The Big Bear

The problems we face today come from an attitude that there is such a thing as a “free lunch.” Though the majority of the people may endorse it, rarely do those who seek a free lunch bother to ask who ends up paying for it. It is not just the poor who are looking for a free lunch, the rich do so as well. It’s called welfarism. Endorsing the use of aggression to achieve this redistribution of wealth is acceptable for those who believe they’ll benefit from it. Generally that’s the majority of people.

Some know that the principle of welfarism is a scam and that one group – the recipients of the free lunch – will benefit at the expense of another – the producers of wealth. Others believe it to be moral and the only way society can care for the poor and therefore they endorse government force to redistribute all wealth in a “free and equitable” manner. They ignore the challenging question as to who will produce the wealth to be passed out. Economists like Paul Krugman belong to this group.

If we give Krugman and his philosophic allies the benefit of doubt, the main selfish motive that drives their efforts is an intellectual need and gratification that their views must never be abandoned or it will be seen as an admission of mistaken economic and social theories.

It is this intellectual stubbornness to prove they are right, regardless, that has driven our economy, and much of the rest of the world’s as well, since the 1930s Great Depression. The current fragility of the world’s economy is a consequence of that policy. Understanding the cause and effect of central economic planning, especially with the emphasis on central banking and fiat money, is required. If sound economic growth is to be restored, certain principles must be understood and followed.

One of the most important economic items to contend with is the need for a market rate of interest. This must replace the silly notion that the Federal Open Market Committee or even the Chairman of the Federal Reserve alone is so all wise that they can know what the rate of interest should be to regulate an economy. This one policy, of manipulating interest rates to a lower-than-market level, has caused great harm to the economy, and the full effects of pretending our money managers have the wisdom to know what the proper rate should be – especially since the 2008 — has not yet been felt.

The consequences will not be minor. Surprises will be many since we are in uncharted waters and the world has never faced the gross misallocation of capital that exists today. The process is self-limiting. It will come to an end. And it’s not going to be far into the future.

Interest rates, which are the cost of borrowing money, when set by economic authoritarians, are literally price-fixing. Fixing prices fouls up the machinery of a smooth running economy. Interest rates have a pervasive influence on all economic transactions. Fictitious interest rates assure that accurate economic calculation is impossible. While it may seem to work for significant periods of time, the results are fragile and vulnerable, requiring corrections to restore true economic growth.

Capital in a free market comes from savings, not from a central bank creating credit out of thin air. This in itself is inflation regardless of what government optimistic reports of the CPI claim.

The Central Bank’s ability to plan the economy in this manner is a fiction and only leads to problems that overwhelm the markets, eventually wiping out the middle class.

The credit and new money when created by a central bank is delivered to the market in a political fashion for which the 1% receives special benefits. It allows the pyramiding of debt through fractional reserve banking, which compounds the long-term problems. It may be fun while it lasts but it always ends with a crash.

The system enables the politicians to be totally irresponsible in fiscal affairs with no restraints on deficits, as the Federal Reserve monetizes all debt as the crisis worsens. This involves excesses in domestic, foreign, private, and sovereign debt.

The planners deliberately deceive the people while others truly believe that rigged price measurements, such as the CPI, assure them that no crisis is pending. Besides if the CPI rises higher than they think is desirable, the solution is simply and foolishly to bring on an economic slump to lower prices. A deliberate economic slowdown as practiced by central bankers is never required in a free market economy. If the rate of inflation is too low, according to their theories — say less than 2% — the solution is easy for the planners. Everybody including the government officials are told to spend more, borrow more, print more, and bailout all those entities that are “too big to fail” — and anyone else in need. There’s only one problem. This nutty solution hasn’t worked over the past six years. Yet from the planner’s view, the 2009 crash was curtailed for the big banks and the large corporations, while the 93 million underemployed sank deeper into economic malaise. We now have a labor participant rate of lower than 63%.

Keeping afloat a flawed economic system such as ours occurs for several reasons. We have been and still are, compared to others, a very rich nation. It takes a long time to squander huge wealth.

Confidence in the markets is a major factor, even though manipulated. Compared to others around the world we still look good. Being able to issue the reserve currency of the world has allowed the United States to export many of the ill effects of inflation.

Our military might allows us to intimidate others and force them to obey our commands. When they do, we just print up more money and reward them with financial assistance. If they disobey, we freeze their financial assets, place economic sanctions on them, and threaten them with military force. If our interfering in their elections fails to succeed in placing “our guy” in charge, we merely support regime change and look for another puppet.

Our policies are carried out in the name of American “exceptionalism” and a supposed need for a “good” world superpower to police the world against the international evildoers.

This process and today’s circumstances have allowed the United States sovereign debt and private debt to exceed all rational expectations of any period in history. This is about to end.

We have enjoyed tremendous benefits from being able to issue the reserve currency of the world. But today there is much talk of an alternative currency replacing the dollar. Already we see the Chinese paying Russia for oil purchases with the Chinese yuan. It could very well be the ushering in of the petro-yuan which will replace the petro-dollar.

How we got here and where we are going

The motivating factor has been the acceptance of welfare transfers to both rich and poor. Modern day Keynesian economics has taught several generations that paying for this transfer system should be of no concern. Their belief is that debt and monetary inflation can handle the problem with smart money managers without inflicting a cost on the people. Those who know this is a lie support the policy for selfish reasons.

