In a recent edition of the Financial Times, Martin Wolf ends up prescribing more government regulation and intervention, yet his description of the government-backed banks and their nefarious behavior is spot on:
No industry has a comparable talent for privatising gains and socialising losses. Participants in no other industry get as self-righteously angry when public officials — particularly, central bankers — fail to come at once to their rescue when they get into (well-deserved) trouble.
Many economists since Mises have noted that every time the Fed manipulates interest rates it creates bubbles of malinvestment. In addition to reallocating scarce resources in inefficient ventures, one of the problems with artificially lowering interest rates is that, ultimately, someone has to pay for these subsidies.[1]
As with every freebie provided by the government, some faceless individuals will ultimately share this unjust burden. And over the course of the Fed's more-than-90-year existence, individuals with dollar-denominated assets have borne the brunt of this devaluation as the dollar is worth about 5% of its original 1913 value.[2]
The Financial Silk Road
At the global scale, if the Fed were the only bank to lower interest rates, the severity of the ensuing bubble could arguably be minimized. However, many other central banks mix and match their own interest rates in a bid to stay on par with the Fed.[3]
For instance, petro-rich Saudi Arabia, UAE, Qatar, Kuwait, and Bahrain all have their currencies pegged to the dollar. As a result, their central planners believe that they "have little choice but to mirror U.S. moves in deposit rates if they want to avoid attracting capital that would pressure currencies higher."
And while petroleum has historically been a safe investment for prospectors and fund managers, the artificially low interest rates always dilute other industries. So while it may begin with the financial sector — which is the first recipient of new cash — it can trickle down to and contort the petroleum space as well.[4]
Thus, the subsequent malinvestment fallout in the next few years will be compounded with every rate change conducted by the central planners; and therefore the falling floor will not be isolated to a small geopolitical area.
The Players
At the beginning of the year, with an interest rate of 2.75%, Switzerland had the fifth-lowest rate. Japanese planners, appearing as if they feel guilty about usury, practically hand money out for free — topping the list at a mere 0.5%. As an aside, if there is no calculated risk involved as a creditor, it's unconscionable to wonder why so many of their loans go bad![5]
In the middle of the developed pack lies Norway (#21), which raised its lending rate 25 basis points two weeks ago, resting at 5.25%. And at the end of the "major economies" spectrum, after eight interest-rate increases since mid-2006, South Africa lends at 14.5%.
As of this writing, the US Fed (#6) has a lending rate of 3.00% -- having lowered it 125 basis points in the month of January.
What is the correct rate? Why have a rate at all? What is the rate supposed to reflect?
No matter how much economic data a central planning board has, it is always inferior to the market in answering these questions. The marketplace continuously fluctuates based on a seemingly infinite set of variables that attempt to quantify risk. And within a free market, entrepreneurs are charged with the task of due diligence, otherwise they become bankrupt. Not so for banks insured and subsidized by the federal government. Why worry about potentially shoddy business models when you can find a lender to always bail you out?[6]
You Can't Spend Exuberance
One of the incredible statements from the recent World Economic Forum in Davos comes from Steve Forbes. He started out brilliant, saying, "I think the Fed should ignore interest rates and realize that if it has a stable dollar, interest rates fall on their own."
Yet he did not see that the new rate decrease would impede the restructuring process, by shoring up businesses that should disappear. To top that off, he believes that the stimulus package (which in reality is just a forced loan — not a rebate) will somehow swing the economy "back by spring." In his mind: a mere slowdown instead of an all-out recession.[7]
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This rose-tinted view wholly glosses over why a slowdown has occurred in the first place, why foreclosures are as popular as iPods, and what expansionist policies encouraged malinvestment.
As Eric Englund chronicled, businesses like Countrywide used government subsidies in the form of guaranteed, soft, artificially low-interest loans in building their myopically shortsighted goal of giving everyone — regardless of financial solvency — a home mortgage.[8]
Therefore, if American investors and financial analysts were dismayed when first-time owners without any credit or even reliable jobs went bankrupt, it would be in their best interest to allow all of the bad loans and businesses to go belly up sooner rather than later. As a consequence, the only thing that this infusion of dishonest money will accomplish is to teach bankers to politic harder the next time they are in a squeeze.[9]
What Goes Around
The subprime mortgage housing bubble was not a microcosm on the North American continent. Asian markets such as Japan and South Korea are only now feeling the credit crunch as their artificially low interest rates also provoked a rash of misguided construction projects and ill-advised investments abroad.[10]
And if central planners around the world continue to manipulate the interest rates there is no reason to believe that the deleterious cycle will stop any time this decade.
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