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Too Much Monkey Businessby
Gary North When making an important point, I frequently quote from the basic texts of Western civilization: the Bible, movie dialogues, and rock and roll lyrics out of the 1950's. Today, it's Chuck Berry. Too much money business. Chuck had it right. All around him were lots of people who were trying to get their hands on his money. He was steadily falling behind. Runnin' to-and-fro, Here is how I imagine the scene. There is Chuck, guitar firmly in hand, with that duck-walk routine of his, moving rapidly across the stage. And there, on the far side of the stage, was the ultimate salesman of our generation, the man with the saxophone in his hand. No, not King Curtis. I mean the player of siren songs, Alan Greenspan. Salesman talkin' to me, Greenspan offered the ultimate lure: below-market interest rates. The borrowers lined up. Throughout the economy, all over the world, people have bought into the idea that a central bank can somehow create capital out of nothing. So compelling did this vision seem that the Japanese central bank adopted it to solve the problem of recession back in 1990, just as Greenspan had done in October, 1987, to reverse the 22% fall in the U.S. stock market. The Federal Reserve System made liquidity available. The fiat money rolled off the digital presses. Japan thought this policy would work. The result was a recession that lasted 13 years. This process creates the carry trade, when investors borrow short at low rates and lend long at high rates. It is a way to get very rich until, without warning, judgment day arrives: when no one will lend short any more. It creates carry trades in every nook and cranny of the economy. A BANK RUN ON MIDDLEMEN When investors cease to lend short to borrowers who have previously lent long, this has the effect of a bank run. Think of the bank run scene in It's a Wonderful Life. The depositors are lined up. They want their money. Jimmy Stewart explains that the money from one person had been loaned to the other person. There is no cash in the Building & Loan, he says. The depositors are not impressed. The building and loan was saved only when Donna Reed started handing out the honeymoon money like there was no tomorrow – which, because of Frank Capra's script, there wasn't. Jimmy's speech was a variation of the New Deal's favorite slogan regarding debt: "We owe it to ourselves." The problem is this: with fractional reserves, the system as a whole creates more loans than depositors have an ability to redeem at the same time. It works like this. The central bank buys $100 of government bonds. (OK, add five zeroes.) The government immediately spends this. The recipient deposits the $100 in his bank. The bank sets aside 10%, and then lends out $90. Its borrower spends it. His recipients deposit $90. Their banks set aside $9 and lend out $81. So it goes, until the system is borrowed short and lent long to the tune of $900, all based on the original expansion of $100. Then someone says, "I want my money." The dancing begins. Who's got the money? Where's Donna Reed? The banking system has solved this 1930's scenario by means of credit cards. Hardly anyone uses currency these days, except immigrants who send paper money back home. So, the old-fashioned bank run cannot torpedo the banking system. For every digital dollar withdrawn from one bank, it is instantly deposited in another bank. The bankers got their dearest wish: no bank runs by depositors. But now the system has revealed another kind of bank run: a refusal to roll over loans. The depositors – lenders to banks – decide not to lend any more money to the clients of the banks. What clients? Those hedge funds and pools of funds whose managers bought long-term debt like mortgages with money borrowed short. The banks thought these loans were safe. They weren't. The middlemen lent money to home buyers. Some were subprime borrowers. Now these mortgage borrowers are not able to repay on schedule. They are being evicted. Foreclosures spread. The home owners are walking away. What now? At this point, I must invoke the words of the absolute master of rock and roll. I don't mean Chuck, great as he was. I don't mean Elvis. I mean the great man himself, Fats Domino. He understood, so long ago, what the middlemen – the mortgage brokers – would be singing in the ears of lenders in 2007 and 2008. I'm walkin', yes indeed, and I'm talkin' Despite these pleas, the investors have not come back. As of this week, 231 major mortgage-lending firms have gone bust since December, 2006. The Implode-o-Meter site reports this, day by day. Greenspan made the carry trade look easy. All you had to do was borrow short at low rates and lend long at high rates. Nothing to it. Come one, come all! As the real estate bubble grew, hopes of Easy Street ventures hypnotized the dreamers. The system was geared to entice the average Joe, unlike debt for other bubbles. The dream of easy wealth spread to the bankers, who designed and funded arcane credit contracts that no one understands. The problem was that those low rates were created by the expansion of money. Bernanke began stabilizing the money supply as soon as he took over as Chairman in February, 2006. This let short-term rates climb higher. On August 11, 2007, lenders decided not to lend more money. The credit crunch began. For the borrower, this is he equivalent of a bank run by depositors. The effects are the same as if they had come down to the bank and withdrawn their funds. Because the middlemen must get refinancing to sustain their existing obligations, they face bankruptcy. They cannot pay the existing lenders because the people they loaned the money to – homeowners – cannot make their payments. How can the mortgage companies stay in business? Their profits come from commissions on sales of mortgages. Without new infusions of short-term money, they cannot make loans. The infusion has slowed dramatically. So, they close up shop. They walk, just as the homeowners who cannot pay them have walked. IT HAPPENS EVERY TIME When it comes to the business cycle, the pattern never changes. The central bank lowers the overnight rate, which is passed on to borrowers. The bubbles appear. A few people get rich. It all looks so easy. Then the central bank slows the rate of fiat money expansion. Short-term rates climb. The borrowers cannot afford to pay. The spread between "borrowed short" and "lent long" disappears. It may even go negative: the infamous inverted yield curve, which is the signal of a looming recession. What happens to the debtor, who bought his home with no money down? He finds that his equity is disappearing. He is upside down in his mortgage. He owes more than his home is worth, just as he owes for his car. And so, we are back to the Everly Brothers' lament, or at least Linda Ronstadt's lament. I've been cheated We are now in the early phases of a great unraveling of credit obligations. Breaking up is hard to do. The public thinks that a new round of monetary inflation will bring back the good old days. But the FED has not been inflating. It has been deflating. I have provided the evidence here. When the investors at last get the picture, it will take more than a speech by Bernanke to reverse their skepticism. He is Jimmy Stewart, trying to calm the depositors. The speech didn't work. The money did. The public thinks of Bernanke as Donna Reed, honeymoon cash in hand. So far, Bernanke isn't honeymooning the public. So far, he is mooning the public. The business cycle is not scripted by Frank Capra. When it comes to central bank policy, Chuck Berry had it right. There is way too much monkey business. February 28, 2008 Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible. Copyright © 2008 LewRockwell.com |
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