So many writers and speakers love to use the phrase. “the elephant in the room that everyone ignores.” That ranks up there with the 800 pound gorilla who sits anywhere he wants but as soon as he does is promptly ignored. One only ignores gorillas and elephants in the room at one’s own peril. The truth of the mater is that the room is full of elephants and gorillas to the point that few of us will be left standing in the room. One of the latest of the species to come of age is world trading of EFTs, better known as Electronically Traded Funds. If an individual believes that the economy of Brazil looks promising and is on a growth track of five or more percent, then one can try and pick individual corporation stocks for investment or buy into an EFT that picks the stocks. The EFT allows through a concentration of small investors to buy many promising stocks and share the profits or losses. These EFTs also trade in commodities, bond markets, and even US Treasuries. Now why would the market for EFTs be an elephant or gorilla in the room? The US GDP currently is $17.4 trillion, but the EFT market trade has hit $18.2 trillion, a seventeen percent increase over last year. Think about that for the moment. Few economists like to point out that the normal measurement of GDP includes government spending and in our case the federal budget being as large as it is, much of which is financed on deficits or debts. Well, that much trading of EFT shares would be caution enough for investors to notice. But that trade is mostly in US Dollars. The US EFTs have only $2.1 trillion in assets and yet the turnover, or the exchange of shares is 870%. The turnover for US stocks normally doesn’t go over 200 percent. The amount of money traded every day is huge and thus blurring the efforts of the FED to control the money supply. But it’s not just the FED, it’s every individual government central bank that bears the brunt of this money turnover. The US Dollar is the reserve currency, the money used around the world and that use has a very inflationary price for us here at home. Thus when a few extremely large hedge funds can turn over that much money in the world failure means economic collapse. Mind you, this is the buying and selling of corporations on a world scale. As the easy money from excessively low interest rates pushed by central banks flows into corners of the markets chasing every higher and greater risk returns, the potential of the failure of these marginal corporations, who are induced to borrow excessive amounts of fund because the rates are so low, to become zombies, sucking up wealth and destroying economies through debt default when interest rates rise, continues to compound.
Of course the Zombie Corporation is the sign of easy money, that is, the lower the interest rate the less it costs to borrow funds and the more funds can be borrowed. If I as a saver can get four percent interest on my passbook savings account at the bank, then the bank must lend that money at a minimum of five percent or more to pay me my four percent interest. But it the Central bank lowers the funds rates at which the bank can borrow money, why does it need my savings and why should it pay me even one percent if it can borrow at a half percent or less? These low central bank interest rates lead by the banks and the savers to finding higher yields to make up the difference and that means higher risk. How long has the FED kept interest rates near or at zero? Seven years. If corporate borrowing costs used to be five or six percent, than the Corporations would not borrow nearly as much money as they do now because the costs would eat into their profits. You tell me why politicians and economists can’t seem to understand that when the cost of borrowing money is near zero the amount of debt rises accordingly and when that cost rises the amount of debt declines. The iron law of debt is that it is either repaid or defaulted. Debt claims future earnings. If you are the debtor, then your future earnings are at stake, you will receive fewer earnings in the future. If you go broke and default, then the creditor will lose future earnings along with the principle less any collateral that can be sold to satisfy that principle. But when excessive debt is contracted by the world and then then the debt defaults start cascading, collateral loses value as there are very few buyers at the end.
