The Fed & Interest Rates: The Nightmare That Will Not End Nicely
QUESTION:
Mr Armstrong;
You have written that the Federal Reserve remains on track to raise interest rates later this year and this will accelerate the capital inflows driving the dollar higher. You previously warned that this will also set off further defaults in emerging market debt and you have also said that the pension funds desperately need higher rates to survive. But higher rates will blow up the government budget. This seems like a real mess. Is there any way out of this nightmare?
Thanks
JF
ANSWER: NO, this is all inevitable. The Fed will be forced to raise rates, and both Congress and the media will blame them for not raising rates sooner and for creating an asset bubble. They will have no choice because that is their job, as expected from the public at large. Even in Australia and Canada where there are real estate booms going on in Sydney and Toronto, criticism is rising attributing the booms to low interest rates when in fact it is foreign capital inflows that have some calling Canada the new Switzerland. The problem is always blinders on with analysts who only see everything domestically and are ignorant of international capital flows. They play with government budgets and money supply and attribute everything to domestic consequences. They help to keep the majority the victim in these major international events. We have asset bubbles in property that will be blamed on low interest rates when it is driven by capital flows. The Chinese are the biggest ticket buyers in US property while Canadians are the biggest buyer in the number of properties in the United States. So just like the 1987 Crash caused by the G5 currency manipulation, the domestic analysts always turn out to be the fool since they cannot see the wildcard coming in from the outside.
The Fed will have to act regardless of the impact upon the Federal budget. They raised rates under Volcker to insane levels, despite the fact that it raised the national debt from $1 trillion to $6 trillion on interest rates alone. So, the budget hasNEVER prevented the Fed from raising or lowering interest rates in the past. However, raising rates in this environment will cause national debts to explode. This is the Fed now trapped and this is what central banks are scared about. They have lost control and the old theories are collapsing. The desperate move is to tax money, eliminate cash, and go negative on rates but that too would compel selling of government debt producing the same net effect as raising rates – eventual monetization. Negative rates will compel the central banks to buy the debt when private entities will not while raising interest rates will explode the deficits. Either way leads to monetization. Manipulating interest rates is its only real tool. Buying in paper as in QE1 to 3 is indirect and there is no guarantee those who sell them the debt are domestic holders so the stimulus leaves.
This is the classic battle between DEFLATION and INFLATION. This is the essence of BIG BANG. Governments have become addicted to low rates that it has reduced their interest rate expenditures, creating a false sense of budgets under control. When rates start to rise, that is when capital will shift from PUBLIC to PRIVATE to get away from insane government debt. That is where rates would normally rise with no bid.
Yet, we may see central banks forced into buying government debt when no one else will both if rates went negative or explode and capital flees government moving to corporate debt and shares as began to emerge during the Great Depression after the sovereign debt default of 1931. That may soften the rate rise, but it will merely transfer the debt into monetization without interest, and that will produce the ASSET INFLATION that should emerge. That will not appear because of an increase in money supply, but because of a collapse in PUBLIC CONFIDENCE.
Every slice of the debt crisis exposes another layer of insanity. The real question becomes, how far do we go before this whole nightmare explodes in our face? It looks like we have 2 years perhaps, at best. This is the Sovereign Debt Crisis and the twists and turns are very interesting, to say the least. Those who focus on only one aspect will never see the whole. This global nightmare is not going to end nicely.
The impact in the pension funds further accelerates the mess. Here, pension funds chased long-term rates to match their maturities and that drove long-term rates lower. Some have run off to emerging markets desperately trying to get yield. An uptick in rates is needed to make them solvent yet most pension funds will lose money on the uptick because their current domestic paper will decline in value and those who bought emerging market higher yield will be slammed. This will force more people to invest in stocks as well. The emerging market debt issued in dollars will blow up, and as I wrote before, municipals in Germany are starting to issue dollar debt at zero interest rates trying to play the decline in the Euro.
Obviously, there are so many layers to this debt crisis you cannot focus on just one fundamental relationship. This is a convergence of many trends going wrong all at the same time. This is the classic flaw in analysis. The typical attempt is always to reduce everything to a single cause and effect. Every government investigation tries to lay blame on one cause. This is a fools game for events are NEVER the result of a single cause. You must see the world dynamically and this is why there are so few good hedge fund managers who can grasp the world and play the capital flows no matter where they lead. The person who can only discuss matters in domestic terms will never make the cut.
Municipals Squeezed Between Feds & State
In response to questions from a major U.S. city and the debt crisis, I will not mention the names for this is sensitive and highly political. I have decided to address the question, which I would normally do privately, only because a lot of municipal governments are in trouble in many countries. The same problems are cropping up in Europe as well as North America.
