Keyser’s been a bit mum on economic topics recently. It’s not that he hasn’t been paying attention. Far from it. But there isn’t much news in this analysis. Basically, sickness the Fed and the US Treasury have spent trillions of dollars that don’t signify anything real, rx and this “money” has resulted in a lot of institutions that are fundamentally bankrupt from not going out of business. Sounds great, online no? Well, that’s the problem. It sounds good, but it isn’t. And most so-called economists don’t even understand reality.
Here’s an example of people’s non-comprehending frame of mind:
Stocks rose Monday as investors avoided big bets before the Federal Reserve’s meeting this week.
The Dow Jones industrial average gained 42 points in midday trading. Broader indexes had modest gains.
Investors are waiting for the Fed’s latest assessment of the economy that will be issued at the close of the central bank’s meeting on Tuesday. They also want to know if the Fed will restart some of its stimulus programs to help the recovery regain momentum.
The market’s growing concern about the economy has added to the importance of the Fed meeting. Recent economic reports have shown that the recovery is slowing. And Fed Chairman Ben Bernanke just a few weeks ago said the forecast for the recovery remains “unusually uncertain.”
The Fed will likely leave its federal funds rate near zero, but the central bank could signal plans to restart some stimulus programs, such as its purchase of mortgage-backed securities. Those programs ended earlier this year when it appeared the recovery was proceeding well.
“The Fed has a lot of tools in its tool shed,” said Larry Rosenthal, president of Financial Planning Services in Manassas, Va. “They have to bring buyers back into the market; they have to bring consumption back into the market.”
“Have to bring consumption back into the market.” This is like a child imploring Santa to bring nice presents for Christmas. Sounds nice, but that’s not how the real world works. In this instance, the child wants Santa Bernanke to get people to buy stuff they can’t afford with made-up dollars that they borrow, ultimately, from the Fed.
The Federal Reserve is hold-over from the “Progressive Era,” the first decade or so of the last century before the start of the First World War. Basically, a bunch of smart people decided that the laissez-faire economy of the nineteenth-century was anarchic and dysfunctional, and everything would work a whole lot better, if only smart-asses with degrees from Harvard were allowed to “manage” things “rationally.” The consummate example of this line of thinking was the Soviet Union. Turns out that in practice it wasn’t so easy for the geniuses in Moscow to figure out how many, say, paper clips should be made in a given year. And indeed, without the feed back of prices determined freely in an open market, they couldn’t figure out the “right” amount of anything.
But somehow, the notion persists that a pack of idiots like Bernie Bernanke can get together every few months and figure out the value of the single most important commodity in a modern economy: money. To understand the full madness of this, we need a bit of background.
Everybody uses money, but most people don’t really understand what it is. Money is a commodity. That is, it’s something useful, like a bushel of wheat or a barrel of oil. But instead being an actual useful item, it’s seem a unit of account that can be instantly converted into a specific commodity at will. In effect, it’s a claim on a commodity, and it’s reality derives from the fact that it’s not a specific commodity. As the old example goes, if you make a shoe but need a hammer, the shoe doesn’t do you much good unless you can find someone with a hammer on offer who happens to need a shoe. Not too likely, right? But if you can exchange the shoe to someone who needs one and has something valuable like gold to give in return, then you can take the valuable stuff and use it to get the hammer. The step of converting “valuable stuff” to money is when it’s made into a fixed quantity in the form of a coin. This “money” with its fixed units then has a lot of ancillary functions, like allowing you to compare value via prices and to store value over time.
Until the 1930s, the US dollar was a fixed amount of gold. In 1933, Franklin Roosevelt confiscated the freely available monetary gold. The dollars then issued by the Federal Reserve had a theoretical connection to gold, but this was ended in 1971, when the French tried to turn in their dollars for gold, and since there were more dollars than gold, the US government was forced to end the pretense. The dollar is now nothing but a number of “units” that have no external value apart from people’s willingness to accept them in return for stuff like hammers.
Now, here’s where things get a bit complicated. Money is of worth only to the extent that it represents a certain amount of value. That is, a dollar is of value only because it can buy something, and has no inherent worth of its own. Substantive value that has been converted into money for the purpose of investment is called capital.
Money has existed for something like 2500 hundred years, since around 500 BC when the Lydian kings started marking lumps of electrum (a natural alloy of gold and silver) and thereby discovered coinage. But the extensive use of money to invest is not much more than 500 years old. Back in antiquity, if you had money to invest, you had to purchase something with it. If you had a lot, you could buy a business venture, but you had to run it (directly or indirectly). There were no paper investments. That is, you couldn’t buy a piece of paper giving you a fractional share of the profits in some fixed organization in return for giving it the funds to operate with. That’s why today we occasionally find thousands of ancient coins buried in the ground. There was no other way to save value in abstract form.
