument had to do with the contention that the open market operations of the
Fed make bond speculation risk-free, which explains the perpetual bull market
in bonds. Bond speculators, knowing that the Fed must needs buy bonds in
order to keep the money supply growing, front-run (or, to use the old-fashioned
term: pre-empt) the Fed’s open market operations. They buy the bonds
beforehand, and pocket risk-free profits when they sell them to the Fed.
Speculators will allow the bond price to fall only so much. Then they show up
as buyers for another ride of the escalator upstairs.
Incidentally,
my theory also gives the coup-de-grâce
to Keynesian and Friedmanite economics. Keynes, and
later Friedman, advised governments to discard the gold standard thus
destabilizing foreign exchange. That would give them free hand to pursue
monetary policy — euphemism for the license to engineer unlimited
depreciation of the currency. Scarcely did they consider that their scheme
was to back-fire. They were shooting for inflation only to bag deflation.
They wanted rising prices; instead, they got falling prices.
A
falling interest-rate structure engenders a falling price-level structure. It
is most destructive to the economy. It devastates existing capital and blocks
the accumulation of new capital. The 30-year old regime of falling rates
destroyed the once flourishing American industry forcing it to flee the
country. There is no chance to accumulate new capital as long as interest
rates keep falling. Continuation of this trend will cause excruciating pain
to those producers who remain. They will not be able to compete with newcomers who carry a much
smaller burden, thanks to their lower cost of capital. The squeeze of the
old-guard producers will show up in the falling price level. The
“grapes of wrath” — the seeds of which were planted by
Keynes and Friedman — will come to full maturity when hoards of angry
and hungry unemployed people will roam from city to city and country to
country.
It
is not the Fed who is in the driver’s seat. It is the bond speculator.
The Great Depression was not due to low demand for goods, as argued by
Keynes. It was due to high demand for bonds, courtesy of speculators
who understood the dynamics of the bond market better than policymakers did.
The GFC is just a repeat performance.
Check-kiting
is the name for the conspiracy, typically between two banks, to tap the float
(the mass of checks in the process of clearing). The conspiring banks send
one another third-party checks that lack any backing whatsoever. They cover
the liability of one unbacked check by crediting
the other, ad infinitum. It is similar to wildcat banking in Scotland
in the 17th century, when the coach hired by the banks carrying
gold was front-running the coach carrying bank inspectors from one bank to
the next. Small wonder the inspectors found the gold reserve of every bank on
their beat in good shape. Check-kiting is a crime to defraud the public dealt
with by the Criminal Code. Except, that is, when practiced by the Treasury
and the Fed, in which case it is called monetary policy.
Let
us bypass the question on what valid grounds do the Treasury and the Fed
issue liabilities which they have neither the inclination nor the means to
honor. The practice boils down to clever prestidigitation: to mislead the
public into believing that the Emperor does have clothes. He is
cheered on by an enthusiastic crowd of bond speculators praising the garment.
Until… until… a naughty little boy starts howling: “Gee whiz,
Dad, the Emperor is stark naked!”
Suppose
the Fed wants inflation and thinks that the best way to go about it is to
keep buying bonds ad nauseam and call the practice by the acronym
QE-X. The belief that pumping up the money supply through unlimited bond
purchases by the central bank will bring about rising prices is a tragic
mistake. A higher price level will never be achieved in this way. Bond
speculators will have a field day. They would just buy the bonds in any
amount. A vicious spiral of falling interest rates is engaged that, like the
black hole of zero gravitation, will suck in and gobble up the world economy.
Keynes and Friedman were hoping for inflation they could control;
instead they got deflation they could not. They cut the tragic
figure of the Sorcerer’s Apprentice who stole the Master’s
password to turn on the spigots, but he has forgotten to steal the other
password to turn them off when enough is enough.
Having
been a lonely voice crying in the wilderness for ten years, I am still in a
minority of one. Most economists expect Fed action to cause inflation
(according to some, hyperinflation). The few who dare mention the d-words,
deflation and depression, hasten to add that, of course, this would follow
hyperinflation, not precede it. Same as in
Zimbabwe. Reports from that unhappy country say that it has 90% unemployment
after the worst hyperinflation on record.
I
am the only one saying that the U.S. is not Zimbabwe, and for the U.S. the
forecast is deflation first, hyperinflation afterwards — at least until
the prestidigitation in the bond market is exposed.
Seldom
do I get a tail-wind in the form of newspaper reports confirming that there
is, after all, such a thing as front-running the Fed’s open market
operations, that bond speculators do indeed buy the bonds only to dump them
in the lap of the Fed at a hefty premium. I have certainly never ever
expected the New York Times to provide that tail-wind. Well, on January 10,
2011, that bastion of central planning published an article from the pen of
Graham Bowley. It quotes Josh Frost who is in
charge of buying hundreds of billions of dollars of Treasuries for the Fed: “We
are looking to get the best price we can for the taxpayer”. Then
the article goes on to quote an authority on bond trading, Louis V. Crandall,
chief economist at the research firm Wrightson
ICAP, who flatly contradicts Frost: a buyer of $100 billion a month is always
going to pay the worst (highest) price. “You can’t be a known
buyer of $100 billion a month and get a good price.”
