Antal E. Fekete
Professor Emeritus
Memorial University of Newfoundland
St.John's, CANADA A1C 5S7
Quartermasters of Inflation
That central bankers are the quartermasters of inflation is no longer a controversial
assertion. That much was admitted by central banker Alan Greenspan in his speech
before the Economic Club of New York on December 19, 2002 (see: www.federalreserve.gov/BoardDocs).
He observed that as long as the gold standard was in charge of money-creation the price
level was relatively stable. For example, in 1929 it was hardly different from that in 1800.
But, after gold was banned and central bankers were put in charge in 1933, the consumer
price index nearly doubled in two decades. And in the four decades after that prices
quintupled. In other words, under the watch of the gold standard the dollar preserved its
purchasing power for a period of one and one third of a century, but under the watch of the
central bankers it managed to lose 90 percent of it in half of that time-period.
The Specter of Deflation
Presently the specter of deflation is haunting the world, so much so that central banker
Ben Bernanke felt obliged to address the problem in a speech before the National
Economists Club in Washington, D.C., on November 21, 2002 (see: www.federalreserve.gov/BoardDocs). He
presented a simplistic view of deflation defining it as a general decline in prices. Actually,
it would be more accurate to say that deflation manifests itself through a general decline in
prices and interest rates. Mr. Bernanke identified the source of deflation as a
collapse in aggregate demand -- a drop in spending so severe that producers must cut prices
on an ongoing basis in order to find buyers. Of course, this is the view of an
unreconstructed Keynesian. But Keynesianism has been brain-dead for some three decades, so
we ought to feel emancipated from its tyranny. We identify the source of deflation as
reluctance of producers to take the loans that bankers try to push on them through ongoing
interest-rate cuts. Uncharacteristically, producers are pessimistic about future profit
opportunities. Instead of contracting new debt, they scramble to get out of the old, and
try to retrench by reducing inventory.
Guided Tour of the Star Chamber
Messrs. Greenspan and Bernanke claim that the Federal Reserve has the situation firmly
in hand. If deflation were to develop, options for aggressive monetary policy response
such as lowering interest rates are available. They admit that the zero lower bound on
nominal interest rates presents a problem. Even if debtors were able to refinance loans at
zero nominal interest, they may still feel excruciating economic pain caused by high and
rising real rates due to the falling price level, as shown by their deteriorating balance
sheet. However, Messrs. Greenspan and Bernanke reassure us that monetary policy will
never lose its ability to stimulate aggregate demand and the economy, zero interest
notwithstanding.
Mr. Bernanke gives us a guided tour of the Star Chamber, showing all the
instruments of torture and explaining how they are to be used. The first of these is the
printing press. Under a fiat money system the central bank generates inflation by this
technology allowing it to create as many dollars as it wishes at essentially no cost. But it
is not enough to create fiat money; you must also be able to put it into circulation or, at
least, to make credible threats (sic!) to do so. Normally the Fed puts newly created
fiat money into circulation through asset purchases. This particular torture instrument is
used by the Fed to reduce the value of the dollar in terms of goods and services. Under a
paper-money system a determined government and its central bank can always generate higher
spending and induce positive inflation, we are told.
Pushing on a String
If this has the result of pushing short-term interest rates to zero, the Fed will still
not be at the end of its rope. It can further stimulate aggregate spending by expanding the
menu of assets that it buys. If we do fall into deflation, we can take comfort in the thought
that "the logic of the printing press" will ultimately assert itself. Sufficient injections
of new money must eventually reverse a deflation.
So what may the Fed do if its target rate, the overnight federal funds rate, has
fallen to zero? Why, it will change the target, that's what. It will stimulate spending by
lowering interest rates further along the maturity spectrum. It will target the two-year rate
by committing to make unlimited purchases of securities maturing in two years or less.
But suppose that deflation is so stubborn that spending is not stimulated even as the two-
year rate is pushed down to zero. Well, then change the target again, this time, say, to the
ten-year rate, committing to make unlimited purchases of securities maturing in ten years
or less. And so on, ad libitum. Mr. Bernanke says that lower rates over the entire maturity
spectrum of public and private securities should strengthen aggregate demand "in the
usual ways", and thus help end deflation.
