05/05/2019
If you have landed on this post, it may be useful for you to read the previous one for some context.
I love to read about economics, but feel that I have had to wade through a lot of arcane crap to get to the "aha moment", the moment of understanding how any part of the market or a mechanism in our economies actually works. Though this is quite rewarding and enlightening, it is also often mingled with the overbearing sensation: why so complicated?
At these times I am often telling myself that there must be some bizarre historical narrative that will explain how such a screwed up mechanism evolved. At times, having not completely scratched the itch of learning, I have delved into the history to satisfy my curiosity. It is this that has lead me down the rabbit hole way further than most ever think of venturing.
Since it was interest rates, and in particular my assertion that negative interest rates are coming, that inspired my last post (link), this is my quirk of the moment.
Ask any classically educated economics student and their answer will go something like this: "The interest rate reflects the risk premium a lender requires in order to forgo the control of their capital to a borrower." It is very much the same as any other supply and demand interplay, but in this case with capital itself. SIMPLE! or not?
I think this definition is rather accurate, even in our centrally planned economy, you may be fooled into thinking it is not. Let me explain myself a little better and share my understanding of how this works.
How a central bank has control of an interest rate has been a question that has always remained unanswered in my mind. After all we are not living in a overtly managed economy where a simple dictate will suffice. There must be some participatory mechanism that is in play to create the correct "free market" incentives to achieve the planned outcome.
Now I am not going to try to convince you all that I have unraveled this mystery completely. My education continues. But I have managed to discover that a central bank can strongly influence the prevailing overnight interest rate, as close as you can possible come to the core interest rate, the LIBOR rate is you may. By its over sized presence in that market and its behaviour in that particular market for overnight lending, the kind of lending that goes on only between the largest of banks, the central bank can, to a strong degree, dictate what the interest rate will be. It will basically muscle out any divergence from its planned interest rate by its sheer size, while leaving the basic supply demand forces in take for the remaining participants.
To the best of my knowledge the central banks operates under much the same conditions as the other large commercial banks surrounding them, but with the added advantage that they have (technically) unlimited capital. This makes them the proverbial 800lb gorilla in the room of peers.
Ok, having a participant of that magnitude in quite a closed and insulated market is definitely not the picture of balance market forces we may associate with a free market economy, but lets continue and see what we discover further.
The control of interest rates is vital to the central planners. This is THE NUMBER 1 lever any self respecting dictator wants in the middle of their world control panel. It is all the better if there is this veil of ridiculous technical complication surrounding it in order to preserve the general notion that the interest rate is a function of the free market forces, while all along being tightly controlled.
(I know I seem to be simultaneously holding 2 opposing concepts. I told you it is confusing and arcane!)
Much of the complicated and alchemedic concepts economists engage in are actually intentionally elaborate in order to mask central control, and concentrate participation amongst the indoctrinated.
The mechanism of interest rate control is a prime example of this, and is of poignant relevance as we flirt with either an inflationary spike to reflect the inflation of monetary supply the world has experienced in stealth mode over the last few decades, and that of negative interest rates, the required course if the colossal debt load is to be prevented from washing over the economy like a default tsunami.
Central banker and central economic planners must retain the veneer of control. Confidence in their omnipotence is vital for the rest of the economy to believe in them.
Articles like this one are starting to peek behind the curtain and see how tenuous their control actually is.
If I have interpreted articles like this one correctly, it may be a rude shock one day in the near future when we wake up to the fact that the central planners in fact can no longer set the interest rates. What will happen on the day after is anyone guess, but allowing market forces to come back as the main driving force determining the price of money will be a shock following such a long phase of manipulations. The force of the free market having been held back for so long will unleash itself in a violent shock. Just as a little taste test, recall the shock in the Forex markets when the SNB (Swiss National Bank) decided to scrap its peg to the Euro back in the start of 2015 CNBC article about the event The shock was so great that the SNB went back to manipulation, but this time it has been forced to call it only a "Soft peg". As if wrapping a hammer in velvet makes it less crude.
Let's keep in mind here the Swiss can not simply dictate what the exchange rate is, the SNB creates this effect by creating billions of Swiss Francs and buying Euros with them. In effect, it boosts the forex perception of the value of the Euro and depresses the perception of the value of the Swiss Franc. But, as seems to always be the case, this intervention created a secondary problem, what to do with all those Euros? Well they started buying equities all around the world like some SWF (Soverign Wealth Fund), but unlike all other SWF, this was not surplus money from a positive balance of trade or some such windfall, it is printed money! So now the SNB is in the business of propping up share valuations of selected companies.
I share this example as one that I have studied in more detail and illustrates the pent up economic energies that market manipulations create, energies that almost always get released in great shocks when the manipulations no longer work as they once did, are causing more damage than good, or break in some other way.
In all my research and reading, I have yet to come across an example where a manipulation has been successfully unwound and returned back to the natural forces of the free market without disruption.
Are we about to see a cascade of breaking manipulations in the global economy? How will these events cascade around us and affect our every day lives. Are the economic choices we are making today and tomorrow being made with a honest understanding of the economic landscape?
These are a few of the questions I am asking myself, and other like minded people around me are asking. Those of us asking these questions have already woken up to the fact that manipulation exists, and its trajectory is unhealthy. This mindset is one of lowering confidence in the future. Politically this also manifests in the promotion of more dangerous actors promising anything that sounds like a solution. In such a condition of insecurity, most economic actors become more conservative and risk adverse, the very behaviour our beloved central planners hate.
Confidence in their divine stewardship of our economic world is their paramount priority, and as one of our high priests of economic planning stated directly: "When it becomes serious, you have to lie" (Jean-Claude Juncker after being caught lying red handed about Greece's default in early 2015). Read more about that here
As always guys, leave comments, and stay safe.