For some hundreds of years, it’s been possible to invest your money abstractly by providing economic organizations (“companies”) with the “capital” they need. The so-called capitalist system involves the wide-spread practice of using money to invest without having to have any direct role in the investment. While some would equate the capitalist system with a free-market system, the two are actually two distinct notions. One can certainly have capitalism without free markets. That’s true even of most highly-regulated Western economies, and when you get down to it, the so-called communist system is simply capitalism entirely regulated and owned by the state. And the Federal Reserve’s control of the money supply fits in much more easily in a communistic system than a free-market one.
Maybe you don’t want to make a specific investment. Instead, you want to keep your “invested” money in as “liquid” a form as possible. And “liquid” means convertible into cash at will. So instead of buying a share in a company or a bond issued by a company or the government, you choose to lend the money as such. In this sort of transaction, you give someone else money to use for whatever he wants, and the receiver of the money pays you “rent” for the money. But instead of calling it “rent” we call it “interest.” Since money takes the form of monetary denominations, it’s easy to calculate the “rent” as a given percentage of the total loan per period of time.
What then is the interest rate? In a free market, it’s the amount of rent that can be charged for borrowing the available money. And what is money? As indicated before, it’s basically just a claim on value in terms of the prices for goods determined by the free market. In effect, borrowing money is way of acquiring the right to enter into that market with the claim on value you have in the form of money.
Proper interest rates than are simply a pricing mechanism on the worth of liquid capital. And capital becomes available because people forgo either keeping their money in the form of money or using that money themselves to buy stuff (which is known as consumption). Real capital is then made available through two processes: consumption and the desire to lend the money out to someone else in return for interest. If not much capital is available in this way for borrowing, then the rate of interest that the market will bear rises.
High interest rates then have two effects. First, it discourages the borrowing of “expensive” money. Why is this good? Because the refusal of people to save and lend means that the capital available for investment is restricted, and so people shouldn’t be making use of loaned money for the purpose of, say, expanding their business, because there isn’t the excess capital to support such activity. The second result is that because there’s a high rate of return, people will be encouraged to save money and to lend it out for interest, which in turn increases the available capital. Interest rates will then fall as more money (“capital”) is made available, and in turn more people will be encouraged to borrow for investment.
Eventually, the supply of increasingly available capital and increasing borrowing will reach natural equilibrium. Conversely, if interest rates are too low, people will be discouraged from borrowing, and rates will rise, with a corresponding reduction in borrowing. That’s how the system is supposed to work.
But that’s not how people like it to function. Back in the late nineteenth century, bankers used to bitch about the “inelasticity” of the money supply. At harvest time in the fall, farmers would take out a lot of their bank savings in the form of cash to pay their workers and pay for the transport of their crops to market. This would lead rural banks to withdraw balances that they would otherwise keep in larger cities, and this compounding process of withdrawal would have the most magnified effect in the financial capital of the country in New York City, where the big bankers had been lending these deposits out for speculation. Somehow, bankers were too stupid to predict the fall harvest, and they repeatedly had troubles caused by the fall withdrawals, culminating in the crisis of 1907. The upshot was the creation of the Federal Reserve Bank, as a banker’s bank whose supposed purpose was to alleviate these purposed crises caused by seasonal fluctuations in the money supply.
In the first place, the whole purpose of interest rates is to reflect the availability of capital. If Mr. Haney is taking his money back to pay the farm hands, then J. Pierpont Morgan should be subject to higher interest rates. And if some idiots have gotten themselves in trouble by borrowing money to speculate in stock and now can’t pay it back, too fucking bad, dumbass. You shoulda looked at the calendar, moron.
But no. God forbid anything should stand in the way of New York speculators. So let’s cook up the Federal Reserve as a way to provide bucks to our worthy NYC speculators by making up money to pretend that capital is available when it isn’t until real capital reemerges when the farmers start banking their surpluses again. So they created the Fed in 1913.
It took ’em a while to figure out the full potential of their diabolical powers. Somehow or other, the Fed has decide it has the right to buy $1.75 trillion worth of bad debts from banks. Now that one’s an eye opener, but its deleterious effects are basically passive. It means that the big banks like Citigroup and Bank of America can pretend they’re solvent when they aren’t. Now of course there is harm caused by this. In effect, the loser banks can acquire cash more cheaply than they deserve because lenders believe (probably rightly) that the “too big to fail” policy means that even if the big banks do stupid things with that money, the government will bail them out. And the ability to borrow money cheaply gives the big banks an advantage over the smaller banks that a) weren’t so foolhardy in the first place and b) can’t count of a Timmy/Bernie bail out. But that’s small change.
