by Gary North: Why
Interest Rates Will Rise
You are on
the back of a tiger. You had no say in the matter. You are part
of the international economy, and central bankers run it.
inflate. Then there is a boom. Then there is price inflation. Then
they stop inflating. Then there is a recession. To keep it from
becoming a depression, they inflate. Year after year, decade after
decade, generation after generation, this is what central bankers
the tiger is really, truly dangerous. The central bankers have lured
the world's highly leveraged speculators and their multinational
bankers into wildly speculative ventures that can keep them growing
richer only by threatening them with bankruptcy if the central bankers
ever attempt to climb off the tiger's back.
How did we
get into this situation? F. A. Hayek's book, A
Tiger by the Tail: The Keynesian Legacy of Inflation (1972),
discusses central banking as the source of price inflation, booms,
and busts. The book was a compilation of his predictions about this
over the previous 35 years. He saw in 1972 that this would get worse.
It surely has. The book
is online for free.
All over the
world, central banks are inflating madly. They have not offered
any theory for their actions. There is no such theory. Nothing in
Keynesian theory ever hinted at the need for central bank policies
that are now in full force. This is ad hockery on a scale unprecedented
in peacetime, other than in defeated nations immediately after a
total military defeat.
of any theory to explain America's position on Asian currencies
can be seen by the schizophrenic policies recommended by the U.
There are two
major currencies in Asia: the yuan and the yen. The United States
government has two diametrically opposed policies regarding the
central bank policies of China and Japan. Yet the policies are the
same. The results of these policies are the same: lower interest
rates and increased Asian exports. The Federal government benefits
from these policies: Asian central banks' purchases of Treasury
debt at low rates.
I know of no
better example of Jesus' words (though not the context): the right
hand does not know what the left hand is doing.
which is utterly ignorant of basic economics, let alone monetary
policy, fiscal policy, international trade, and the Austrian theory
of the business cycle, is unaware of this schizophrenia. You had
better understand it.
Washington has been screaming bloody murder about China's yuan policy.
It's a manipulated currency, we are told. The Chinese central bank
is holding down the value of the currency by inflating, we are told.
This has to stop, China is told.
Who says this?
Senator Charles Schumer of New York is a major figure. But the Secretary
of the Treasury, Timothy Geithner, has been even more vociferous
There is no
question that the People's Bank of China has inflated in the range
of 20% per annum for years. The Chinese central bank is the world's
leader in monetary inflation. It has financed the boom in China
by a policy of goosing the economy with low interest rates.
If we believe
the Austrian theory of the business cycle, we should expect an economic
crash in China when the central bank finally ceases to inflate because
prices are rising. The central bank says that it has been raising
interest rates by fractional percentages over the last 12 months,
but the yuan's exchange rate with the dollar has not changed much.
China's central bankers have climbed on the back of the tiger, and
they have persuaded the businessmen of the nation to join them.
They cannot get off without a crash. The only question is when it
Bank of China has bought U.S. Treasury debt with its inflated money.
This has helped to fund the massive Federal deficits of the Bush-Obama
era. The Chinese central bank sits on top of some $3 trillion worth
of foreign reserves, mostly IOUs from Western governments, all paying
little interest. These purchases of Western government IOUs have
reduced interest rates on government debt in the West. The politicians
have benefited. But they are an ungrateful bunch. They complain
in public about the low-yuan policy. Then they send their foreign
ministers to China to beg the Chinese to keep buying their debt.
China for its low-yuan policy. Clinton goes to China in order to
beg the government to tell
the central bank to keep buying T-bills. The right hand knoweth
not what the left hand doeth. Or, better put, the American government
talks on both sides of its mouth. Or, finally, "White man speak
with forked tongue." This is because the government is beholden
to multiple interests. Geithner represents the manufacturing interests.
Clinton represents the business community as a whole.
There is no
theory or policy that will let the government borrow at low rates
from China if China stabilizes its currency. China will face a recession.
