Sunday, August 9, 2015


Today, the Telegraph UK published a work by Liam Halligan, Raising rates is trickier now that QE is a lifestyle choice.

"Since the financial crisis, QE has morphed from a just-about-justifiable emergency medicine, into a grotesque, self-serving lifestyle choice of our financial and political classes ... for many years now, QE has been less about crisis management than about pumping up equity and government bond prices to levels that belie underlying economic and fiscal realities.
QE, and the closely related policy of keeping interest rates nailed to the floor, has sent stocks to repeated all-time highs despite the lack of truly convincing recovery either here or in the US. It has allowed busted “zombie” banks that should have been thoroughly audited, rendered insolvent, then closed down and broken up, to keep trading."

Central bankers (CBs) have backed themselves into corners. In effect, through their near-ZIRP, CBs have severely harmed capitalism, if not mortally wounding capitalism for all time.

If CBs raise rates, there can be few new entrants in markets. How can would-be enterprisers compete? At higher rates, would-be new entrants would pay more for their capital relative to enterprisers operating with capital bought on credit at lower rates. Without new entrants, what will cause job growth?

CBs aren't smart enough to know what rates should be for millions of borrowers making many times more decisions about their daily lives. If central bankers knew what rates should be, never would there be banking crises such as the 2008 Banking Crisis.

The time to have raised rates long since passed — 2008 to 2009 — when speculation ran rampant. Rates should have been pushed high, blisteringly high between 2008 and 2009 to force many into bankruptcy. Such a policy — the right policy — would have bankrupted all of the shakiest of firms, culling the herd  while at the same time, protecting extant capital bought at higher rates of credit.

Instead, CBs Ben Bernanke and Janet Yellen have kept alive a sickly herd of bad enterprisers who have built edifices of bad businesses upon low interest rates during the Greenspan-Bernanke Great Inflation (1994 to 2008), the biggest credit bubble in the history of mankind.

The results of the Bernanke-Yellen near-ZIRP should surprise no one. Near-ZIRP has led to massive job cuts as enterprisers reduced their expenses to restore ROI on extant capital structures. Near-ZIRP has led to little borrowing and few new entrants since few can foresee expected future profits forthcoming from high true unemployment (7.57% as of today).

Worst of all, Bernanke-Yellen near-ZIRP has led to a massive decline in the economy, a decline that has gone unabated more or less since peak GDP of Q4 2007.

First under Bernanke and now under Yellen, CBs have engaged in an exercise of academic stupidity. Their beliefs run counter to real-world commerce driven by actual capitalism.

Paul Volker had it right between October 1979, and October 1982. When bankers ran amuck with bank credit, rates need to be pushed to the ceiling. Volker did that exactly by targeting the quantity of bank credit rather than the price of bank credit. Targeting bank credit, the federal funds rate reached a record high of 20% in late 1980. Consumer prices growth rate (wrongly called "inflation" by many) peaked at 11.6% in March of 1980.

William Poole, the eleventh chief executive of the Federal Reserve Bank of St. Louis (March 23, 1998 to March 31, 2008) had this to say, Volker's action:

How bad was the period of the Great Inflation? The inflation rate, a mere 1 percent in 1965, hit 14 percent by 1980. Unemployment trended up from a low of 3.5 percent (annual average) in 1969 to 9.7 percent in 1982. The stock market was in the dumps. Oil prices jumped off the charts. Presidents Richard Nixon and Jimmy Carter became desperate enough to tinker with price controls, the results being disastrous.
Volcker, in office only two months, took the radical step of switching Fed policy from targeting interest rates to targeting the money supply. The days of "easy credit" turned into the days of "very expensive credit." The prime lending rate exceeded 21 percent. Unemployment reached double digits in some months. The dollar depreciated significantly in world foreign exchange markets. Volcker's tough medicine led to not one, but two, recessions before prices finally stabilized.
Before Volker, the meddlers of Congress mandated that Federal Reserve CBs set targeted growth rates for circulating bank credit (wrongly said as "the money supply") and report on their success or failure. To try to meet the foolish mandate, using an unscientific approach, Fed Res CBs kept the federal funds rate within a narrow range.

And contrary to popular belief, incoming President Reagan and his treasury secretary Donald Regan did not like Volker's policy. Regan said, “What I am suggesting is that if (bank credit growth) stays here, you’re going to have a severe recession.”

By the summer of 1982, the recession hit bottom even though the active job seekers rate as a percent of workers and job seekers, the so-called unemployment rate, hit a peak of 10.8% in late 1982.  By 1983, the CPI had fallen to 3.7%. It had taken Volker three years to fix the economy on a sustained path of growth.

Raising rates to heights rapidly kills off bad business while protecting the capital structures of enterprisers who have built firms upon firm ground. Near-ZIRP destroys returns to capital bought on credit borrowed at higher rates for existing firms.

Interest rates ought to be set in futures markets by many players. In the abstract, futures markets are risk-reducing mechanisms, which curtail glut and prevent shortages.

Interest rates set by futures markets would see rates fall when the economy can handle the creative destruction forces of new entrants with superior technology pushing out the inefficient while at the same time producing sufficient returns to capital

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