REPHRASING THE QUESTION: Specifically, they wonder if the potential implications of solving the problem as I have outlined in the Solution Conference might actually hurt the city instead of helping at the local level. As they explain, their community has been cut to bare bones and it can hardly offer reasonable services to its residents, if state or federal government starves it further. Their experience is that the state decided to fix its debt problem by starving and passing the buck to local communities, which is coming out of 3 ½ years of a state government emergency takeover. They argue that current residents are now paying for money that was spent before it was even received, or money promised in the past, which decades of previous governments never provided. The city of … is paying for city services today that were provided to citizens 20 to 30 years ago, but were never paid for then. The city of … seems to be barely surviving on some kind of federal funding programs that would be cut first in the event of a major crisis. They wonder how communities like … will survive if fixing the problem means leaving … and similar local communities to fend for themselves, with the burdens they already carry.
What this boils down to, is what your message would be for the local government in …, for local civil society, for local academics, and for the citizens of … generally? What role can they play? In a place where you can buy a house for between $6,000 and $20,000, where illiteracy rates are high, salaries are low, and even providing water as a public utility is becoming impossible. Is this something they can do?
ANSWER: Municipal levels of government are in a vice between declining budgets from the federal and state/provincial government levels. Raising taxes has only sent the higher class and business fleeing elsewhere. This is the exact same pattern that unfolded in the fall of Mainz during the 15th century. Arming police and increasing fines will only further ensure the demise of the city.
The Solution I have set forth is much deeper than what meets the eye. Eliminating taxes at the federal level terminates the competition for taxes between the state and local government v the feds. Taxes will then be implements solely by local government. Now, if we take my proposal and look closer, the funding of the federal government will be capped by a percent of GDP. Now, interest expenditures will exceed defense by 2020, even if we do not raise interest rates. We can see that up to 70% of the total national debt is accumulated interest expenditures. This did not benefit anyone but bondholders.
Ending the government’s borrowing will actually free up the cost of funding the debt for the betterment of society. Socialism has failed because they borrowed, and now the cost of that borrowing is absorbent.
Furthermore, eliminating taxation will bring jobs home. In the course of advising major multinational companies that were moving into Europe for the birth of the Euro, I placed a skilled worker operations in Britain for the cost of labor that was 40% cheaper compared to Germany. This was the tax burden, not merely wages.
If we eliminate the taxes, the net income retained by labor will increase and we will begin the process of restoring the middle class. This will be vital to restoring local communities.
The London Meeting to End Cash
The conference to tax money was held on May 18, 2015, in London at the Mandarin Oriental Hyde Park in Knightsbridge. I can only assume that the lack press coverage was deliberate, and intended to avoid sending panic to the people, which would lead to a massive bank run if people understood what these guys are discussing.
Of course the main two characters behind creating this new Age of Economic Totalitarianism are Kenneth Rogoff of Harvard University and Willem Buiter of Citigroup. Mainstream media coverage may have been non-existent regarding this gathering, but they have been cheering the demise of money in support of this new change.
The importance of eliminating cash is largely not discussed in any real depth. It is being marketed as one means to stop illegal trade in drugs and crime, such as terrorism. Yet there are financial, legal, and practical issues at stake here, which ends all privacy for individuals.
The mental-masturbation of economists advocating eliminating physical money is rather alarming. They see the zero lower boundary on interest rates as the point at which people will withdraw their money from banks and hoard it in a shoe box. Therefore, they still believe that lowering interest rates is the only direction. They propose that if currency were eliminated, nations could retain a zero inflation rate, and still get all the monetary stimulus it needs. This is truly an astonishing bit of reasoning, but that is why they are academics and not in the real world where they would be forced to watch how people react and move with trends.
Theses academics argue that nations (such as Japan) who are trying to raise their inflation rate, but are blocked by going negative because of concerns regarding the zero lower boundary, that there is only one direction and that is negative. These academics have been studying ways to eliminate the zero lower boundary on interest rates, trying to ascertain the costs and benefits of such policy. They argue that this is especially urgent, since increases in inflation are not easy to reverse.
The Pension Crisis – Illinois Tops the List in the USA
Illinois is now regarded as the worst state in the nation, with respect to the prospect of a collapse in state pension. On May 8, 2015, the Illinois state Supreme Court handed down a decision that severely restricts the ability to revise pensions. The court ruled that the Illinois constitution prohibits a 2013 bill that intended to address the pension funding gap. They cannot raise minimum retirement age, lower the cost of living adjustments, or place a cap on the base salary that serves to determine pension payments. This ruling effectively warns that Illinois has a major risk of moving in the direction of bankruptcy.
We will be issuing a special report on the Pension Crisis. This report will be included in World Economic Conference materials for all Princeton and Berlin attendees. Illinois is at the top of the list, but the others are not far behind. It will be available to everyone else at $300 shortly.
No comments:
Post a Comment