This betrays our central bankers' ignorance of the nature of the beast. The Fed
may be pushing on a string. People may refuse to spend the money in the "usual ways". It
is one thing to print fiat dollars, and another to make people spend them. No problem,
Mr. Bernanke says. If lowering yields on longer-term securities proved insufficient to re-
start spending, the Fed might next consider offering fixed-term loans to banks at zero
interest, with a wide-range of private assets (including, among others, corporate bonds,
commercial paper, bank loans, and mortgages) deemed eligible as collateral.
Operation Helicopter-Drop
But the banks may not use the loans at zero interest in the way intended by the Fed.
They may not want to make further loans to their clients whose prospects to turn a profit
are dim at best. The banks may find it far more attractive to invest in bonds for the
capital gains guaranteed by the central bank's zero-interest policy. Business lethargy may
not react to loans offered at ever lower rates. In this case Mr. Bernanke recommends the
helicopter-drop of money, an idea first suggested by Milton Friedman. There must be a
way to put fiat money into circulation, if not by hook then by crook! A broad-based tax-
cut financed by open market purchases of securities by the Fed should do the trick. This
"manna from heaven" should re-start spending. The Federal Reserve and other policymakers
are far from helpless in the face of deflation, even if the rate of interest is already
pushed all the way to zero.
Taking Risks out of Bond Speculation
All this talk is old hat, except for the fact that heretofore it hasn't been considered
polite behavior for central bankers to flaunt their authority to create fiat money in
unlimited quantities, and to boast their power to drive down the value of the dollar in terms
of goods and services. More interesting than what these gentlemen say is what they don't
say. They studiously avoid reference to the 100 trillion dollar behemoth: the interest-rate
derivatives market, and to bond speculation. Derivatives are a tell-tale, revealing the big
picture. Far from trying to prevent or to combat it, the Fed is promoting deflation. It does,
in fact, act as the quartermaster of deflation. Every one of the torture instruments in the
Star Chamber enumerated above is making deflation worse, not better.
What the $100 trillion derivatives market shows is that the main feature of deflation is
the invisible but nonetheless real bull market in bonds. Nobody is talking about it,
although the bull market in bonds that started in 1980 has been the largest of all bull
markets of all kinds in all history. Fabulous fortunes have been made and will be made
before it is over, thanks to the Fed that has taken the risk out of bond speculation.
The speeches of Messrs. Greenspan and Bernanke are the best example to demonstrate the
charge. Speculators are told that the Fed is prepared to buy unlimited quantities of
securities across the entire maturity spectrum. What is this if not an invitation to get
aboard the bandwagon and share the ride to infinite riches? Come and get the bonds before
we snap them up. Fear not, your investment is absolutely safe. Your friendly central banker
has made bond speculation risk-free. He underwrites the unlimited capital gains you are
going to make on your speculative bondholdings (or on your long positions on bond futures,
or on your call options on bond futures). The figure $100 trillion shows the extent to
which speculators have rallied to the call of the Pied Piper. It measures bets in the
aggregate that speculators have made on ever-increasing bond prices or, what is the same
to say, on ever falling interest rates.
Multiplying Asset Values a Thousand-fold
Of course, interest rates will never go to zero. They just keep getting halved. The yield
on long-term Treasury bonds was 16% in 1980. It has been halved to 8% and will be halved
again to 4%, according to the script of Messrs. Greenspan and Bernanke. After that the
target at successive halvings will be: 2%, 1%, 0.5%, 0.25%, 0.125%, 0.0625%, etc. As
you see, it never gets to 0%. Yet at each halving, the market value of the long-term
bond will practically double. Suppose that in 1980 you invested $1,000 in a 30-year
bond. Suppose further that the rate of interest would continue to be halved again and again.
Your investment after each consecutive halving would increase in value to $2,000,
$4,000, $8,000, $16,000, $32,000, $64,000, $128,000, $256,000, $512,000, $1,024,000,
etc. On the top of that, by clipping coupons you would be reaping a nice income, too.
