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On Wednesday, March 18, another
handsome gift was delivered by the Fed to the bond bulls. It was the
announcement that the Open Market Committee has made a unanimous decision for
the central bank to buy $300 billion in long-term Treasury bonds and notes
over the next six-month period. 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 from 9726/32 to 10128/32, the biggest one-day rise in years. The
gift of risk-free profits is granted to the bond bulls through 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 Treasurys 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. 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 that 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 Mr. Shiraskawa, 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
flipside of the capital losses suffered by the real risk-takers, the sitting
ducks in this shoot-out.
I have
been in a minority of one in my quest to inform the public about the single
cause of the present economic disaster. In fact I have been predicting it for
the past eight years. The single cause 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 has 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. Of course,
speculators would 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 would
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.
* * *
Mine is a
cry in the wilderness. 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. A Cassandra such as myself would never get a hearing before the
disaster struck.
Now, as
it turns out, I won't get a hearing even after disaster hasstruck. Keynesians
and their Friedmanite cronies want to control the rescue effort and they
certainly do not want to see their past errors and misdeeds, that 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 crap 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, i.e., 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 U.S. 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 malicious 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 6, 2009,
www.professorfekete.com.
Antal E. Fekete
www.professorfekete.com
Professor,
Intermountain Institute of Science and Applied Mathematics
Missoula, MT 59806, U.S.A.
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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