Using state-backed force to artificially set the price of money and loans always causes dislocations and misallocations in the economy. A look back at the history of the booms and busts and bubbles and crashes that have plagued the developed world’s economies for the last century, reveals a simple truth:
When the Central Bank artificially lowers rates so that some select group of bankers, corporations or people can borrow money cheaper than everybody else in the market place, asset bubbles will ensue.
When I first studied the concept of economics, and financial systems back in college at UNM under a professor who had gotten his PhD in economics from the University of Chicago, we were taught about a “Natural Interest Rate” and we were taught that there would always be consequences to any attempts to artificially manipulate such rates.
Specifically, the idea is that when a Central Bank moves nominal interest rates below the “natural rate of interest” there are real world ramifications in the economy. Tweaking the interest that people with money are able to get artificially through state-backed force obviously impacts real life business decisions.
Back before the banking cabal formed a Central Bank in the US to control interest rates with state backing, Knut Wicksell defined “a natural interest rate” as:
There is a certain rate of interest on loans which is neutral in respect to commodity prices, and tends neither to raise nor to lower them. (1936 translation from 1898 text, p.102.)
This “natural rate of interest” would naturally be set in the free markets and thus would simply reflect the cost of money by the people who have money based on a certain interest rate that they’re willing to lend the money out at.
The Federal Reserve used to talk about things like a natural interest rate, real rates and other concepts of financial systems that are simply truisms. There’s no sense in pretending that a group of fifteen bureaucrats beholden to the banks whom they literally serve as “Central Bank Board Members” since the TBTF banks literally own all the shares in the Federal Reserve.
For example, in the San Francisco Board’s report on Natural Interest Rates back in 2003, they wrote, http://www.frbsf.org/economic-research/publications/economic-letter/2003/october/the-natural-rate-of-interest/:
“In thinking about the natural rate of interest, economists generally focus on real interest rates. They believe that movements in those rates, more so than in nominal rates, influence businesses’ decisions about investment spending and consumers’ decisions about purchases of durable goods, like refrigerators and cars, and new housing, and, therefore, economic growth.
…One way of providing that benchmark is to consider what level of the real federal funds rate, if allowed to prevail for several years, would place economic activity at its potential and keep inflation low and stable.”
And the St. Louis Federal Reserve wrote a report on Natural Interest Rates back in 2005 http://research.stlouisfed.org/publications/mt/20050301/cover.pdf:
“Most central banks now implement monetary policy by setting a near-term target for an overnight interbank interest rate. In turn, policymakers face the difficult issue of how to choose, and adjust, the target rate. One widely discussed policy guide is the “natural,” or equilibrium, real rate of interest.
To use this guide, one compares the level of a medium-term financial-market real interest rate—such as the yield on a 10-year Treasury inflation-indexed bond—to an estimate of the long-term “natural,” or equilibrium, rate of return on the economy’s capital stock. The idea that inflation will be approximately constant when these two rates of return are equal is an extension of an idea advanced in 1898 by the Swedish economist Knut Wicksell.”
So if you were a big time bank executive and you know that you have unlimited access to other people’s money (the taxpayer, that is) through a Central Bank that has the backing of a state that is borrowing, taxing and/or confiscating the money you’re borrowing from that Central Bank, what would you do? What if you knew that you’ll be bailed out if you lose everything that you borrowed from the Central Bank after risking it and gambling in derivatives and stocks and options and even lending it back to the government that gave you the money at a much higher rate than you borrowed it from them at?
What if the Central Bank not only lent you as much money as you want for no cost or interest at all but even promised to buy at least $85 billion of whatever securities you own at whatever price you set each money? What if the Central Bank then promised to actually pay you interest for borrowing the money and then depositing it in their bank?
Does this sound healthy?
That is what we are living through in this Revolution Investing economy. We have completely veered off any semblance of a “Natural” anything in this financial system. Natural Interest Rates? Gimme a break.
A look back at history shows you that when the Federal Reserve moves its interest rates below the “Natural Interest Rate,” that it leads to asset bubbles and overheated economies and eventually serious inflation. We are not just below the natural interest rate these days. We are in completely uncharted territory of Central Bank manipulations and a global movement to inflate asset prices.
So what’s our playbook here? You’ll likely eventually see a 10%-20% pullback in the major stock market indices if/when the Fed finally starts to “taper”, which I would expect to happen sometime in the next six months. That will likely be your last great opportunity to buy stocks before they completely take off into what I’ve long expected will turn out to be the Biggest Stock Market and Asset Bubble in History because there will be no quick way to undo all the years of excesses that this system and the bailouts and the 0% interest rates and QE and so on and so forth. That bubble could probably take us higher for another year, two years or even five years. But at some point, the bubbles will pop, money will become more expensive and those who have nagivated the swings successfully will be in a great place to start buying up assets in the crash. Finally, a “natural” order of free markets and rule of law will return. I’ll help us navigate this along the way.
Being aware of the reality of this sick economy and the policies that got us here is the only way for us to succeed under this regime.