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Are the Fed and the Bank of Japan conspiring to
protect the dollar
by propping up the
American bond market?
"If fiat money... falters, we may
have to go back to oxen as our medium of exchange.
In that event, I trust, the Federal Reserve... will have an adequate
inventory of oxen."
(Alan Greenspan, The History
of Money)
Hey, Mr.
Chairman, in case you haven't noticed, the Federal Reserve already has a goodly
supply of oxen!
My father was
fond of relating a story about a professor lecturing on geography. A short
fellow, he was extolling the agriculture of Switzerland. "In our country
oxen are not even as tall as I am. In some countries you see oxen just as
tall as myself. But, believe it or not, on the fat
pastures of Switzerland there are even greater oxen than myself". For
emphasis the good professor stood on his tiptoes and stretched his hand
upwards above his head. "We don't believe so!" - shouted someone
from the back benches of the lecture theater.
The reason for
my dusting off this (not at all funny) wisecrack of the Chairman is that a
conjecture of mine got published inadvertently. Rather than recanting, I
elaborate on it lest there be any misunderstanding about what I mean. In a
private letter I have conjectured that a conspiracy may exist between the
Federal Reserve and the Bank of Japan. The latter is buying U.S. Treasury
paper through the good offices of the former, over and above the
deficit America is running in its trade accounts with Japan. These highly
secret transactions are reported nowhere, as they are on custodial account.
I am well aware
that this conjecture can be neither proved nor disproved. The conspiracy, if
one exists, is part of the highly classified contingency plan hatched out at
the Fed. It calls for bribing (blackmailing?) the Bank of Japan to get its
cooperation in forestalling a run on the dollar led by other foreign central
banks. If such a run were to take place, it would destroy the dollar as well
as the international monetary system, and drive the rate of interest to
stratospheric heights, rendering the Japanese hoard of American paper
worthless.
The run is
widely expected by many a knowledgeable observer, and the bond market is
girding itself for a rise in interest rates more vicious than that 25 years
ago. The obituary of the bull market in bonds has in fact been written
already by the world's foremost bond trader, Pimco's
Bill Gross. However the market, like Mark Twain reading his own obituary,
talked back saying: "the reports of my demise are Grossly
exaggerated". Chances are that this particular bull, taunted by the oxen
at the Fed, is getting ready for another run.
The conjecture
is eminently plausible. Why, the Chairman of the Fed is so well conditioned
that, even while thinking the unthinkable, the faltering of the irredeemable
dollar, he will not think of gold. He compulsively thinks of oxen as the
obvious alternative for defunct fiat money. Any contingency plan prepared
under his watch must likewise ignore gold. I hereby issue a challenge for
anybody to come up with a better contingency plan to save the moribund dollar
(barring to make it gold-redeemable) than conspiring with the Bank of Japan
to extend the bull-run in bonds in order to massacre the Cassandras, on
either side of the Pacific, who bet on the collapse of the American bond
market.
The conspiracy
may be to the liking of the Bank of Japan which has a reputation of dealing
most ruthlessly with speculators who oppose its policy of a weak yen. It
prints yens clandestinely at no cost to itself. The Bank's acquisition of
bonds is therefore a windfall. Thrown in as a bonus is the appreciation of
the Bank's inordinate hoard of bonds in the wake of falling American interest
rates. These bonds were accumulated during earlier decades, in consequence of
the U.S. government twisting the Bank's arm not to buy gold with unwanted
dollars, which is what Charles De Gaulle would have done. The Japanese know
only too well that their hoard is so enormous that the chances of getting rid
of it in case of a dollar crisis are nil.
But isn't this
conspiracy, if it exists, immoral? Yes, of course it is! It is the epitome of
the total depravity of the fiat money regime. Printing yens to support
productive enterprise is one thing; printing yens to support bond speculators
who have insider knowledge is another. It must also be clear that, if such a
conspiracy exists, it is nothing but a rape of the American taxpayer who will
have to be skinned alive by the Treasury to pay the maturing coupons on the
bonds given away by the Fed.
I have said
that the Bank of Japan in printing the yens was supporting bond speculators
with insider knowledge. That's right, there is a huge speculative scheme
afoot called the yen carry-trade. Speculators borrow yens at 1.5%, sell them
for dollars, and buy U.S. Treasury bonds yielding up to 5%. Not only do they
pocket the difference, they are also the beneficiaries of the huge
appreciation of bond prices in the wake of the falling dollar rate of
interest. That is no conjecture. That is a fact. The conjecture is that
speculators are acting on insider information. The conspiracy of the Fed and
the Bank of Japan provides the favorable back-wind to their speculation
which, without it, would be nothing short of suicidal. But with the
back-wind, it is extremely profitable, especially in view of the weak dollar
which improves the terms of trade of yen sellers and dollar buyers beyond
their wildest dreams.