Domestic purchasing power Keynesianism will trump mercantilist Keynesianism.
have been put out of business by this arrangement, because China's
central bank policy has kept the yuan lower than it would otherwise
have been. Western consumers have been benefitted greatly. They
have been the beneficiaries of increased exports from China. This
has kept consumer prices higher in China, harming Chinese consumers
who are not involved in the export trade, which means most Chinese
consumers. But China's exporters as a minority special interest
have done wonderfully. This is mercantilism in action. Mercantilism
has not changed in 400 years.
When the crash
hits China, Chinese manufacturers will do poorly for a time. That
will be the fault of the central planners in both China and the
West, all of whom pursue low-interest rate policies that create
a temporary boom, followed by a crash. That was Ludwig von Mises'
insight in 1912, and it is still valid.
to Geithner on China is Bernanke on Japan. On Friday, March 19,
the G-7 nations announced a coordinated plan to drive down the yen's
price in Western currencies. The yen fell against the U.S. dollar
by about 3% in one day, an unheard-of move in currency prices.
this. The G-7 nations' central banks intervened to keep down the
value of the yen. But they gripe because China's central bank keeps
down the value of the yuan. What's going on here?
see the central banks of the West coordinate their policies in an
unannounced move, three words usually suffice to explain it: big
Reagan's Director of the Budget and long-term critic of the Federal
Reserve, has explained what was at stake: bank profits. It has to
do with the yen carry trade.
I have told
my readers to go long the yen ever since March 2009. I had several
reasons. The yen carry trade was one of them. The yen carry trade
is the product of he Bank of Japan's policy to hold down interest
rates to zero. This has been easy, because the collapse of the boom
in 1990 created demand for any asset that would hold its value.
Investors have bought government debt. They have an anti-entrepreneurial
mindset based on their fear of the economic future.
have borrowed yen at almost zero percent to buy higher-yielding
bonds in the West. In other words, they went short the yen. They
assumed that the yen would not rise, or even fall, in relation to
foreign currencies. I told my subscribers to invest on the assumption
that this assumption was wrong.
It has proven
to be wrong for two years. But the earthquake speeded up the process
of the yen's rise. The crisis triggered a familiar investment reaction:
repatriation of currency. Japanese wanted yen to cover them in the
crisis. I told my subscribers on March 13, the day after the earthquake,
that this would happen. On Monday, March 15, investors sold the
Nikkei. They also sold foreign currencies to buy yen.
Bank of Japan frantically pumped in a staggering $700 billion worth
of yen in the next three days: Monday to Wednesday. This had
no visible effect. The yen kept rising.
the yen shot up. Those traders who had been short the yen in their
carry trades faced a disaster on Friday. The forex (foreign exchange)
market was about to crush them. What to do?
Bernanke and his loyal cavalry rushed to the rescue of the carry
traders, who had been funded by the big banks. Stockman describes
Thursday evening's short-covering panic in the yen forex markets,
and the subsequent panicked response by the central banks, wasn't
just a low frequency outlier the equivalent of an 8.9 event
on the financial Richter scale. Rather, it is the predictable result
of the lunatic ZIRP [Zero Interest Rate Policy] monetary policy
which has been pursued by the Bank of Japan for more than a decade
now and with the Fed, Bank of England and European Central
Bank not far behind.
The joint announcement
by G-7 bureaucrats of combined intervention dropped the yen sharply
and let the carry traders postpone the day of reckoning.
short, the BOJ is sitting on a financial fault line. Thursday afternoon's
rip to 76 yen to the dollar was not the work of a fat finger; instead,
it represented a real-time measure of the furies bottled up in the
financial system due to Japan's foolish rental of its "funding currency"
to global speculators. Having long ago urged the BOJ to embrace
this absurd monetary policy, it is not surprising that Bernanke
and his confederates have come to the rescue for the moment.
Let me review.
Big, nice Japan is the Japan of the carry trade, the friend of Western
currency speculators and the large banks that lend them money to
engage in the carry trade. Big, nice Japan has made Western speculators
rich. But they started to get less rich as a result of a steadily
rising yen. The earthquake and repatriation caused them to start
getting poorer, fast.
is big, bad China. China's yuan in not an openly traded currency.
