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CREATING ANOTHER
CARRY-TRADE MONSTER
Remember the “yen
carry-trade”? The Bank of Japan drove yen interest rates so far
down that big hedge funds and speculators began to borrow yen at 1%
or so, sell them into the market, buy US Treasury bonds paying 4%
with the proceeds, and drive home with free money. The only danger
was that the yen would rise while they were short yen – not a very
great danger, since a rising yen would slow demand for Japanese
exports, which the Bank of Japan and Japanese government were trying
to boost.
The same mechanism has
been at work in the gold market, with the “gold carry-trade.”
Central banks have been loaning gold at miniature interest rates –
less than 1% -- and so the sharks lined up to borrow gold, sell into
the market, and invest proceeds in safe government securities paying
4% or more.
Now it appears that the
Great Governor Greenspan has set up a “dollar carry-trade” by
keeping interest rates low. Hedge funds can borrow dollars at low
rates, three months for less than 2%, invest the proceeds in Euro or
other-denominated bonds paying higher rates, and presto! free
money, just back up the truck.
Here’s the kicker: the
dollar drops, and keeps dropping and dropping, so chances are you
pay back cheaper dollars than you borrowed.
Neat, huh? Trying to
manipulate the economy with low interest rates (Greenspan’s
“liquidity weapon”), Greenspan creates a trap for himself. As his
low interest rates tempt more and more people to borrow and then
sell dollars, that puts more pressure on US interest rates to rise,
or the value of the dollar to fall. But rising interest rates is
exactly what the Great Governor wants to prevent, so what can he
do? Shoot the problem with more liquidity, that is, print more
dollars.
So first of all, he has
fallen into his own trap, in which the more liquidity he throws at
the problem (by lowering interest rates and printing money), the
more he must throw. Second, this illustrates why I do not foresee a
deflationary outcome to the present economic slowdown, at least not
in terms of fiat US dollars. For good or ill, the only weapons that
the Establishment has are liquidity and blarney – print more money
and blow more smoke. As the good South Carolina doctor says, “When
all you have is a hammer, everything looks like a nail.”
For an illustration of
the paradox of inflation, look at Japan today. Mired down in
deflation, the government and the Bank of Japan have continued to
throw liquidity at the problem (via lower interest rates, greater
money creation, and government spending) but economic activity just
continues to stagnate or decline. So in terms of the fiat yen, you
have “inflation,” both an increase in the money supply and a drop in
the currency’s value. However, in economic terms, you have
“deflation,” that is, lower economic activity and an actual scarcity
of credit as borrowers are afraid to borrow, lenders to lend, and
bankruptcies abound.
What is going on here?
This seems to contradict everything we know about monetary inflation
and deflation influencing economic activity. In fact, the
contradiction is only apparent, not real. By inflating the
currency, the government and central banks make money artificially
cheap. That misdirects money into investments that are actually
unprofitable, blowing up bubbles that eventually burst in
bankruptcies. Inflation produces a short, feverish burst of
unsustainable and non-productive economic activity that eventually
perishes. Thus the monetary inflation produces deflationary
economic activity.
How is that? Any
increase in the money supply (everyone assumes) increases economic
activity, and any decrease decreases economic activity. Actually,
after the initial boost, the longer an inflation persists, the more
it decreases economic activity. If the rate of inflation
rises high enough, it will actually cause a deflation in purchasing
power. Why? Because when folk catch on to the inflation, they
begin to discount further depreciation in advance. It’s what Andrew
Dickson White called the Law of Accelerating Issue and
Depreciation. The faster the rate at which the government inflates
the currency, the faster the rate at which the public discounts it,
until it becomes worthless.
But again I have
wandered too far from my point, which is: the
United States government and the Federal Reserve
will never stand by while the economy sinks into a
depresssion without increasing the money supply. Inflation is their
only weapon, and they will use it.
They will keep on using it, even if they destroy the dollar. Yes,
there will be a deflation of debts. Yes, there will be a decrease
in purchasing power. But there will be no decrease in the rate of
inflation, or increase in the value of the US dollar. They will
inflate it out of existence if they have to, and they probably will.
CONCLUSION
Reduce your exposure to
United States dollars. Convert dollars to productive tangible
assets or gold or silver.
-- F. Sanders
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