Monday, August 12, 2013

WHY FUTURES MARKETS SHOULD SET THE FEDS FUNDS RATE RATHER THAN THE FEDERAL RESERVE BOARD OF GOVERNORS

Did you ever wonder why futures markets exist? Did you ever think that along with potable water, sewerage, and credit, futures markets are among mankind's greatest inventions?

There is one great, invariant law for the whole of trade — the Law of Prices. The Law of Prices holds that winning bids of purchase and sale in the face of what is on offer set the price.

There is one great, axiom for the whole of trade — the Axiom of Profit. The Axiom of Profit holds the sum of sales of winning bidders must at least equal the cost of production otherwise any producer goes to ruin.

Any farmer growing corn does not know how much rain shall fall from the sky, how hot or cold temperatures shall be, how many pests shall arise or how many farmers elsewhere on other lands shall fare during the growing season. These factors affect the supply of corn. If every farmer gains a bumper crop, there shall be an abundance of supply and thus bidders shall need to bid less to buy corn. Likewise if many crop failures arise, supply shall be dear.  Winning bidders shall need to drop much money to win.

Since no one knows the future, men can do the next best thing. They can make their plans by hedging. That is why men invented futures contracts and futures markets.

Futures contracts let someone buy or sell something for an agreed upon price on an exact agreed upon date. A futures contract, locks-in a price for something in a distant date, regardless of what actually happens between now and then. 




A futures market acts as a kind of a unseen, know-it-all god who decrees that this is the price that must exist so that winning bids of purchase and sale in the face of what is on offer can sum to be enough so that all efficient producers can remain to produce another day.

Truly, futures markets is one of the most brilliant things men have ever conceived from their minds. With many potential buyers and sellers competing freely, futures trading is a most efficient way of determining what should be the price for something.

Most fail to know that an interest rate is a price and like all prices ought to conform to the Law of Prices. Yet, one kind of interest rate, the Fed Funds Rate gets decreed by members of the Board of Governors of the Federal Reserve.

The Feds Funds Rate is an inter-bank lending rate. It is the rate that one member bank of the Federal Reserve System charges another member bank if that other member bank has sold too many loans relative to the deposits it has bought from depositors.

So in a way, the Fed Funds Rate acts as a regulator to how much credit, both revolving and non-revolving gets introduced and perpetuated into the economy. Yet there is a big problem with the Feds Funds Rate. Central bankers do not know what the rate should be. 

However, that does not stop Fed Res bankers from trying to keep the Feds Fund Rate at the rate they want. Fed Res bankers forever engage in swimming up Niagara Falls trying to repeal the natural Law of Prices.  And that is where all of the problems of our economy arise. 

How Fed Res bankers attempt to set the rate at their desired rate is through buying and selling government bonds. It is from the buying of government bonds that lets politicians spend money not collected in taxes and not seen as prudent by private bond buyers. So Fed Res bankers help politicians engage in unnecessary wars and build bridges to nowhere. 

If ever Americans want to return to freedom, to live among a people where those who get rich do so from earnest effort rather than political connection, here is where true change must arise. Fed Res bankers ought to be prohibited from buying government bonds. Even better, the Fed Funds Rate ought to be set in a futures market rather than by the wrong decisions of a handful of men led by the Chairman of the Federal Reserve.

Instead Congress requires Fed Res bankers to collateralize each dollar in circulation. Fed Res bankers do so mostly with bonds from Congress and its various agencies.

It was the wrong setting of the Fed Funds Rate, led by then chairman Alan Greenspan that led to the banking crisis of 2007 (and no, it wasn't any other kind of crisis).

Futures markets exist that set the price of many things, like butter, orange juice, gasoline, coffee, natural gas, silver, gold, oats, corn, soybeans, wheat, copper, lumber, sugar, foreign money like yen, Euros, Aussie dollars, Norwegian Krone. There are even futures markets to price hurricane damage to a certain geographical area using the Chicago Mercantile Exchange Hurricane Index and to price the the amount of snow or rain that falls in a specific area designated by a major airport in a city.

In the 21st century, there is no justifiable reason to have the Feds Funds Rate set by a small group of stodgy know-nothings (currently led by chairman know-nothing Ben Bernanke) rather than by the wisdom of thousands of market participants.

With interest rates set by a futures market, Americans would gain for themselves the right supply of bank credit into the economy so that sound economic growth could arise. It is likely that a futures market Feds Fund Rate would put an end to the endless cycle of recessions and crazy bubbles like the realty bubble of the 2000s. 

It is my belief that a futures market for Feds Fund Rate is an original idea. I am not aware of anyone on earth who has proposed so either publicly or privately. 

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