The financial industry, most of the time, operates under false pretenses. The business of true capitalism is to destroy them. The two are natural enemies.
“Central banks seek to unblock markets,” reported the Financial Times on August 12. The gist of the story was that the financial industry seemed to be having something akin to a cardiac infarction and central bankers, rushing in like heart surgeons from the golf course, were attempting a bypass. If successful, we were led to believe, Bernanke, Trichet and the lot would get their mugs on the cover of Business Week and TIME, and soon join the great assembly of capitalism’s saints.
In fact, what the bankers were up to was the exact opposite of what the FT reported. At the end of that week and the beginning of the last one, central banks all over the world were engaged in a vigorous attempt at price fixing and market manipulation; that is, they were trying to block markets from doing what they needed to do.
As we mentioned two weeks ago, no man worships capitalism. Instead, if he has any sense, he fears it… and aims to put a stop to it as soon as he is able. In any economy, mistakes are made. People invest in projects that don’t pay off. They pay too much for a stock. They lend to people who can’t pay the money back. If these errors were to go unpunished, the mal-investment and misallocation of resources would continue. Eventually, the whole shebang would collapse into a heap of unwanted products and un-performing assets. That is why we have corrections… bear markets… and panics; they are an economy’s equivalent of natural selection, eliminating the weak and unfit.
The key variable in capitalism is the cost of money – the interest rate, which establishes a “hurdle rate” against which to judge all financial transactions. It is the natural environment in which capitalists must survive. If a new project will return 5% per year and the cost of money is 6% per year, the proposed investment doesn’t make it. But if the cost of money drops to 1%, all of sudden even the most absurd and clownish investments get to reproduce. Soon, the world is full of them.
In a free market, the ‘hurdle rate’ is set like all other prices – based on supply and demand. But central banks meddle with interest rates – typically pushing down on the short rates, and thus lowering the hurdle rate for all borrowers. In fact, most of the freaks now crowding the financial world are the spawn of central bankers who held down rates too low for too long.
Corrections can take many different forms. Occasionally, speculators panic; they stop worrying about the return ON their money all-together; instead they fret about the return OF their money. Then, it becomes hard to borrow at any rate.
Over the last few weeks, capitalists have become edgy and disagreeable. Lured by an artificially low lending rate, maybe they lent a little too freely. Maybe they spent a little too much. Maybe their speculations weren’t as good as they thought they were. Mistakes were made; they needed to be corrected. As a result, markets began to wobble. Stock prices came down, with more than a trillion dollars trimmed from US stocks alone. And credit markets began to constrict; banks on both sides of the Atlantic were stuck with nearly a half a trillion dollars’ worth of corporate loans that investors refused to take.
These were the facts when, on the ninth of August, the capitalist cops were doing their job. They were beating up homeowners who had bought houses they couldn’t afford. They were taking their cudgels to the lenders too…and to CDO speculators, hedge fund players, imprudent bankers, and whiz-kid mathematicians. And once their blood was up…they were whacking away at everyone who came into range – including stock market investors, pension fund managers, City investment banks. Rich, poor…smart, stupid…they were giving them all a good thrashing.
But then, along came the central bankers.
On August ninth and tenth, the Bank of Japan, the European Central Bank, the Bank of Canada and the Fed all began to intervene. One report said the ECB had ‘injected’ US$215 billion into the system. Others said the Fed had put US$38 billion to work. By Monday, the Bank of Japan and the ECB were still at it…colluding to knock down the hurdle all together. The BOJ put in another US$5 billion, which was already having a “calming effect” on Asian markets, said the papers. On Monday, too, the ECB put in another 47.7 billion euros.
Whatever the final numbers turn out to be, it is a lot of new money in a short period of time – more than at any time since the days immediately following 9/11 in 2001. Lending by the New York Fed was so vigorous that the fed funds rate fell to the lowest rate since 2004.
The purpose of all this lucre was said to be to provide “liquidity”. What is liquidity, you may wonder? Lo…it is the same cheap money that got markets in trouble in the first place! It is as if they had opened a new mortgage lender in Santa Ana, California, offering no-money-down, teaser-rate, no-document adjustable rate mortgages.
If we’re lucky, borrowers won’t fall for it and the cops can get back to work.
Markets and Money