When The Price Of Money Is Zero---Sharpies Can Get Away With Almost Anything

By Bill Bonner

When we left off yesterday, we were explaining how the feds had unlearned the three critical lessons of more than 2,000 years of market history:

1) Make sure the money is backed by gold (otherwise it loses its buying power).
2) Don’t let the government spend too much money it doesn’t have (otherwise it will cause havoc).
3) Don’t try to centrally plan an economy… especially not with fixed prices (or you’ll soon have a wealth-destroying mess on your hands).


The US took gold out of the global monetary system through two closely related measures: the first, taken by President Johnson, in 1968, when he removed the requirement of the dollar to be backed by physical gold; the second, taken by President Nixon, in 1971, when he ended the direct convertibility of the dollar to gold.

The US federal budget was last balanced (not counting Social Security contributions) under President Carter. It hasn’t been balanced since. And after 1980, when the Republican Party became the Party of Big Spenders, there was no hope of controlling federal deficits.

Since then, the only two electable political parties were in favor of spending more than the government collected in taxes. Republicans wanted to spend on an activist agenda overseas. Democrats wanted to spend on an activist agenda at home.

In the resulting compromise, they agreed to overspend on both.


Federal DebtThe federal debtberg in all its terrible glory – via Saint Louis Federal Reserve Research – click to enlarge.

Manipulating Prices

The government, meanwhile, manipulated prices lightly before… then heavily after… the Black Monday crash in 1987. Nixon had tried general price controls in 1971. Those were quietly abandoned and quickly forgotten.

But after the October 1987 crash, the new Fed chairman, Alan Greenspan, began to closely manage and grossly distort the single most important price in capitalism: the price of credit.

As political appointees with a mandate to make life as easy as possible for their masters in Washington, naturally, Greenspan and his successors had a bias to fix the price of credit ever lower… until it finally hit zero in 2009.

That’s where the Fed funds rate – the rate at which banks lend money on deposit with the Fed to each other overnight and the base rate for all other credit – has been for the last five and a half years.

As the price of credit went down, the price of assets went up. Dot-com stocks in the 1990s. Real estate in the 2000s. Now just about everything is inflating – fast. Even consumer prices are starting to show signs of bloating.

This inflation was more or less what the Feds were looking for. They wanted to mislead entrepreneurs into believing there was more demand than there really was. They also wanted investors to believe they were richer than they really were.

On this last objective they were rewarded with rampant speculation, risk taking, complacency and grotesque distortions.

Merrill-CCC-yield indexHere is one of the above-mentioned examples of “rampant speculation, complacency and grotesque distortions” - via Saint Louis Federal Reserve Research – click to enlarge.

 When Capital Is Free …

Putting so much money in the hands of the moneyed classes led them to feel cavalier about it. The fix was in… and they knew it. They quickly realized that speculating on further distortions would deliver more immediate profits than investing in capital stock and new ventures… even though only these types of long-term investments would create more genuine demand.

This was the most retarded part of the Fed’s program. By making it appear that real capital had no value (wasn’t the price of it near zero?) they gave investors little incentive to create more of it.

Instead, speculators took their EZ credit and used it for various forms of gambling and financial engineering. Buybacks, buyouts, LBOs, M&As – corporate debt rose as corporate managers figured out ways to get more cheap money into their pockets.

One of the classics was to buy a corporation… have the corporation borrow heavily (which even the junkiest business could do)… then pay out huge fees to managers and manipulators.

Lending standards are so lax… and lenders so forgiving… the sharpies can get away with almost anything. Reagan’s former budget director David Stockman elaborates:

“[I]t is plainly evident that most of the massive expansion of business credit since the last peak has gone into… stock buybacks, LBO’s and cash M&A deals – not expansion of productive business assets.

Indeed, total non-financial business credit outstanding has risen from $11 trillion in December 2007 to $13.8 trillion at present, or by 25%, yet real business investment in plants and equipment is still $70 billion or 5% below its pre-crisis peak.”

None of this should be surprising. It’s what you get when you artificially set the price of credit too low for too long. It’s like selling diamonds too cheaply; pretty soon customers will be gluing them to the backs of their blue jeans.

The result is less genuine demand. Remember Say’s Law of Markets (named after French economist Jean-Baptiste Say): “Products are paid for with products.” In other words, production is the source of demand.

Demand comes from output, not from printing money. If you could boost real demand simply by printing money, we’d all be rich already.



Jean-Baptiste Say – production is what ultimately pays for consumption.

(Image via mises.org, author unknown)


The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.




David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

Get Access