This takes us
back to the supply of oxen at the Fed. If the conjecture is correct, the Fed
has engineered a scheme to push the rate of interest lower in defiance of the
falling dollar. Such a policy is bovine. It spells disaster. It stokes the
fires of deflation as I shall now explain.
Let's define
inflationary spiral under Kondratiev's long-wave
cycle as the decades-long rise of prices and interest rates, and
deflationary spiral as their similarly long fall. Interest rates may lead and
prices may lag, or the other way round. The important thing is linkage. The
long-term movements of prices and interest rates are inevitably linked.
Linkage epitomizes a huge oscillating money-flow back-and-forth between the
bond and the commodity markets. When the money-tide begins to flow at the
commodity market and ebb at the bond market, we have the inflationary spiral.
When it is reversed and flows at the bond and ebbs at the commodity market,
we have the deflationary spiral.
Chairman Greenspan
in a speech on the History of Money, from which I took the quotation above as
well as the title of this article, congratulates himself and his central
banker colleagues in other countries for "the success in containing
inflation during the past two decades and raising hopes that fiat money can
be managed in a responsible way." This is akin to the surfer on the
beach boasting that he has turned the flow of the tide back through skillful
surfing. What the Chairman calls "containing inflation" is nothing
but the receding money-tide from the commodity market that started in 1980,
now flowing at the bond market. The Chairman did not cause it but could make
it a lot worse and more devastating. In particular, if such a conspiracy
between the Fed and the Bank of Japan exists, the receding money-tide could
become a tsunami, repetition of the Great Depression of the 1930's wiping out
sound businesses and the life savings of most people.
A bull market
in bonds is the sine qua non of the deflationary spiral. Deflation is greatly
aggravated by central bank intervention in putting more money in circulation
through open market purchases of bonds. The central bank hopes that the new
money will flow to the commodity market. Speculators forestall it buying the
bonds first. The new money, thus intercepted and diverted, flows to the bond
market, instead of the commodity market as hoped by the central bank.
Interest rates fall, and linkage makes prices to fall with them.
Contra-cyclical policy backfires. No wonder, its author, Keynes, was ignorant
of the linkage. If the conjecture about the conspiracy between the Fed and
the Bank of Japan is correct, there is an insatiable demand for dollars,
especially for falling ones, by bond speculators. The Fed is the
quartermaster general for the coming depression that may make the Great
Depression rather tame in comparison.
In 1980 the
dollar had a close brush with sudden death. It was saved, barely, by the
shock-therapy of ultra-high interest rates, quite openly administered by Chairman
Volcker. The dollar now appears to have another death-spell. Is it possible
that there is a similarity between the two episodes, except this time the
attempt to save the dollar will be through the shock-therapy of ultra-low
interest rates, clandestinely administered by Chairman Greenspan? If so, it
won't save the dollar, only prolong the agony.
In his History
of Money speech Chairman Greenspan observes that "savers have been in
sufficient abundance since the beginning of the Industrial Revolution to
enable investment to further material well-being. Money, as a store of value,
was an early facilitator of savings and one of the great inventions of
mankind. The history of money is the history of civilization or, more
exactly, of some important civilizing values." We may add that it was
the savings of the people that has made America great. In the nineteenth
century the American people working hard and saving hard created an economic
and financial giant on the continent. America was the world's greatest
creditor nation. Now, America is a financial and economic dwarf. It has
dismantled its great industries with the exception of the industry producing
military hardware. Now the capital, embodying the great savings of earlier
generations, is being dissipated. Now, thanks mainly to Chairman Greenspan's
long tenure, America is the world's greatest debtor nation. Now, savers in
America are no longer in abundant supply. In fact they are an endangered
species, at the verge of extinction. Now, the dollar is no longer a store of
value. It is a certificate of guaranteed confiscation of value. The most
recent history of money is a history of decline of civilizing values.
In his speech
Chairman Greenspan related a story. He had met a friend and told him about
the speech he was going to make on the history of money. The friend's
response was: "I know all about the history of money. When I get some,
it's soon history." He could have added: "And if I save some, its value
is soon history!" The Chairman called his friend "spendthrift".
He failed to mention that it was precisely his policies at the Fed that had
made his friend, and many millions of others, spendthrift by turning the
dollar into the peso of a banana-consuming republic.
Chairman
Greenspan said in his speech that "the early history of the post-Bretton
Woods system of generalized fiat money was plagued, as we all remember, by
excess money issuance." The cheek of the kettle that dares to call the
pot black! The excess money issuance under all his predecessors combined is
eclipsed by the excess money issuance during this Chairman's tour of duty at
the Fed! Nor can he have the excuse that he was misled by the siren-song of
the welfare state. As his earlier article "Gold and Economic
Freedom" will testify, he is one of the precious few who understands the
gold-freedom nexus.
The Chairman is
traitor to the cause of sound money.
Antal E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright
© 2002-2008 by Antal E. Fekete
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