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Japan’s tragedy has led some economic
commentators to ponder the possibility that she might try to fund a recovery
by selling masses of US treasuries which would raise interest rates and
therefore deepen the depression. The thinking behind this view is based on
the assumption that in buying huge amounts of treasuries Japan — and
China — helped drive down interest rates by raising bond prices.
This is a very simplistic approach. Foreigners do
not determine US interest rates, Americans do. These commentators seem to
have no genuine understanding of the real nature of interest rates and how
monetary policy actually operates. Interest, as the Spanish economist Faustino
Ballvé succinctly put it, is the price of
time. This is why future goods are discounted. This discount rate (interest)
is determined by the social rate of time preference, i.e., aggregated
individual time preference scales. What this means is that interest rates are
ultimately determined by the social rate of time preference.
Nevertheless, we all know monetary policy is used to
manipulate interest rates. (Manipulating rates is not the same as determining
them.) Operating through the banking system the central bank artificially
lowers rates by expanding credit. As a rule this generates disproportionate
investment in the higher stages of production and excess spending on housing.
It eventually also leads to balance-of-payments problems as
the inflating country begins to run a trade deficit with its trading
partners.
If this explanation holds then changes in the money
supply would correlate, after a time lag, with changes in the mortgage rate,
which is what we find. Now these commentators have overlooked the fact that
Japan is actually holding US assets, not simply dollar notes, many of which
are treasuries. Every student of economics knows that exports are the price
of imports. So when countries export to the US they get something in return.
Most of these students would sagely nod their heads at this insight, saying:
“What these countries are really getting are just little bits of green
paper”. Not quite.
When Japan or China get those little bits of green
paper they use them to buy US assets, whether they are treasuries, hotels,
factories or oil companies. In short, any US asset Japan has bought with its
dollars is in effect a US export. Hence the dollars returned. Therefore these
dollar balances are not holding up the dollar because once these dollars have
returned they are no longer part of Japan’s demand for dollars.
Now there is no denying that if Japan was to
suddenly sell off its treasuries the price would fall and so interest rates
would rise. At this point it gets a little tricky. If the US was running a
sound money policy the effect of any sell off, no matter how huge, would be
only temporary. Even if the bonds were sold for other currencies any fall in
bond prices would be quickly reversed as interest rates returned to their
market levels.
The reason is that in a sound monetary environment
there would be no inflationary induced changes in prices, including interest
rates. Therefore expectations of inflation would be absent. This means that
any forcing down of the exchange rate would result in an undervalued dollar
— not a devalued dollar — and this why the old exchange rate
would be restored. We conclude from this that serious problems appearing to
spring from a large-scale selling of US bonds actually have their roots in
the Fed.
US monetary policy is run by people who have no
respect for sound money, people who seem to think it is something of a joke.
Bernanke has driven yields down to historical lows by injecting vast amounts
of money into the banking system in the Keynesian belief that this will restore
the economy. The result — as predicted — has been more than
disappointing. Moreover, it beggars belief that Bernanke really thought that
his explosive monetary policy would not eventually cause accelerating
inflation.
It is very likely that Bernanke’s reign will
see the end of the dollar as a reserve currency, which might very well be his
aim. The fact that the dollar has dropped against other currencies by about
15 per cent since last June strongly suggests that the process is well
underway. If the world abandons the dollar it would quickly fall, inflation
would accelerate and interest rates would rise. Naturally, the great majority
of the punditry will pin the blame for rising prices on the devaluation,
completely ignorant of the fact that it was deliberately engineered by
Bernanke’s monetary policy.
Irrespective of what Keynesians like Bernanke think,
devaluations are no way to promote growth.
Gerard Jackson
Brookesnews.com
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