Thus, as a rule of thumb, the value of your investment would be multiplied by a factor of
1,000 as the rate of interest fell to 0.03%. Although this result cannot be guaranteed, the
downside risk is nil, thanks to Messrs. Greenspan and Bernanke. (My example is a
simplification for purposes of illustration. In the actual case bond speculators may use
strip bonds, and they may roll forward the maturity several times.)
Needless to say, bond speculators are very much alive to the risk-free opportunity
to multiply the value of their assets 1,000-fold. Already they have amassed wealth greater
than any group of speculators has ever done in history. Their combined financial
resources exceed that of central banks and governments. Naturally, they have a vested
interest, and the financial strength, to keep the merry-go-round going -- and they will.
Essence of Deflation
The U.S. government may well be unconcerned about the fact that the liquidation-value
of its debt is escalating 1,000-fold due to the falling interest-rate structure. After all,
the Fed has the printing press to create dollars with which to liquidate any liability,
however large. The producers are not so fortunate. They have to produce more and sell more
if they want to get out of debt before maturity. Producing more and selling more in a
falling interest-rate environment may not be possible, however. What this shows is that
the essence of deflation is not falling prices. Rather, it is falling interest rates, being
pushed down by bond speculation that has been made risk-free by the central bank.
Falling interest rates bankrupt productive enterprise by rendering it unable to extricate
itself from the clutches of debt contracted at higher rates. The debt becomes ever more
onerous as its liquidation value threatens to increase 1,000-fold.
What these central bankers don't understand is that, while they have the power to
put unlimited amounts of fiat money into circulation, they have no power to make it flow
in the "approved" direction. Money, like water, may refuse to flow uphill. In a deflation
money shall not flow to the commodity market to bid up prices as central bankers hope
that it will. Instead, it shall flow downhill to the bond market where the fun is, to bid up
prices there. When the central bank makes bond speculation risk-free, then the bond
market will act like a gigantic vacuum cleaner, sucking up dollars from every nook and
cranny of the economy. In putting ever more fiat money into circulation the central bank
cuts the figure of a cat chasing its own tail. More fiat money pushes interest rates lower;
falling interest rates put more pressure on producers to cut prices, calling for still more
fiat money, completing the vicious circle. The interest rate structure and the price level
are linked. Subject to leads and lags, they keep moving together in the same direction. It
is not funny to watch the Fed chasing its own tail. In doing so it generates a deflationary
spiral that may ultimately bankrupt the entire producing sector. Like the Sorcerer's
Apprentice, the central banker can start the march to zero interest, but it hasn't got a clue
how to stop it when the deflationary spiral gets out of control.
Falling Interest Rates Squeeze Profits
Paradoxically, falling interest rates squeeze profits. Conventional wisdom suggests
otherwise: lower interest rates are considered salubrious to business. However, we ought
to distinguish between a low interest rate structure and a falling one. Only
the former is salubrious; the latter is lethal. Falling interest rates reveal that past
investments in physical capital have been made at too high a rate of interest in view of
lower rates presently available. Furthermore, even the low rates of today will appear too
high tomorrow. This explains business lethargy. Expanding production would appear foolhardy
as long as the decline in the rate of interest continued. Falling interest rates make the
cost of servicing past investments soar. As bond prices rise, the present value of debt
will rise as well. So does the cost of liquidating a liability. These increases hit the
profit margin, regardless whether the fact is realized by the producers or not. If not
realized, the outcome will be that much worse. As the firm is paying out phantom profits
in dividends, it is undermining its own financial strength already weakened by the falling
price level. At one point the firm will be unable to pay its bills and will be forced to
seek bankruptcy protection. Then there is the matter of the domino-effect. Even perfectly
healhy firms are hit by deflation: they may find it impossible to collect their receivables
and go under after their debtors have -- all because of the falling interest rate structure.
Financial Vampirism
In the view presented here deflation is a huge wealth-transfer scheme from the producing
sector to the financial sector, denuding the former of its capital, and enriching the latter
with risk-free capital gains. Indeed, the beneficiaries of the falling interest-rate
structure, making risk-free profits thanks to the zero-interest policy of the central bank,
are the principals of the financial sector, chief among them those of the big money-center
banks. Their obscene profits do not come out of thin air. Their wealth is not newly created
wealth. It is existing wealth siphoned off the balance sheet of producing enterprise,
forced into bankruptcy by the falling interest-rate structure. This is modern vampirism
practiced by the financial sector, aided and abetted by the central bank, and its victim is
the producing sector.