To their great dismay the economic planners have run into multiple unintended consequences. They build an economy on sand and destroy the foundation on which a free market system is built. All the markets have been distorted. Bubbles have come and gone yet continue to develop. Excessive government growth is an obvious consequence of such a system. And as has happened so many times throughout history, liberty is diminished in the process. This type of system, built without concern about productivity and free markets requires corrections called recessions and depressions to erase the mistakes that are characteristic of all central economic planning. The planners, who never admit a mistake, will not change policy but instead will place all the blame for the downturns on too much freedom and not enough government regulations and spending.

The tragedy of course is that when the corrections come, they are very painful and injure some groups much more than others. The middle class gets wiped out as the poor demand more benefits while the rich reap the rewards of a monetary system designed to protect those who claim they are too big to fail. This includes special interests like the military-industrial complex, which could not exist without a system of debt, financial bubbles, inflation, and an aggressive foreign policy.

There are many signs on the horizon today that a correction much bigger than that of 2009 is on the horizon. The size of the world debt is unbelievably huge. Despite the government reports, the economy remains very weak worldwide. Inflation, though denied by the government, is significant both as measured by the money supply as well as by the cost of many products. There’s little doubt that this process has motivated many to anticipate the serious changes coming.

The reports that are worth paying specific attention to are: interest rates, the dollar price of gold, stock markets, but most importantly the bond market. There are many warning signs of the danger lurking in this market that Washington politicians and central bankers refuse to see as a problem.

For the most part in the last 100 years recessions and depressions were brought on by the Fed deliberately raising interest rates. Markets however can force interest rates up even if the central bank tries to hold interest rates at 1%. Today were seeing signs that the 35 year bond bull market has ended. If this is true it will prove to be a huge event, not only for the US economy, but for the world economy as well.  

This bull market in bonds started in September 1981 when the 10 year bond interest rate reached slightly over 15%. Ironically at that time nobody wanted them. At the beginning of the bull market in bonds in 1981, short-term rates reached 21% and mortgages were as high as 16%.

But under today’s circumstances how much higher can bond prices go since the government and the Federal Reserve have manipulated interest rates down to barely more than 1%? When inflation is taken into consideration, it’s less than 1%. But there have been signs in the past couple years that the exuberant bond market is coming to an end. Just possibly the beginning of the bear market in bonds occurred on June 1, 2012, when 10 year treasury bills reached 1.44%. Since that time they have been lingering and trying to show that the bull market is over and a bear market has started. Interestingly now when these bonds are not much of a bargain everybody seems to be wanting them. Even a year after the rates hit 1.44% by April 2013 they were still as low as 1.67%, and almost 2 years later in February 2015 they were still under 2% at 1.68%. Demand has remained high as one would expect in a bubble.

Obviously individuals who buy 10 and 30 year government bonds  aren’t actually “investing” in them but merely parking their cash for hours or maybe a few weeks. Government bonds are not seen as a wise investment to provide a nest egg for your children or to send them to college at a later date.

Today however, the interest rate for the 10 year bond is 2.4% and the odds are that we are more likely to see a 4% rate than a rate below 2% again. Though the Federal Reserve has tremendous power and influence over the markets, there is a limit and the market can overwhelm the Fed’s plans. Just as our government has in the past tried to fix the ratio between dollars and gold and print as many dollars as they pleased, eventually the market took over and assured that the ratio reflected a market value. This was obvious when the Bretton Woods agreement broke down and gold went from $35 an ounce on its way to $100 and even $1200 and higher.

Inflation, i.e. the increase in the supply of money and credit by the Federal Reserve, will inevitably lead to higher interest rates. Though inflation of the money supply is unbelievably high, the markets have avoided an inflation premium under today’s conditions since many investors believe the Fed is capable of increasing the price of a bond for an indefinite period of time. Likewise the same sentiment is recognized in the stock market. They believe the Federal Reserve along with the Plunge Protection Team can indefinitely prop up the stock market as well. But knowledgeable people realize that these bubbles are never permanent and eventually they will burst. And it just may be that that day is not far off. A race to the exits by both bonds and stocks holders will be a gigantic event.

Most likely it will be the breaking out of interest rates on US sovereign debt, in spite of what the Fed says or does, that will convince the government optimists that their policies have been a total failure.

At the present time most of these economic planners have convinced themselves that they are a lot smarter than their critics claim. They point to the “success” of their efforts to contain the debt crisis of 2009. Instead of providing a solution, the money managers have only delayed the inevitable correction that must come if we’re ever to see true economic growth again.

My suggestions are these: Keep an eye on the price of gold. Watch for a spike in interest rates, especially for the 10 year U.S. Treasury bond. Anticipate the beginning of a sharp correction in the stock market. Look for a sharp fall in bond prices associated with panic selling. Another QE may be tried but will not restore confidence the next go-around. The money lost in the coming bear market in bonds will far exceed the very big losses that will occur in the stock market. Turmoil will surely come to Wall Street and beyond.

My assessment

The 35 year bond bubble has ended. No more 10 year treasury yields below 2%. A bear market in bonds will last for a long period with inexorable increases in all interest rates. This will lead to stock market chaos along with exacerbating the current great recession in an environment of a very fragile economy. The Federal Reserve will lose control. The dollar will remain under attack and will eventually be replaced as the reserve currency of the world, a process that has already begun. The great fiction that the creation of debt is equivalent to money will no longer remain credible. 

Federal Reserve policy removed gold and silver as the monetary reserve and replaced it with a promissory note issued by our government to pay in another promissory note of less value. The fractional reserve system and the pyramiding of debt that has been a driving force during this 35 year bull market in bonds, with abnormally low interest rates, will be reversed. It will then be necessary for the current monetary system to be replaced by a new monetary order based on honest commodity money and elimination of the fraudulent system forced upon us in 1913. Defining this replacement in a positive manner should occupy our attention in order to promote peace and prosperity.