See No Evil, Speak No Evil

The Jackson Hole speeches of Janet Yellen and Mario Draghi last week were notable for the omission of any comment about the burning issues of the day:

…where do the Fed and the ECB respectively think America and the Eurozone are in the central bank induced credit cycle, and therefore, what are the Fed and the ECB going to do with interest rates? And why is it still appropriate for the ECB to be injecting raw money into the Eurozone banks to the tune of $60bn per month, if the great financial crisis is over?ⁱ

Instead, they stuck firmly to their topics, the Jackson Hole theme for 2017 being Fostering a dynamic global economy. Both central bankers told us how good they have been at controlling events since the last financial crisis. Ms Yellen majored on regulation, bolstering her earlier-expressed belief that financial crises are now unlikely to happen again because American banks are properly regulated and capitalised.

Incidentally, more regulation hampers economic dynamism, contra to the subject under discussion, and confirms Ms Yellen has little understanding of free markets. Mario Draghi, however, told us of the benefits of financial regulation and globalisation, and how that fostered a dynamic global economy. But a cynic reading between the lines would argue that Mr Draghi’s speech confirms the ECB is in thrall to Brussels and big business and is merely representing their interests. And he couldn’t resist the temptation to have a poke at President Trump by expressing the benefits of free trade.

Hold on a moment, free trade? Does Mr Draghi really understand the benefits of free trade?

That’s what he said, but his speech was all about the importance of regulating everything Eurozone citizens can or cannot do. It is permitted free trade in a state-regulated environment. It is a version of free trade according to the EU rule book, agreed with big European business, which advises Brussels, which then sets the regulations. It is a latter-day Comintern that allows you to trade freely only on terms set by the state for prescribed goods with other states of a similar disposition. Draghi’s speech was essentially justifying the status quo laced with Keynesian-based central bank dogma.

The Fed is clueless about the credit cycle

Let us return to the real issue at hand, the questions that went begging about monetary policy. More confident central bankers in control of their brief might have said something about it, if only in passing. But with Ms Yellen, we have a problem. If, as she claims, the Fed has cured America of financial crises, why hasn’t the Fed normalised interest rates already? Even on the US Government’s heavily-sedated consumer price index, inflation is at the Fed’s target, as are its highly-questionable unemployment numbers. Interest rates should already be normalised, which means they ought to be considerably higher than they are today.

As a rough rule of thumb, bond market investors in the past expected a free market to reflect the original rate, the real rate shorn of all lending risk, of two or three per cent adjusted for price inflation for medium to long-term government bonds. That indicates a yield level of four per cent or more on 10-year Treasuries, even on government inflation estimates. Meanwhile, the 10-year US Treasury yields only 2.15%, and the Fed funds rate is currently targeted between one and one and a quarter per cent. Something is very wrong.

Correction: everything about this is wrong. The statistics are self-serving and bogus, so you cannot judge interest rates by referring to them. But worst of all is something that goes unquestioned today, and that is interest rates are a function of the markets, not central banks. They cannot possibly know what normalised rates should be.

That’s why we have a credit cycle, born out of the central banking system’s guesses. Central banks always err on the low side for interest rates, partly because of the long-standing moral antipathy against high-interest rates and partly because of the Keynesian theology which accords with it. Over time, this suppression of interest rates has led us all into a global debt trap, because of the sheer size of it, which has accumulated to well over $200 trillion. That’s about three times global GDP.