In
my papers I have commiserated with traders of the Fed facing, as they are,
hungry lions in the arena bare-handed. The latter are the bond speculators
who, unlike the former, are not working for wages. They work for profits. (If
the profits happen to be risk free, so much the better.) True, the loss the
Fed’s traders habitually make is not their loss. They are passed
on to the taxpayers with a shrug. It is the taxpayers’ blood that is
spilled so valiantly.
This
reminds me of the object-lesson offered by George Soros. He made mincemeat of
the traders of the Bank of England some years ago who were trying to fend off
his serial attacks to sell the British pound short. Soros took the traders to
the cleaners and, to rub it in, he bragged about it in his book. No need to
feel sorry for the forex traders of the Bag Lady of
Threadneedle Street. It was not their blood anyway
that was flowing so abundantly. It was the blood of the British taxpayers.
I
didn’t know the identity of the Fed’s traders facing the hungry
lions. Now I do, thanks to the New York Times. They are babes in Toyland. All
three of them are in their 20’s. Their only prior experience in trading
comes from playing Monopoly. One of them is still a student at NYU. According
to the story in the NYT, “most days” they talk to the big banks.
How is that for guarding against conflict of interest? Their supervisor, Josh
Frost lives in Brooklyn and every morning he takes the subway to commute to
work. As one may figure, not for too long. Wonder how one gets such a
rags-to-riches job at the Fed? Well, take the example of Josh Frost’s
boss, Bryan P. Sack, age 40.
In 2004 he co-authored a paper with Ben Bernanke, the
future chairman of the Fed and another economist about “unconventional
measures for stimulating the economy in extraordinary times” — by
buying Treasuries in batches of hundreds of billions of dollars. “We
didn’t know then that some day the Fed would
be putting it to test” — Brian is quoted as saying.
The
best part of it all is that the line between success and failure is
hopelessly blurred. If the rate of interest goes down in consequence of Fed
action, then: “hooray, we’re dead on with targeting inflation.
And that’s good news”. If, on the other hand, the rate of
interest goes up, then: “hooray, the economy is turning around. Rates
have risen for the very reason we were hoping for: investors are more
optimistic about the recovery. It is a good sign.”
The
fact that in the meantime the economy is wiped out, gets lost in the noise of
loud self-congratulation.
References
The Federal Reserve, the Quartermaster General of
Deflation, A. E. Fekete,
ThereIs No
Business Like Bond Business, A. E. Fekete,
www.professorfekete.com,
January,
2010
Front/Running
the Fed in the Treasurys Market, www.jessescrossroadscafe.blogspot.com
January,
2010
The Fed`s QE2
Traders, Buying Bonds by the Billions, Graham Bowley,
The
New York Times, January 10, 2011
Meet the Fed’s POMO Desk… by
Tyler Durden, www.zerohedge.com, January 10, 2011
ANNOUNCEMENT
New Austrian School of
Economics
Course Two at the Martineum Academy in
Szombathely, Hungary,
from March 5 through 13, 2011. Title of the course:
ADAM SMITH’S REAL
BILLS DOCTRINE AND SOCIAL CIRCULATING CAPITAL
What makes this course especially topical today is the fact that more
and more hints are being dropped about the possible rehabilitation and restoration
of the gold standard — following the ignominious collapse of the
irredeemable dollar. However, a gold standard without its clearing house,
the bill market, is not viable and
itself is liable to collapse in short order — as it did in the early
1930’s. The level of public ignorance about the necessity of a clearing
house is appalling. It is made that much worse by a tottering banking system.
We have an urgent message: only gold standard cum real bills can
restore prosperity to the world, in view of the fact that we have to write
off the world’s banking system as a total loss.
This
is the second in a four-course series on Austrian Economics, a branch of
economic science based on the work of Carl Menger
(1840-1921). It is meant for those, including beginners, who are interested
in the theory of money, credit, and banking, with special emphasis on the
current financial and economic crisis. The complete program consists of
four courses (10 days, 20 lectures each). Completion of each course will earn
one credit. Participants who have accumulated four credits get a diploma
signed by Professor Fekete. Course One that was
given in 2010 is not a prerequisite. It is available on DVD for
purchase.
All
scholarships have now been awarded.
For
further information please contact Dr. Judith Szepesvari,
e-mail:
szepesvari17@gmail.com
Antal E. Fekete
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal
E. Fekete - All rights reserved
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