You can often hear proponents of the ‘Austrian’ school and others on the ‘right’ calling for the market to set base interest rates. This bizarre call is a non sequitur – meaningless.
The market is made up of both buyers and sellers and their interests are necessarily conflicting. The market does not ‘speak’ with one voice; by definition, it cannot. How can it set anything?
It is like asking a field of runners halfway through a race to come to an agreement on where the finish line should be…
Of course the market can’t collectively determine anything. Firstly, when the market ‘speaks’ it is the preponderance of individual views of within the market. When the market ‘speaks’ it is the result of something; it is a reaction; the exact opposite of being the cause of something.
Secondly, for communication to convey meaning it has to be the result of some form of reason. For the market to actually express a meaningful point of view it would be necessary for it to consciously arrive at a point of view, enunciate that point of view and stick to it.
But the market changes, literally from second to second because the balance of forces within the market changes from second to second. Even if you were to somehow accept the idea of ‘speech’ from the market, you have to accept that the meaning of that speech will change in a couple of seconds time. Even if you try to argue the market has a mind, you have to accept that the market can never make that mind up.
Because although the buyers and sellers who make up a market are supposed to be rational agents expressing their own rational self interest, the cumulative consequence of their actions is not. These are the ‘animal spirits’ of ‘fear’ and ‘greed’ that everyone agrees the market expresses.
Market religion claims that by means of alchemy the market changes base instincts into what is best for everybody inside and outside the market. Somehow something even better than considered reason appears spontaneously!
The market cannot speak because it cannot have an established continual rational point of view and it cannot create a rational point of view because it is made up of conflicting impulses. If there was no such conflict it wouldn’t be a market.
It does not matter whether it is a pre-centralised system of private banks or a modern central bank system, a rational market ‘mechanism’ to set base rates is impossible.
It follows from this that if base interest rates are to be set for any given period, they have to be presented to the market in advance by somebody outside the market, working to some kind of rationale. And every nation and collection of nations operates on this basis.
So what is behind the call for base interest rates to be set by the market? The main reason given is that interest rates are seen to be all going one way. Since the Credit Crunch and the implementation of ’emergency measures’ central banks have followed a Zero Interest Rate Policy.
Of course, it is becoming harder and harder to see ZIRP as an ‘emergency’ measure after seven years or so. Direct government dictat has the consequence of shredding the rhetoric of supposed central bank independence.
And ZIRP disguises a secular decline in interest rates that has been taking place in the Anglo Saxon economies since the 1980’s. Economists on left and right have no way to explain this outside of tautology: Interest rates are low, well…. because interest rates are low.
I argue that base interest rates are proclamations made by an authority, be that authority elected government officials or ‘independent’ central banks.
The interest rate setting authority makes a proclamation; sometimes characterised as an offer depending on how you wish to portray it. Depending on how many individuals take up that offer, the issuing authority amends the offer next time, this is the market reasoning justification for the system.
If an increasingly large number of people take up the credit offer at a given interest rate the interest rate is increased to stem the ongoing flow of credit applications. If a decreasingly small number of people take up the credit offer at a given interest rate, the interest rate is decreased to stimulate the flow of credit applications.
You might ask: Why don’t authorities amend the interest rate from hour to hour or even minute to minute – why do they only change the interest rate quarterly?
The answer is they need time to collect, collate and process the information. Because their decision is supposed to be based on reason to some extent. You might not agree with their reasoning, but you wlll see that if a central bank announced that base interest rates will be 1.5% for the next hour based on a ‘hunch’, the economic system it was set up to administer wouldn’t last for very long!
In other words the system we used to have and the system as it is now are not the result of arbitrary choices, they operate at the exact limit of development allowed by politics and technology at any given time.
Since the system is not really open to arbitrary change what does that say about the decisions that the system makes? It means that the decisions it is making at this time are the only possible decisions it can make given the limitation of politics and technology. If we understand the constraints of politics and technology we can understand what the decisions have to be.
With this in mind, we should address the fact that the main decision of central banks seems to be not to make any decision. Interest rates are effectively at zero and staying there. We have the quarterly ritual of: ‘Will they, won’t they move off ZIRP?’ and the answer so far is always no.
This is problematic for me as I have argued that moving towards a new baseline average interest rate of 2.5-3.5% is the next step in the implementation of Democratised Money. I have also argued that international exchange rate blocs are a fundamental requirement for the international framework for Democratised Money. And neither of these things has happened yet.
