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Are Interest Rates Evil?

Aug 14, 2018

27

POITOU, FRANCE - "Do you follow what is going on in Turkey? That guy is a real moron..."

Thus began a conversation at a party we attended last night.

Reuters provided some background:

  • The Turkish lira has long been falling on worries about Erdoğan's influence over monetary policy and worsening relations with the United States.

    On Friday the currency dropped as much as 18 percent at one point, the biggest one-day fall since a 2001 financial crisis in Turkey.

"That guy," we later realized, was the president of the country, Recep Erdoğan.

Meanwhile, America's number one guy, Donald J. Trump, did not rush to Erdoğan's aid. Instead, he whacked him hard in a tweet that flabbergasted everyone:

  • I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!

That ought to help!

Now, The Donald's trade war includes a currency war.

And Erdoğan fought back, giving like for like. That is, he came back with a pile of irrelevant nonsense:

  • Don't forget this: if they have dollars, we have our people, justice and God. We will come out of the economic war successfully.

But wait... What sense does any of this make? Why declare war on countries whose currencies go down? What is the U.S. president doing interfering with markets and stirring up trouble?

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Strongman President

More context:

Erdoğan is a "strongman" president, recently sworn in for a five-year term with enhanced powers. Among the enhancements was the right to control the central bank by appointing its directors.

The trouble with strongman governments is that they are no better than the "strong men" themselves.

Alas, they are human, subject to all the weaknesses to which flesh is heir. With the possible exception of Frederick the Great and Lee Kuan Yew, they almost always turn out to be morons... especially in modern democracies.

And for an obvious reason: The strongman leader can only incite the support of the masses by dangling a gaudy fantasy in front of them.

Free money is almost always part of the promise. Nobody sells a weight-loss book that tells people to eat less. Nobody sells a financial program that tells them to work hard and save their money.

And neither Erdoğan nor Trump got into power by offering restraint, modesty, and pay-as-you-go government.

Donald Trump is famously a "low interest rate" guy. While he said he wouldn't interfere with the Fed, he made it clear that honest interest rates were not something he was hankering for.

For the moment, he has nothing to worry about. Stocks are still very high. And interest rates are still very low.

The inflation number we got last week showed consumer prices rising at 2.9% year-over-year. The Fed funds rate is now 1.9%.

That means that with a 2.9% Consumer Price Index reading (which probably significantly understates inflation), the Fed is lending to member banks at a real rate that is nearly 100 basis points below zero; that is, nearly a full percentage point below inflation.

Our guess is that in the next crisis, even that will turn out to be too high.

Indoor Plants

Here's a prediction...

When stocks plunge and the economy goes into recession, Donald Trump - like Richard Nixon and George W. Bush before him - will blame the Fed. And he'll be right.

When you've put your economy in a hothouse of negative real interest rates for more than a decade, the delicate plants can't survive out in the cold. They're indoor plants now.

So as the Fed makes its classic Mistake #2 (raising rates after leaving them too low for too long), Mr. Trump will be fully justified in saying that the Fed is causing the next crisis.

When it comes, he will then call upon the Fed to reverse course and cut rates, which, of course, it will do promptly (Mistake #3).

But then the Fed will be in a jam. Because while it is fully committed to providing aid and succor to America's strongman president, it is also charged with keeping a lid on inflation.

That was easy to do when the inflation rate was below 2%. But now, the rate appears to be going up.

Fed governors are already preparing for the inevitable. Chicago Fed president Charles Evans, for example, says "...2.25% would not be troubling at all, and even 2.5% as long as that is expected not to accelerate, could well be consistent with symmetry of our 2% objective."

But 3%?

The Fed will hesitate - at least for a moment - before lathering on the grease.

No-Interest Guy

Turkey enjoyed low interest rates, too, and borrowed - in dollars - to fund infrastructure projects, among other things. But Turkey doesn't print dollars. So paying back the loans can be tough... especially as the lira - the Turkish currency - goes down against the dollar.

The Turkish government and Turkish companies earn their money in lira. As the lira goes down, it becomes harder and harder to make the loan repayments. So, fearing a default, investment capital leaves the country and drives the lira down further.

Look at the problem for Erdoğan's central bankers. The Turkish lira has lost 35% of its value over the last 12 months. The natural and normal thing for the bank to do would be to raise rates to defend its currency.

But while Donald J. Trump is a "low interest" guy, Erdoğan is a "no interest" guy. He says interest rates of any sort are "evil" and calls himself the "enemy of interest rates."

Lending money at interest is a no-no to conservative Muslims. Instead, lenders have other ways of making money - such as charging fees for services rendered.

But a modern central bank typically manipulates interest rates to get the outcome it wants. When a currency sells off, rates should go up. But the strongman always wants rates low - to finance his visionary program.

Usually, he gets it.

And the country gets it, too - good and hard.

Regards,

BILL BONNER Founder, Agora Inc
Bill Bonner, Bonner & Partners
Vivek Kaul's Diary

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Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "Are Interest Rates Evil?"

Ramesh Gopinath

Aug 15, 2018

Nice info on Equity and interest rate.

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