The bear market in stocks is not the cause but the effect of deflation. The cause is
the artificial bull market in bonds financed by the central bank. If you ask the bond
speculator about his obscene profits while the rest of the economy crumbles around him,
he will shrug: "I play by the rules. And I did not make those rules either."
Bond Speculation Is No Zero-Sum Game
The proof of complicity of the banks in the bond-speculation-scheme is the $100 trillion
derivative monster. No small-time speculators could create such a Moloch. It was created
by the big money-center banks, for their own benefit, with complete disregard for the
disastrous effect it has on the producers of goods and services. The total face value of
outstanding bonds falls far short of the colossal figure of $100 trillion. It is against
common sense, and an invitation to disaster, to allow speculative long positions to exceed
total supply. Messrs. Greenspan and Bernanke have no comment on all this, except to
confirm policies that are conducive to further increasing the debt behemoth and further
whetting the appetite of the $100 trillion derivatives Moloch.
We are told that the sum of $100 trillion is "only a notional amount". However, the
profits of the bond speculators are not notional. They are payable in cold cash. If indeed
interest rates did go down, and the price of bonds did go up, say, one percent, then
the speculators' profit would be $1 trillion in cash. Who is going to pay that?
Economists will tell you that the profit of one bond speculator is the loss of
another. Don't buy that. It would be true only if speculation was a zero-sum game, and it
was a case of stabilizing speculation. It is true that some speculative markets answer that
description. An example is the commodity market trading agricultural goods. It fits the
model of a zero-sum game. This is so because the risks involved in commodity trading
are nature-given, having to do with the fickleness of the weather and the unpredictability
of natural catastrophes such as a flood or a tornado. Human mortals are not privileged to
see the future. Speculators in agricultural commodities make money by resisting the
formation of price trends. But in markets where the risks are made (unmade!) by man
such as the market for bonds and their derivatives, speculation is not a zero-sum
game. There, speculators make money not by resisting price trends but by riding
them. This is the case of destabilizing speculation.
But if the profit of one bond speculator is not paid by another, then who is paying
it? This is a critical question and it deserves a careful answer. The other side of the bet of
A, the bull speculator in bonds, is taken by a banker B for hedging rather than
speculative purposes. He has sold the bond to A in order to hedge his exposure in
lending money to C, an entrepreneur in the producing sector. His risk is that interest
rates might rise before his loan to C matures that would punch a big hole in his
balance sheet. With his hedge on, the position of B is neutral with regard to changes
in the rate of interest. His position is that of a straddle with a long and a short leg.
Losses on one leg are canceled by profits on the other. Therefore, if there is a loss on
B's short leg, as is virtually certain in view of the "threats" made by Mr. Bernanke,
then it is simply transferred to C, the counter-party to the long leg of B's
straddle. The loss is charged to C. The profit of bond speculator A is paid by
C. This means that, ultimately, the losers paying the $1 trillion in gains to the
bond speculators are the producers. To add insult to injury, they are kept in the dark about
the existence of Mr. Bernake's casino where the fleecing takes place.
Power to Create Is Power to Destroy
The producers are sitting ducks in this speculative shoot-out. They have no choice.
They must carry the risk of owning productive capital, without which there will be no
consumer goods for Mr. Greenspan and Mr. Bernanke, or for you and me. This is an accurate
description of the mechanism whereby the capital of the producing sector is surreptitiously
siphoned off for the benefit of the financial sector as the rate of interest is driven down
to zero. The producing sector is condemned to bankruptcy. It is a victim of plunder
sanctioned by the Criminal Code. This is the essence of deflation: speculators aided and
abetted by the central bank are allowed to bid bond prices sky-high, in complete disregard
for the havoc that falling interest rates will wreak with the capital accounts of the
producing sector, not to mention losses inflicted on stockholders. The $100 trillion
derivatives market is a monument to the folly of man in delegating unlimited power to the
central banker to create as much fiat money as he wishes. Former central banker Paul Volcker
knows. He has been there. He is quoted as saying that "the truly unique power of a central
bank is to create money and, ultimately, the power to create is the power to destroy." If
the central banker has unlimited power to create, then he has unlimited power to destroy.