It is possible that the delay in normalising interest rates and creating exchange rate blocs is linked to the Pacific and European TTIP agreements. Trade blocs like Pacific and European TTIP are an inevitable part of the Democratised Money world. It could be that nothing else will be done until they are both securely in place. Now that the Pacific TTIP is moving forward again, the increase in interest rates and exchange rate blocs will be implemented.
But I think there is another reason for continued ZIRP and it comes from the internal ‘logic’ specific to this exact time and place.
All central bank rate setters, be that the Federal reserve, The ECB or the Bank of England are ‘democratic’ to the extent that they vote to decide about where to set base rates but that is as far as the democracy goes.
Nobody elects the members of any central bank committee, they are there by appointment. So they cannot claim any democratic mandate per se. The justification for being there is actually an inversion of a democratic argument.
Independent central bank advocates argue that political control of base rates by an elected official is detrimental to market confidence in that rate. The rate setter needs to be able to operate independently of democratic ‘pressure’ e.g. pressure from electorates. Democratic voting is the method by which rates are arrived at, but technocratic reasoning is the justification.
But this line of argument presents certain problems.
The post 1970’s call for independent banking was justified by the Monetarist shibboleth of inflation. This was supposed to be the one and only overriding consideration. Monetarists claimed that if inflation was under control and the money supply regulated all would be well. But as the Credit crunch and resulting QE opened the door to direct political interference reasons had to be found to provide cover for and justify direct interference. And so the mandate of central banks was modified to include macro-economic ‘stability’.
When the situation was ‘stabilised’ to some extent it was suddenly found that central banks also needed to target unemployment and so interference would have to continue.
When employment seemed to recover somewhat, central banks discovered that broad economic growth must also be added to their macro economic mandate.
When growth seemed to recover somewhat central banks discovered the ‘productivity gap’. When it became apparent nobody really believed in the productivity gap or understood what it was, central banks discovered the threat that interest rate rises posed for developing economies and that is where we stand today.
The specific logical conundrum is this: If central banks are indeed identifying problems and fixing them as they claim to be, then they either have to find new problems to fix or to stop interfering in the market at some point. On the other hand, if central banks are identifying problems and not managing to fix them, then something is seriously wrong with the central bank system itself.
The upshot of this is that insurgents continually claim that central banks have failed to solve any of the serious macro economic problems. The establishment claim that they have solved a number of problems and are effectively managing the new ones that always seem to be appearing.
But what unites establishment and insurgents is the claim that central bank interference in the economy is somehow voluntary and limited. The establishment claims that the central banks will stop interfering at some point in the future because they will have fixed all the problems. The insurgents claim that the central banks interfere because they want to protect their fraudulent ponzi scheme etc.
But I argue that Monetarists have no choice but to interfere to in order to protect democratised money. Once the creation of privately issued money began, everything else that followed was inevitable.
The purpose of QE and ZIRP is to defend and promote the growth of privately issued democratised money. The Fed and the Bank of England cannot and will not stop with emergency measures until they believe that derivatives are completely integrated into the global financial system in a way that means they can never be removed.
It is this imperative to protect democratised money that has been the real reason behind the ongoing interference in money markets. It is this imperative that is the logic behind QE and ZIRP. And it was the belief that the project of irreversibly integrating democratised money has largely been achieved that led to the recent hints of a rise in base interest rates in America and Britain.
But the Fed cannot bring itself to pull the trigger. They are trapped in their own logic.
By citing an increasing number of different reasons for intervening, the central banks built for themselves a new group of constituencies. Effectively Inflation, GDP Growth, Unemployment, Productivity gap and Developing economies all represent constituencies that the central bank committees have come to claim to represent. And this is the argument that has largely been successful in justifying the central bank approach to the markets. It is a polygamous marriage of convenience. But to raise interest rates will undermine the interests of this collection of constituencies and bring to the fore the question of what the purpose of the central banks actually is.
This is the reason central banks are reluctant to begin raising interest rates. They cannot say they have fixed the central problem and ‘new normalise’ base rates without saying what the problem they have fixed, is!
The collection of constituencies that central banks have gathered together as a justification and cover for the democratised money project has proved to be very useful. But at some stage there is going to have to be a parting of the ways and at that moment a lot of people are going to be asking the central banks: ‘Did you ever really love me?’