So, it could not become a part of the carry trade. Western speculators
could not borrow money at near zero percent from the People's Bank
of China to buy Western bonds. The PBOC lent its money directly
to Western governments, not Western private speculators. It cut
out the middlemen.
central bankers are on the side of big, nice Japan. The Bank of
Japan desperately flooded the economy with newly created yen, but
this had no measurable effect. The Bank tried to keep the yen low,
so as to stimulate Japanese exports. It failed for three days. On
the fourth day, the yen moved sharply upward. The G-7 intervened.
Will the intervention
last? I don't think so. Neither does Stockman.
It is only
a matter of time, however, before the yen explodes under the next
bout of short seller's pressure, and then the lights will really
go out on Japan Inc. In the meanwhile, ordinary people the world
around will get less food per dollar from Wal-Mart and speculators,
basking in the wealth effect, will have even more dollars to spend
at Tiffany & Co. (TIF).
Why will this
policy fail? Because Western central banks cannot create yen. They
can intervene to lower the price of the yen only by selling yen.
When they run out of yen to sell, the yen will resume its ascent,
unless the Bank of Japan continues to inflate. If it does, this
will create an inflationary crisis in Japan. For two decades, the
Bank of Japan has resisted this.
BANKERS ARE MYOPIC
bankers of Japan for a decade did not inflate wildly, unlike the
central bankers of China. They climbed on the back of the tiger
in the 1980s. When they attempted to get off, the economy went into
a recession. The stock market, at 39,000 in December of 1989, is
now under 10,000 for the third time. The commercial banks refuse
to lend. They are loaded up with bad real estate loans, and have
been for two decades.
get off the back of the tiger gracefully.
after 2004. He handed the reins over to Bernanke in February 2006.
In less than two years, Bernanke came face to face with the tiger.
In the final quarter of 2008, the Federal Reserve more than doubled
the monetary base. Bernanke swapped liquid T-bills with the big
banks. The big banks gave the FED toxic assets at face value. You
can see it here.
tried to get off the back of the tiger, beginning in February 2010.
He allowed the monetary base to shrink. But he climbed back onto
the tiger's back in January 2011 with QE2, a term he prefers not
to use. This new policy is a policy of open inflation. You
can see the extent of this increase huge here.
has described the situation well. There is no economic theory
guiding Bernanke and the Federal Open Market Committee.
the evidence that the Fed no longer has any clue about the transmission
pathways which connect the base money it is emitting with reckless
abandon (e.g. Federal Reserve credit) to the millions of everyday
pricing, hiring, investing and financing outcomes on Main Street
sits right on its own balance sheet. . . .
the Fed's current money printing spree has no analytical foundation,
and amounts to seat-of-the-pants pursuit of a will-o'-wisp
the idea of a perpetual bull market. Like the BOJ, the Fed has
thus made itself hostage to the global speculative classes, and
must repeatedly inject new forms of stimulus to keep the bubbles
This is what
we should expect. It is what we have seen throughout the history
of central banking. It surely is the history of the FED, ever since
it opened its doors in 1914. Its decision-makers have inflated,
then stabilized the monetary base, and then watched in horror as
the booms turned into busts. Their solution: another round of inflation,
and another ride on the back of the tiger.
Tsunami, and nuclear plant crisis combined to persuade Japanese
investors to sell their assets and get into cash. For them, cash
means yen. This threatened to create losses for the speculators
and their banks.
Bank of Japan, the Federal Reserve, and the G-7 bureaucrats decided
in the business week of March 15 to keep the yen carry trade from
unwinding. They see their task as thwarting the results of Japanese
central bankers are unofficially pledged to save the big banks whenever
required, no matter what the cost. So, they placed us all even more
firmly on the back of the monetary tiger.
We will not
get off gracefully. Most people will lose their retirement portfolios
at some point when the tiger finally threatens to become hyperinflation.
They have no clue that this is in store for them.
long-run interests will be sacrificed to the tiger in order to save
the big banks in the short run. Such it has been since 1914. Such
it will still be in 2014.
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.
2011 Gary North
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