The Central Fact of the LIBOR Rate Scandal

Tea Party Economist

Recently by Gary North: Putter, Fritter, and Guess

I begin with two charts.

First, the 1-month LIBOR rate.

Second, the 1-year LIBOR rate.

What do we see? First, they loosely parallel each other. Second, the move up began in late 2004.

What happened in 2004? The bubble in housing, all over the West. What caused this? Years of subsidized rates by central banks.

Why were rates low in 2002-4? Inflationary policies, led by Greenspan’s Federal Reserve.

None of this should surprise anyone.

Then rates climbed. Why? The boom. There was greater demand for loans, because businesses were prospering. The real estate bubble grew.

Notice that the 1-month rate was slightly lower than the 1-year rate in late 2006. The yield curve was close to inverted. This is a warning sign of recession.

Let us look at American Treasury bill rates in this period. First, the 90-day rate.

It was a little over 5% in late 2006.

Look at the 1-year rate.

It was a little over 5% in late 2006.

In other words, rates were less than one percentage point higher in the LIBOR market for both short-term and 1-year debt. But these were privately issued IOUs, so the risk premium was higher. This is a normal spread.

Rates fell in 2008 in both markets. That was because of the recession. They kept falling through 2009. People sought safety. They went into short-term debt. This took place in all credit instruments.

Beginning in 2009, rates bottomed in both markets. They have stayed low. Why? Not QE2. Fear among bankers. They are keeping excess reserves in Europe and the USA. They do not lend to each other, because there is no demand for funds. Banks do not need to cover overnight. They have plenty of reserves at the central banks.

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July 19, 2012

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 © 2012 Gary North