The Fed has the ability to manipulate the interest rate for the whole country (by making up money for banks and putting money in circulation through buying government bonds, among other ploys). Why anyone thinks this is a good idea is a beyond Keyser. The theory is that in times of expansion, the Fed will put the brake on excess by increasing interest rates, and in times of trouble, it will encourage consumption via low rates. So how’s that turned out?
Clearly, the Fed and its low interest rates have led to a massive expansion in prices since the ’50s as a result of a constant expansion of credit. In effect, the Fed is always inclined to have low interest rates, either to keep the good times rolling or to pump them up again in recessions. As we all know, low interest rates in the years following the bursting of the dot com bubble in 2000 resulted in the massive real estate bubble that burst in 2007 and caused the financial meltdown in 2008. And what’s the prescription for this problem? Why, low interest rates of course.
The point being to get people to borrow more money to buy shit they can’t afford, and in the process reinflate the price of housing to bail out the banks stuck with millions of mortgages on houses whose current market value can’t cover the loans taken out to buy them.
But this is insanity. As any dimwit should be able to predict, low interest rates discourage savings, and in the absence of actual capital behind it, lending for its own sake with made-up money is entirely deleterious. In the first place, the Fed has no control of what anyone does with the borrowed money. Since economic prospects aren’t good, many businesses and people aren’t so inclined to borrow and in any case, banks are now being stingy with lending. So that means that the cheap money provided by the Fed is borrowed to speculate (hello, stock market run up since March of last year!). Secondly, and perhaps more importantly, the whole purpose of interest rates is to give people feedback about the availability of capital. That is, low interest rates should tell economic agents that savings is making excess capital available for investment in things like more production. But we’ve already seen that the low rates are having the exact opposite effect on savings, and true economic state is that there’s excess capacity, so investment is counterproductive.
You know, in a show last night, there was talk about who the worst presidents were, and the name Warren G. Harding came up. Now, it may be true that he had some losers in his cabinet. But he was also responsible for the Great Depression of 1920. Oh, wait a minute. No, he wasn’t. Harding was the last president whose attitude was “not my problem.” Prices had become inflated during the big borrowing to pay for the First World War, and there was a major retraction in 1920 as prices began to tumble. Instead of trying to reflate prices, Harding let things go. The imprudent and improvident went bust, there was high unemployment for a year and a half, and then… It was all over, and the boom of the ’20s started. Of course, there was another inflation in the later ’20s, and when that one went bust in 1929, the “modern” period of economic intervention started. With all the deleterious consequences of government intervention, and other Keynesian nonsense.
You’d think by now that the manifest failure of the Fed and the parallel policies in the Federal government should be clear by now. Yet idiots like Bernanke and Geithner are listened to as if they weren’t responsible for the disaster we’re in in the first place. Interest rates are the most basic of signals for a free market, conveying to investors the availability of capital. They shouldn’t be manipulated at will by a pack of pseudo-experts, who have a large number of abstract theories of how the world works and little or no understanding of its fundamental principles. People like this are so deluded by their own misconceptions that they can actually argue that because they have no more ability to lower interest rates since they’re pretty close to zero already, it’s advisable to induce a higher regular inflation rate, so that they’ll have more “wiggle room” to keep lower rates (can’t find the link, but some lunatic proposed this last year). That’s like saying that because the fever-reducing medicine that you’ve prescribed isn’t bringing down the fever much, the patient’s body should be made to have a persistent low-grade fever to improve the effectiveness of the drug. That’s entirely back to front, but fully in keeping with the idea that the Fed should apply its delicate touch to the level of interest rates on the grounds that its board knows best.
Surely, it should be clear enough by now that the Federal Reserve board, and virtually all economists for that matter, have little idea of even what’s gone on and what’s happening now, much less what’s going to happen. And the idea that they can manipulate interest rates in helpful manner is thoroughly laughable.
Emulate Warren G. Harding, the president least known for solving an economic problem, because his lack of action forestalled a far worse downturn than the one that resulted from letting the system work out the problem on its own. A bit less 1900s progressive arrogance and a bit more 19-century laissez faire is what’s called for. No doubt Goldman Sachs and Citigroup and some other “big boys” wouldn’t exist. So what?
But today’s economists and politicians can never leave well enough alone. Because they know better…