And destroy he does, especially the savings of ordinary people.
Why Are Economists Silent?
I am aware that my warnings will be received with a great deal of skepticism. The
central banker as the quartermaster-general of deflation? Arrant nonsense! Not only does
the central bank has its own army of research economists, it also has the benefit of the
knowledge and research of the entire profession. There can be no question that the central
bank wields its awesome power while enjoying the best economic advice money can buy!
Siphoning off wealth from the balance sheet of others is straight out of science fiction,
my critics charge. The allegedly injured party, the producing sector, hasn't complained
that its capital is open to pilferage. The media in reporting the crash of Swissair and
United did not suggest foul play in plundering the airlines' balance sheets.
Yet you may dismiss my charges only at your own peril. The awareness is growing that
not just the media, but the entire profession of monetary economists has been bought off
by the central banking establishment in order to put the best possible spin on our fiat
money system. In an interview on December 17, 2002, entitled "Our Dishonest and Corrupt
Monetary System" (www.kitco.com), Dr. Larry Parks
recalled that John Kenneth Galbraith, the Paul M. Warburg Professor Emeritus of Harvard
University, had published a book in 1975 entitled Money, Whence It Came, Where It Went.
In this book the professor wrote: "The study of money, above all other fields in economics,
is one in which complexity is used to disguise truth or to evade truth, not to reveal it."
In other words, Galbraith is saying that when it comes to money, economists lie! Dr. Parks
asks: why do they lie? They have tenure. Why don't they tell the truth? He concludes that
the monetary economists, for the last fifty years or more, have been bought off. With
Nobel-prizes, endowed chairs, research grants, board memberships, and other perks.
Monetary economists have betrayed their Muse, to serve Mammon.
Off-Balance-Sheet Wizardry
That the profession of the accountants has been bought off by the financial sector came
to light recently in the wake of the Wall Street accounting scandals. But in spite of the
great publicity given to these scandals by the media, the problem has not been fixed. A few
small-time crooks may have been apprehended, but none of the authors of the scheme
whereby banks are allowed to cook their books has been charged. The truth is that banks
can carry assets, such as bets in the derivatives markets, "off balance sheet". They do this
in order to find shelter from the scrutiny of depositors, creditors, shareholders; more
generally, from the scrutiny of taxpayers at large. Accountants, regulators, and bank
inspectors know this, but that's a different matter. Apparently, they have been bribed, too.
They are part of the conspiracy. This is how Dr. Parks describes the fraud:
"Fractional reserve lending is jargon for creating money out of nothing.
That's what that means. In the case of derivatives, these are bets that the banks
make. The banks today in the aggregate worldwide have made roughly $110
trillion worth of bets. That's all they are. Banks are making bets and creating
money. One of the things that obscures this for everybody is that banks alone do
not have to reveal their entire balance sheets, as all other public companies must
do under Securities and Exchange Commission regulations. Banks have the
option, with some of their assets, to put them in a basket that they call "held for
investment". When they put assets in that basket (they could be stocks, bonds, or
whatever), then those assets are held at historical costs, rather than at market
value... Nobody else gets away with this except for them. The reason they get
away with it is because they say, in effect: 'If we had to mark everything to
market, there would be too much volatility in our earnings. We don't want you to
find out.' All this is secret. It's called bank secrecy... There are winners and
there are losers. The losers are the ordinary people who lose their pensions, their
savings, their jobs. The winners are the financial guys... These guys have no
downside... Do you know what the banks took out of the economy last year?
Nearly $400 billion. The Wall Street firms who get transaction fees for moving
the newly created money around took another roughly $250 billion. Between
them they took out nearly three times the amount of money that the auto
industry took out. But from the auto industry we got 20 million cars. What did
we get from these guys? We got cancelled checks and bank statements. This is
monstrous, don't you think?"
