End Interest Rate Manipulation

September 22, 2015

Last week, the FED head, Janet Yellen, announced that they were keeping interest rates pegged to zero. They haven’t raised rates now for almost 10 years.

Keynesians grant the FED / Government the power to manipulate rates. But, even they must say that the ZIRP and long term suppression of Free Market rates of interest is Socialism in the US. For those readers who may not be aware, Socialism is wildly destructive of an Economy, and of Individual Freedom.

Since the FED ended their QE programs, they have reverted to buying US Treasuries almost entirely at the short end of the yield curve. Traditional Keynesian dogma calls for short rate manipulation to be used to suppress long rates indirectly.

The Bond Market reaction has been interesting. Since last week, short rates – 3 month Treasuries – have gone down 5 basis points to negative 0.2%, while 6 month Bills have plunged from ) 0.23% 0.06%!

Long Bonds, however, haven’t been cooperating, with the 30 Year Bond going up 7 basis points. The rise from a month ago is over a quarter of a point.

Admittedly, these hundredth of a percent moves look small, but at these ultra-low levels, changes in the rates are magnified.

Now, manipulating interest rates, just as manipulating any price, has winners and losers. To me, this is a clear violation of the Constitutional mandate guaranteeing Equal Protection Under the Law.

Further, the Constitution requires the government to coin money And Regulate the Value Thereof. Manipulating rates can be achieved ONLY by debasing the currency – by printing more and more and more of it. This cheapening of the Dollar violates the Regulating the Value provision.

Aside from the Unconstitutionality of it, it’s just plain STUPID! While financial repression (eg. ZIRP) may benefit the connected few, it reduces the growth of the Economy. Looking at GDP growth, adjusted for the CPI the way it used to be calculated in 1980, the Economy has SHUNK for a generation.

That means that the vast majority of Americans – rich, poor, or middle class (while it lasts) – is poorer because of it. It’s time to end Socialism in the US, starting with this horrid example.

Now, the FED tries to justify its rate manipulation by saying that it’s stimulus. This is BOGUS! There are four distinct phases of the interest rate cycle:

  • While rates are being lowered
  • While rates are level at a low rate
  • While rates are being hiked
  • While rates are level at a higher rate

What the FED calls stimulus works only while rates are being lowered. Consumption as well as Investment which otherwise would not make economic sense are stimulated. People consume more and save less, reducing the pool of capital which allows for growth. Businesses MAL-invest in projects which make sense only in a low rate environment.

When rates have bottomed – we’ve had ZIRP for 7 years – low rates no longer stimulate higher investment. However, people and businesses still are getting a bogus rate signal, so they make less than optimal choices. Low growth is made worse by continued mal-investment which crowds out the good investment. Think defaulting student loans, defaulting car loans, and the remaining inventory of underwater home mortgages. Low and steady rates are the worst of both worlds.

When rates go up from suppressed levels, it affects all those bad earlier decisions by consumers and businesses. The investments which couldn’t be justified by Free Market rates stop being justified. The loss of jobs and closing of businesses are not caused by rising rates but by the previous rate suppression. Rising rates “clear away the brush from the forest floor.” But, in the process, real people are hurt – hurt by what never should have been allowed in the first place – interest rate suppression.

When rates get to more normal levels and then stop rising, consumers and businesses get a more accurate – a more realistic – view of the economic world. People buy only what they can afford. Businesses use capital only when they can justify the project in the real world. Businesses err, lose their capital, allowing the better allocators of capital to grow their businesses. In the process, they help the whole Economy and all Americans.

I’ve talked before about phasing out the interest rate suppression – about ending the FED’s Economy killing manipulations. I prefer that the return to Free Market rates be gradual enough so that the pain, which will come as rates return to normal levels, will be gradual as well.

End the FED’s manipulations…and then end the FED itself.

Robert (Bob)  Shapiro is self-taught in Austrian Economics and has consulted briefly for the governments of Mexico, Greece, Portugal and Spain. He has traded Gold & Silver and their stocks since 1970. Bob Shapiro’s blog is http://us-issues.com

Spanish Conquistadores invaded the Inca Empire in 1528 to steal their silver and gold.