Now there's a headline which would make quite a few people spray their morning cup of coffee all over the kitchen (or the computer screen). Whatever could it mean? Well, as you may know, both the US and Japan have had negative REAL interest rates for some time now, their official interest rates are BELOW their annual increases in price inflation. On June 5, the Europeans lowered their official rates to 2.0%. The latest European inflation number is 1.9%. Europe now has a REAL interest rate which is effectively ZERO.
This is a phenomenon which is NOT getting the ink it deserves. In fact, we haven't seen it get much ink at all. We go into it in detail in the early June issue of The Privateer (#477 - Published on June 8). Suffice it to say here that the three most important currencies in the world, the three currencies in which EVERYONE has a stake and in which almost ALL world trade is conducted, do not offer ANY real rate of return on investment.
Remember the long-standing "reason" why owning Gold is a bad idea - that it offers no rate of return? Well now, neither does the Dollar, or the Yen, or the Euro.
If the situation wasn't so potentially financially deadly, it would be screamingly hilarious. Japan has been in recession for nearly a decade and a half. The US has a manufacturing industry (the part of the economy which actually makes things) which has lost at least 60 years worth of growth. And Europe (especially Germany) is widely billed as facing the closest thing yet seen to 1930s depression levels of economic activity. Japanese government debt has passed 150% of GDP and is rising fast. US government debt is rising even faster. Anglo-Saxon and Japanese "economists" are urging Europe to scrap their 3.0% deficit limit
But according to the interest rates in these three economic bohemoths, there is no risk whatsoever to holding their currencies. There is no risk component built into their interest rates. In fact, nothing (except rampant manipulation and wishful thinking) is built into their interest rates. In real terms - THEY DON'T EXIST.
It is, of course, a fact that interest rates are one of the least understood phenomena in economics. An interest rate is (or should be), in essence, the physical expression of the truism that a present good is valued higher than a "future good". Austrians call this the "originary interest". For a lender, an interest rate compensates an individual for giving up the ability to acquire goods now by lending a portion of his saved capital. For a borrower, an interest rate reflects the fact that he does not have the capital to procure a present good and can only get it by borrowing it from someone who does. Again in essence, an interest rate is supposed to reflect the fluctuations between the supply of and the demand for capital.
All this, of course, subsumes a MARKET economy, an economy where "capital" is not created out of thin air and an interest rate is not merely a number at the mercy of those who inhabit the Central Bank. Unfortunately, none of us has any contact with a market economy, so capital is created at whim and interest rates are manipulated to get us to borrow it.
Today, most capital is borrowed to obtain consumer goods. But when capital is borrowed for investment, to create capital goods and thereby increase wealth, additional components become more important in the interest rate picture. Austrian economists speak of the "entrepreneurial component" of the interest rate, which is the portion of the rate which reflects the judged credit-worthiness of the borrower. They also talk about the "price premium", which is the portion of the rate which takes into account the possibility of future fluctuations in the purchasing power of the currency in which the loan must be repaid.
On the capital markets where interest rates would be derived in a MARKET economy, the rate is the total of the originary interest, the entrepreneurial component, and the price premium. The longer-term the loan, the more the second and third component enters the picture as RISK increases. In modern "money markets", interest rates are either derived by decree or "massaged" by Central Bank action. Now, with real interest rates at or below ZERO, "risk" is generally regarded as an outmoded concept, something like a "market economy".
It is precisely at such times that REAL risk is at its highest! Japan, the US, and now Europe have removed ALL impediments to borrowing. The nation at highest risk from this is the US, simply because Americans are much more prone to borrowing than are either the Japanese or the continental Europeans. Japan, the US, and now Europe have made the servicing of existing loans as "cheap" as it is ever going to get. Again, the nation most at risk is the US because their combined (internal and external) debts are the highest.
When the US divorced the Dollar from Gold in 1971, all discipline confining the borrowing and spending practices of governments was withdrawn. When the Fed hauled interest rates down from almost 9% to 3.25% between 1990 and 1992, the US private sector decided that what was good enough for government was good enough for them and the US savings rate started its journey towards ZERO. Now, the legacy of three decades of profligacy has reached the point that to sustain the present debt burden, it has been deemed necessary to reduce real interest rates to ZERO.
There is no incentive to save, there is no incentive to invest, there is no incentive to correct the decades of malinvestment which the debt orgy has created. In short, there is no incentive except to eat what remains of the seed corn.
The ultimate fate of every nation in history which has (literally or figuratively) eaten its seed corn has been the destruction of its medium of exchange, its MONEY. Except for a short interlude in 1994, the last time that the US had ZERO or negative REAL interest rates was in late 1979-early 1980. That came with the near extinction of the US Dollar, and the only cure was to leave interest rates to market forces, which forced them up to 20% plus levels very quickly indeed.
In stark contrast, with the ECB rate cut of June 5, a huge sigh of relief was felt around the world. The reason for this was the conviction that NO major nation would be RAISING its interest rates for a LONG time to come. But without higher interest rates to provide an incentive for REAL savings, investment, and CAPITAL ACCUMULATION, no "recovery" from the present economic malaise affecting Japan, the US, and Europe is possible.
No, currencies have not been "cancelled". But all impediments have now been finally removed for their continued creation out of thin air. The point is nearing when the lack of any incentive to hold such currencies will start to weigh heavily.
The efficacy of Gold as a medium of exchange lies in many factors. It cannot be created out of thin air. It is impossible for governments to rule and distort markets by decree when Gold acts as the money. When governments DO attempt to do this, they ALWAYS remove Gold from its monetary role. Then, it provides an escape from the ultimate destruction of its replacement as a medium of exchange.
Economic history is replete with the detritus of "cancelled currencies". It is one thing for governments to hold interest rates at a level below where they would have been without their interference. It is quite another thing to try to deny that the future is uncertain by doing away with interest rates altogether. In such a situation, the one certainty is that the longer it is maintained, the closer the currencies so affected are to being (to use the term euphemistically) "cancelled for lack of interest".