Playing with Fire
I am not predicting that interest rates will keep falling to zero and that the world
economy will succumb to deflation. I just want to sound the alarm that it might, in view
of the counter-productive monetary policy of central bankers. Other scenarios, no less
frightening, are also possible. Paradoxically, the threat of zero-interest (deflation) and
that of infinite-interest (hyperinflation) are separated only by the knee-jerk reaction of
the marginal bond speculator. He may get scared by the threats of Mr. Bernanke to
undermine the purchasing power of the dollar further. As he becomes persuaded by the
"logic of the printing press", the marginal bond speculator may cut and run. Then other
bond speculators, especially those abroad, could dump their U.S. Treasury bonds, too,
and run for the exit. Quite possibly Mr. Bernanke thought that he was just "fine-tuning"
the purchasing power of the dollar. Under this scenario he would destroy it. When the
central banker threatens to reduce the value of the dollar in terms of goods and services,
as Mr. Bernanke does, he is playing with fire. After dumping the bonds, people may
dump the dollars, too. First the foreign and then the domestic holders. They need not be
reminded that the central banker has the card to trump deflation -- by triggering
hyperinflation. How desperate must the specter of deflation appear to Mr. Bernanke that
he has seen it fit to flaunt his possession of that card!
Congress, Not the Fed, Has the Solution
It is not too late for the U.S. Congress to act to fend off disaster. It should
immediately take away the unlimited power from Messrs. Greenspan and Bernanke to create as
much fiat money as they wish, and to drive down the value of the dollar in terms of goods
and services. Not only are the present monetary arrangements blatantly unconstitutional,
they are responsible for the destabilization of the rate of interest allowing it to swing
from one extreme to the other, causing grievous economic damage along its path. The House
of Representatives, to which the Constitution delegated the monetary powers, can rectify
this by going back to constitutional money. It should stabilize interest rates without any
further delay, and remove the threat of both zero and infinite interest, by opening the
Mint to gold and silver. This is a Republic based on checks and balances. It has a
government of limited and enumerated powers. Neither arm: not the legislative, not the
executive, nor the judiciary may claim to have unlimited powers under the Constitution.
Why should officers of the Federal Reserve be allowed to make such claims?
Free coinage, a right of the people enshrined in the U.S. Constitution, would remove the
greatest threat this Republic has faced in its entire history up to now, greater even than
that of foreign terrorists. This is the threat to destroy the capital of the producing
sector, through the machinations of the financial sector, aided and abetted by the Federal
Reserve.
January 1, 2003
| Copyright © 2003 by Antal E. Fekete |
January 18, 2003 |
CORRECTION
I am very grateful to James E. Schoenbeck for calling my attention to a
mathematical error in the example I used in my latest article The Central
Banker As the Quartermaster-General of Deflation. I also used the
same example in earlier articles such as Wrecker's Ball of Swinging
Interest Rates. Mr. Schoenbeck wrote me on January 8, 2003, as
follows:
"Professor:
While I enjoyed reading your article, I take dramatic exception to your
pricing of the hypothetical bond as interest rates decline. If the interest
rate dropped from 16% to 0% overnight, the price on the 30-year bond with 16%
coupon, $1,000 par, would go to $5,800. A nice increase, to be sure, but
nowhere near the 1,000-fold capital gains of which you talk
While it is true that the value of a 30-year bond will almost double when
the rate is halved from 16 to 8%, it is no longer true as it is halved further
from 8 to 4%, from 4 to 2%, from 2 to 1%, etc. Below is a table showing how
the value of a $1,000 investment in a 30-year bond goes up with each halving
(after which the investor takes profits and rolls out to a new 30-year maturity)
| 16 to 8% |
$1,000 to $1,900 |
- - - - - - - - - - - - - - - |
| 8 to 4% |
$1,000 to $1,700 |
or $1,900 to $3,200 |
| 4 to 2% |
$1,000 to $1,450 |
or $3,200 to $4,684 |
| 2 to 1% |
$1,000 to $1,260 |
or $4,684 to $5,855 |
| 1 to 0.5% |
$1,000 to $1,140 |
or $5,855 to $6,675 |
| 0.5 to 0.25% |
$1,000 to $1,070 |
or $6,675 to $7,142 |
| 0.25 to 0.125% |
$1,000 to $1,037 |
or $7,142 to $7,406 |
| 0.125 to 0.0625% |
$1,000 to $1,019 |
or $7,406 to $7,546 |
Wouldn't you agree that we are fast approaching a limit here? The value
of the $1,000 investment will stay below $10,000 no matter how many times
the rate of interest is cut into half, and will never be worth anything like
$1,024,000 under any circumstances. Sorry... but making money is not that
easy..."
