Bernanke Is Riding the Tiger

Recently 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.

First they 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 do.

This time, 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.

The absence of any theory to explain America’s position on Asian currencies can be seen by the schizophrenic policies recommended by the U. S. Government.

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.

The public, 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.


For years, 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 about this.

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 will occur.

The People’s 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.

Geithner excoriates 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.

Western manufacturers 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.


In contrast 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.

Think about 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?

Whenever we see the central banks of the West coordinate their policies in an unannounced move, three words usually suffice to explain it: big bank bailout.

David Stockman, 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.

Western speculators 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.

The 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.

On Thursday, 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?

Then Captain Bernanke and his loyal cavalry rushed to the rescue of the carry traders, who had been funded by the big banks. Stockman describes it well.

So 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.

In 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.

In contrast 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.

So, Western 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.


The central 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.

You cannot get off the back of the tiger gracefully.

Greenspan tried 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.

Bernanke has 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.

Stockman has described the situation well. There is no economic theory guiding Bernanke and the Federal Open Market Committee.

Indeed, 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. . . .

In truth, 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 rising.

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.


The earthquake, 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.

The 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 investors.

The 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.

The public’s 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.

March 26, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North