In practice, the most effective way to produce low
interest rates is to ensure the reliability of the currency. This means a
gold standard. When a currency is considered to be reliably pegged to gold,
interest rates typically fall to the mid-3% for the government and the 4%-5%
range (die 50 bps to 150 bps over the government rate) for high-quality commercial
loans. This was true in Rome under Augustus, around 10 AD, it was true in
Amsterdam in the 17th century, Britain in the 18th and 19th centuries, and
the U.S. in the 1950s. Indeed, as I explain in my book, a major reason that
Britain adopted a formalized gold-based currency in 1698 was to promote lower
interest rates.
This being the case, it should be most odd that the
great advantage claimed by the currency manipulators is the ability to
"lower interest rates." I mention in my book that nobody seems to
notice that when Keynes published his General Theory in 1936, the
bible for two generations of currency manipulators and the great paean to the
government "lowering interest rates" in a recession, that the yield
on the 10-year U.S. Treasury bond was about 2.76%! Wasn't that low
enough? In Britain, it was 2.96%.
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How did the yields get so low? It wasn't central
bank manipulation in those days. Keynes was just starting to make those
arguments. It wasn't until the 1940s that Keynes' arguments were being put
into practice, and even then it was within the confines of the existing gold
standard system. The central banks were not free to "lower interest
rates" as they pleased until floating currencies appeared after 1971.
So -- although there were some complications and
minor details -- it is reasonable to say that the low interest rates of the
1930s came about via the unmolested free market, within the context of a gold
standard.
What this means is: you don't need a government to
"lower interest rates." They go down all by their damn selves.
Anyone involved in the markets will tell you that when the prospects of
getting paid via equities or risk bonds look shaky, in a recession for
example, people rush into Treasuries, driving their price up and their yields
down. This assumes, of course, that the currency of denomination for the
government bonds is reliable, which in practice means pegged to gold.
An economist might say that the bond yield reflects
the return on capital available in an economy. When it seems like you can get
a high return on capital by investing in a commercial enterprise, you sell
your low-risk bond and invest the money elsewhere. This tends to drive
interest rates up until they reach a point at which they are attractive
compared to risky ventures, on a risk-adjusted basis. The opposite applies in
an environment where returns on new investment appear to be low. Thus, on a
theoretical level too, it makes sense that interest rates decline in a
recession, assuming stability of currency value.
We can see from these charts, too, that if a gold
standard system tends to lead to the lowest possible sustainable interest
rates, quite sensibly any system which is not a gold standard leads to higher
rates. The floating currency system in place since 1971 led to an explosion
of currency devaluation, inflation, and higher rates. Indeed, rates began to
rise from around 1950, as central banks were already starting to play the
manipulation games that got a lot more serious in the 1970s.
Here is a little more detailed look at the early
1930s. It's from Milton Friedman's Monetary History of the United States:
click here for .pdf
The Fed's discount rate in those days basically
reflected interbank rates generated in an unmanipulated market. The series
where the label got smudged is the yield on BAA corporate bonds. We see that
the mostly-unmanipulated free market was perfectly capable of taking
short-term rates to about 1.5% in mid-1931. That is low enough for the most
ardent "lower interest rates" fan. Notice a major selloff across
the yield curve beginning in September 1931, which is when Britain devalued
the pound. This led to selling pressure on the dollar as well, and the
process by which base money was removed to support the dollar and maintain
its gold peg also resulted in briefly higher interest rates. Economists today
make a big deal of the rise of the discount rate to a whopping 3.5% during
this period. It wasn't that important. The Great Depression didn't happen
because someone had to pay 3.5% annualized interest. You would think this was
obvious.
So, let's summarize:
1) Over the long
term, a gold-linked currency allows the lowest possible interest rates.
2) With a
gold-linked currency, and without government manipulation, market interest
rates would go down all by themselves in a recession situation.
3) This had been
well established by the mid-1930s, as interest rates had already fallen to
multi-decade lows.
4) Nevertheless, a
whole generation of economists decided that they wanted a currency
manipulation body to "lower interest rates" in the case of a
recession.
This makes no sense. Or does it?
Of course we are now very familiar with this
interest rate-manipulation system. We've been living with it for several
decades now. It was only theoretical in Keynes' time. We've seen that there
are many problems with such a system, such as the 1970s inflation or the many
currency disasters worldwide that have been taking place at a regular clip.
We have also demonstrated that this system, over 40 years of trying by many
central banks around the world, has never produced sustainable interest rates
as low as that produced by a gold-standard system.
It would seem that this interest-rate manipulation
system doesn't really produce anything worthwhile.
If you ask the mainstream economists what great
advantage this floating currency system provides, they will typically counter
with two responses:
1) We can't
go back to a gold standard system because of blah blah blah. The problem here
is that today's economists don't know how to establish and manage a gold
standard system. Thus, although it is indeed possible and in fact very easy
to implement, as far as they are concerned it's impossible because they don't
know how to do it. We saw this a few weeks ago: Why Not the Gold Standard?
2) We want to be
able to "lower interest rates" in the case of a
recession/depression. Or, the gold standard prevented governments from
"lowering interest rates," which made the Great Depression worse,
etc. etc.
OK, fine. This "lowering interest rates"
must be so wonderful that we will put up with all the other disasters caused
by floating, manipulated currencies -- and even though the market would
"lower interest rates" automatically anyway. So, what happens when
we "lower interest rates" in response to recession? Hmmmm?
"Pushing on a string" is what happens.
Inevitably, when central banks "lower interest
rates", the results are disappointing. I don't think there's been a
single example where "lowering interest rates" produced anything
particularly positive -- with the possible exception of the 2002-2003
period, when there was indeed a ridiculous credit boom which soon after laid
waste to just about the entire financial system.
In short, this "lowering interest rates"
doesn't accomplish much, or at least you better hope it doesn't. It's pretty
safe to say that it doesn't accomplish much more than what would have
happened under a gold standard, when rates would have fallen anyway. And,
everybody knows this.
My conclusion is that all of this "lowering
interest rates" talk is really just a cover for something a lot simpler:
currency devaluation, that oldest of economic band-aids. Because, while
"pushing on a string" doesn't have much effect, currency
devaluation does have very large effects. Just about all the currencies in
the world were devalued beginning in 1931. This was not done via a central
bank and "lowering interest rates." Mostly it was an overt policy
of the central government, and the central bank was just along for the ride.
My suggestion: if you want to devalue the currency,
just devalue it. Let's not get involved in this stupid system of
"lowering interest rates." Or, to put it in more practical terms,
have a gold standard, and if, for whatever reason, people want to devalue the
currency, then devalue it, but stay on a gold standard. The U.S. devalued
from $20/oz. to $35/oz. in 1933 -- but it didn't leave the gold standard. The
dollar remained pegged at $35/oz. until 1971. This was basically OK. If you
have one or two devaluations a century, of similar size, that would be
tolerable. An even better solution: don't devalue the currency. Whatever the
economic problem is, it wasn't caused by a currency that is too stable. Just
fix whatever is causing the problem, without playing games with the currency,
causing new problems.
That's pretty much the response to the last 70 years
of blah blah from the academic economists. You see, this stuff really isn't
that hard.
Nathan Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United States, Japan, and the Middle
East. About the Book: Gold: The Once and Future Money (Wiley, 2007, ISBN:
978-0-470-04766-8, $27.95) is available at bookstores nationwide, from all
major online booksellers, and direct from the publisher at
www.wileyfinance.com or 800-225-5945. In Canada, call 800-567-4797.
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