Keynesians, which make up all of the economists you will ever hear from in government, academia and the popular media, religiously believe that money is a commodity and that the rate of interest is the price for that money. They further believe that the Federal Reserve Board controls the supply of the money commodity as well as the price, or interest rate, they charge for dispensing it to member banks. Liesman explained to me today that whenever the elitists at the Fed believe they need to stimulate economic growth they increase the commodity known as dollars and decrease the cost of those dollars by lowering interest rates. Then, according to the law of supply and demand, we will all grow wealthy beyond our wildest dreams.
Strangely, however, sometimes all of those reductions in interest rates and increases in the supply of money cause the economy to "overheat." The concept of overheating is never defined and based upon how they use the term I believe it means that the rate of economic growth they are witnessing as a result of their wise stimulative policies is higher than they believe it would or should be. In those cases they will raise interest rates and increase the supply of money somewhat more slowly. Why they allow the economy to grow faster than they wanted it to initially, given their omniscience, is never explained. Inevitably when the economy does begin to grow faster than they want it to (they call that inflation) they will blame profit seeking businessmen for it. It is not true but with socialists it is always a winning move to blame profit seeking businessmen for anything that goes wrong.
You may wonder why the Fed never decreases the supply of money You would think that decreasing the supply of money would be a great way to quickly cool off an overheating economy. But they never engage in that practice. They will tell you that doing so would immediately result in another Great Depression. They call it deflation and they worry about that more than anything. That idea is also economic nonsense. The real, and only, reason why the Fed will never decrease the money supply is because the federal government spends more money than it takes in via taxation. The real reason for the existence of the Federal Reserve Board is to create money to give to career politicians who continually spend more money than comes in in order to buy votes from those on the receiving end of their various wealth transfer scams. But that is another story and not the point of today's blog post.
Let's consider the two Keynesian fallacies listed above:
- Money is a commodity, just like wheat, oil or pork bellies.
- The rate of interest is the "price" that must be paid to buy (borrow) some money.
Money, on the other hand, has no intrinsic value at all. Its value is determined by the product or commodity it represents as a medium of exchange. A dollar has no value on its own. If you were stranded in the mountains in the winter time and needed to start a fire to stay alive you would set your money on fire well before you would set your down jacket on fire. The down jacket has intrinsic value whereas the money does not (except to produce heat when burned). When we describe something as being worth X number of dollars we are only saying that the exchange value of X would require a certain number of dollars before anyone would be interested in buying it. When you buy X from me I do not do it for the dollars. I do it for what I can then turn around and buy with those dollars. This is such a plain, simple and obvious point it is no surprise that it is utterly lost on career politicians, bureaucrats, media types and economists.
Since money is not a commodity and has no intrinsic value it necessarily follows that its supply is irrelevant in terms of exchange. It does not matter how many dollars there are as long as the supply of dollars is kept constant. That, of course, never happens. It also necessarily follows that an increase or a decrease in the supply of money has nothing to do with the creation of real wealth or economic growth. All that happens when the money supply changes is a requisite change in the value of the remaining dollars as they are exchanged for real tangible goods. More money decreases the exchange value of money and less money increases its exchange value. Therefore we can conclude that when the Fed adds dollars to the economy in an effort to stimulate economic growth it is not accomplishing any such thing. All that the Fed accomplishes when it adds dollars to the economy is to decrease the exchange value of the existing dollars and distort the process of exchange as market participants attempt to figure out the new ratios.
Although it is tempting to believe that the interest rate is the charge for using money, that empirical observation is not accurate. Yes, when you borrow money you will pay interest and, in a sense, that is a charge to you for borrowing that money. But the fact that you have to pay interest to borrow money misses the entire point about where the rate of interest comes from in the first place. The rate of interest (there is no single rate of interest as it changes every second in every place) is determined by the future orientation and time preferences of all market participants. When one person is willing to loan out his $100 to another person for 4%/year and another is willing to do the same for 6%/year we have an economy of four people and two transactions with an average interest rate of 5%. The rate of interest is exclusively determined by market participants. Furthermore, it is determined entirely by the long term orientations and time horizons of those market participants. Those who are willing to take a longer term time horizon will usually command a higher rate of interest. They do so because they will not have access to their money for a longer period of time and the anticipated payout to the person who has borrowed the money is also higher over a longer period of time. The opposite is also true. Short term loans will usually command a lower rate of interest. This explains why long term CDs pay a higher rate of interest than short term CDs. It also explains why you have a lower rate of interest on a 15 year mortgage compared to a 30 year mortgage. The same is true of all fixed income investments under normal circumstances.
All of this is to say that when the Fed artificially changes interest rates in vain attempts to either stimulate or cool down the economy it is utterly incapable of doing any such thing. The real rate of interest is established by market participants and it exists in the real world despite the Fed's attempts to mask or destroy it. Equally important is the truism that the real world eventually wins. All attempts by government elitists to manage the economy will eventually fail because they are not gods, despite their belief that they have god-like powers. They are incapable of performing feats that only God Himself is capable of doing.
The real interest rate in the economy of the Socialist Democracy of Amerika is not zero. There is no real interest rate of zero anywhere in the world because no person ever values a future dollar exactly the same as a present dollar. If I must wait a week for a dollar I am going to demand some interest. Hence, the zero interest rate the Fed has imposed upon this country the past six years has done nothing more than create a make-believe world in which it was hoped people would take advantage of the zero percent rate and spend themselves to prosperity. Spending ourselves to economic growth is, incidentally, another glorious Fed fallacy that I have addressed many times before. Does the Fed understand anything about economics? It sure does not seem like it.
Most market participants have been smart enough to realize that the fake economy of the Fed does not exist in the real world. That explains why the vast amount of free money created by the Fed's various stimulus packages over the past six years is still sitting in reserve accounts with the Fed. Banks haven't loaned those dollars out and nobody in the business world is interested in borrowing those dollars. Banks are not loaning out the dollars they have in reserve because the Fed is paying them interest to keep them parked in their accounts with the Fed. Since banks make money by earning interest on loans they have no incentive to make loans to the private sector when they have a guaranteed return coming from the government. The best thing the Fed can do is give up the charade and allow rates to rise to their real level. Since that will never happen the next best thing it can do is start raising rates now. The more rates are allowed to reach the real rate of interest the more likely we will experience real and robust economic growth. Rising interest rates, by the way, also do not hinder the stock market.
Will the Fed's activities impact the stock market? Of course they will. They will do so because most market participants stupidly believe that the Fed actually has an impact upon economic growth. But over the long term all Fed watching is a waste of time. The real economy always wins. If you want to be a successful investor you must be a long term investor and you must ignore everything you hear from all government agents like the Fed, as well as their media lackeys.
Update: September 18, 2015
To the surprise of some the Fed decided to leave interest rates at zero percent yesterday. The stock market originally rose dramatically and then it sold off dramatically before the close. Today the stock market has sold off dramatically. All three moves the last two days have been attributed to the Fed. Does that sound like insanity to anyone besides me? The worst thing about the decision is that we will have to go through this all over again in late October. What a waste of time and energy it all is.