James E. Schoenbeck
j.schoenbeck@rcn.com
I concede that under the simple strategy of buying and holding the
30-year bond, or continually rolling it over to new 30-year bonds, the $1,000
investment cannot be doubled in value with each successive halvings of the
rate of interest. But there are other more sophisticated strategies available
involving strip bonds, and derivatives such as: bond futures, call and put
options on bond futures, knock-out calls and knock-out puts, interest-rate
swaps, and various combinations of these which bond speculators can use, and
do use, in order to double their investment (or do even better) every time
the rate of interest is halved. I quote from J. Taylor's Gold &
Technology Stocks newsletter, January 7, 2003, issue (www.miningstocks.com):
"Michael B. O'Higgins was able to turn $1,000 into $415,302 by being in bonds,
not stocks... If you invested $1,000 in the Dow in 1972, that investment would
have been worth only $27,347 as of December 27, 2002. But had you invested
$1,000 mostly in bonds during that time, your initial investment would have
turned into $422,819." (Visit
www.miningstocks.com for more information on this amazing but true story
which can be fully documented. The point is that lenders make a killing during
periods of falling interest rates at the expense of debtors.)
But even these fabulous profits could not explain the creation of the $100
trillion derivatives market coming, as it did, out of nowhere. Individual bond
speculators could not possibly accomplish this feat. It was accomplished by the big
money-center banks. They are responsible for the prolonged agonizing fall of the
interest-rate structure, the flipside of which is the snowballing of the
derivatives monster. They make up the bond market. They run it. They buy the bonds
and interest-rate derivatives before the Fed can buy, since the Fed buys through
services they can provide. If there has ever been socially devastating insider
trading, then this is it.
My point is that Keynesian monetary policy takes the risk out of bond
speculation. It makes it extremely profitable and a sure bet. This explains the
persistent fall in interest rates, and the snowballing of the derivatives market,
all of which spell deflation. Deflation is not merely falling prices; it is falling
prices plus falling interest rates, squeezing the debtors. This deadly
combination is not an Act of God. It is caused by unlimited speculation in
bonds, with profits underwritten by the central bank.
Keynesian contra-cyclical monetary policy and "deflation control" is
a disaster. Nostrums advocated by Milton Friedman and other monetarists are
equally disastrous. Far from containing deflation, the central bank is causing
it, through its counter-productive measures such as bond-buying programs widely
advertised through speaking engagements such as those of Messrs. Greenspan and
Bernanke, prompting more and more bond speculators to climb on the bandwagon to
have a free ride to riches. Rather than relieving debt-implosion, this mindless
monetary policy is, in fact, the one identifiable cause of it through the
bankrupting of the producing sector.
Mr. Bernanke made a solemn vow to Milton Friedman at his 90th birthday party
at the University of Chicago. He vowed that the Fed would not repeat the mistakes
it had made in the 1930's in not whipping and chastizing deflation vigorously
enough. This brings to mind the Biblical story of King Rehoboam, the son of
King Solomon, who answered the people when they petitioned him to lighten their
burden: "My father hath made your yoke heavy; I will add to your yoke. My
father chastized you with whips; I will chastize you with scorpions."
(First Book of Kings, 12:11.) May God save the producers of this country from
the yoke and the scorpions of the Fed.
January18, 2003
Antal E. Fekete
Further Readings
Whither Gold and Other Collected Essays by Antal E. Fekete,
Hammond, Louisiana: Ededge (www.ededge.com), 2002
From the same author, on the website:
www.goldisfreedom.com:
The Economic Consequences of Mr. Greenspan, December, 2001
Japan's Finest Hour, January, 2002
Revisionist View of the Great Depression, March, 2002
The Wrecker's Ball of Swinging Interest Rates, September, 2002
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