Now the FED is talking about raising the interest rates, that is the rate at which if lends money to banks, and the Federal Government. Oh, you didn’t know that it lends money to the Federal Government? Take a look at that dollar bill in your pocket and what do you see at the top of the bill? It says Federal Reserve Note. That’s right, a note, meaning a debt instrument. And do you know what you can redeem that one dollar note for? Another note. At one time that dollar was redeemable in silver. You see, our currency is a fiat currency. You know, the government issues a fiat or law or order that a one dollar federal reserve note is worth one dollar in federal reserve notes, a tautology, for those who have studied logic. The Federal “Reserve is also charged with the printing of these notes. But, unlike some countries, there is a limit as to the amount of “money” it can print. This is linked to the Federal Budget. This is why there is a spending limit. Our national debt sits at $16 trillion or so, that is, the accumulated national budget deficit spending. If the Congress could only spend what the government takes in in tax revenues, fees, and other such monies, our congressional budget would be vastly less. Imagine a government that could only spend what it could collect in taxes. That is one of the great problems about Greece and most of Europe. Once part of the EMU they could spend other countries money. The other two problems is that they believed to could have a socialist country to provide all the good things like Hugo Chavez’s early administration. Venezuela showed that there is a finite limit to wealth confiscation. Once the Free Shit Army spends it all, everyone starves and does without. Now one of the reasons why Congress can spend money it doesn’t have is that the cost of that borrowing is very low. Back in 1982 on count purchase a 10 year US Treasury Bond with a coupon rate of 10 percent below par value. Imagine, ten percent interest rate and for a thousand dollar bond you only needed to pay nine hundred and ninety dollars. By holding that bond till maturity you would have more than doubled your money. A Treasury bill is an instrument of indebtedness. The FED will buy them as the lender of last resort but must have the authorization to issues any increase in the money supply. There are other ways that the FED can make sure that Treasuries are bought, such as repurchase agreements with banks. The banks buy the bonds and the FED will repurchase them at a later date for a specified price. Or the banks buy the bonds, the FED then purchases the bonds from them and the banks agree to repurchase the bonds in the future. There is all manner of financial games the FED can play. Hell, look at its current balance sheet, it owns trillions in Treasuries, Mortgage Back Securities, Corporate Stocks and Bonds, and what have you. At some point is will have to sell all those purchases and it may take a hell of a loss doing so.
Meanwhile there is talk at the FED of raising the FED rate by one quarter percent. That in itself is not earth shaking. But a rise in interest rates, and the FED can’t control the other interest rates, by the way, can hurt those who have taken on debt and those who have lent money. If the interest rates on six month Treasuries were to risk to one percent Congress could not afford to run the huge deficits they do now. The cost of debt on sixteen trillion is almost nil now. What would the cost of that debt become if raised to one percent? Do the math yourself, you’re a tax payer. And we are not talking about future liabilities, those contracted future payments, like Social Security for next year and the following years. And let us not forget all the interagency debt that has floated through the administrations. Bill Clinton balanced the budget once because he subverted the Social Security Tax payments into the general budget. Oh yeah, the SSA got special Treasuries to make future payments, but tis really robbing Peter to pay Paul. Taxes have to be collected to pat for those Treasuries or new Treasuries will have to be issued to replace the maturing Treasuries. It’s a shell game. Heads, the government wins, tails the tax payers lose. This is the big Greece Government problem. To pay for the promised good life the government has to wither collect enough taxes or borrow the money to cover the expenses. The Greek people, like the Italians, have raises tax avoidance and evasion to a very fine art. Thus, their governments have had to resort to borrowing. Before they became a part of the EMU the creditors limited the amounts they would lend and set the interest rates and the conditions. Hence, socialist governments were limited to the amount of benefits they could offer. What so many socialists can’t seem to comprehend is that if everyone works for the government and the government must pay everyone out of tax revenue, the no one gets anything because what is earned is immediately paid back in taxes. This is the problem with the progressive mindset. The more you want government to pay out in services to more taxes government has to collect. And once the government starts borrowing, then it takes more taxes to pay the cost of interest.
So that leads to the bond vigilantes. You think the Treasury sets the interest or coupon rates? In a way, they do, but, those rates are subject to what bond buyers are willing to pay for that bond. The Treasury can offer a 30 year maturity bond at one half a percent (the current coupon is about 3 percent), but they will never sell them for par value. A one thousand dollar bond will not sell at that price. It will sell at a discount, meaning that the other two and a half percent coupon paid over the thirty year maturity will be reflected in the reduced price. This works the same way with corporate bonds and we are starting to see the same thing occur in the municipal and state bond markets. If the Illinois state government allows cities to declare bankruptcy, Chicago will never sell another bond again for many years. But more than that. Remember we started talking about the EFT markets? What did I say? The ability of EFTs to chase all many of high yield regardless of risk means that as interest rates rise corporations go zombie or even bankrupt. This leads to more failures as investments go bad. Suddenly the 800 pound gorillas are not just sitting anywhere they like, they are sitting on you and the elephants are helping to stomp you into the ground.
And oh, Eric Hare, Brazil is not doing so well as you claim. It in effectively in a depression and there will be no Summer Olympics, the water quality is so dangerous no athlete would dare travel to compete under such conditions. And yes, the dependence of Chinese trade had a significant part in creating this depression. The central bank of Brazil has raised its rates to almost 15%, hardly the sign of a robust economy. Inflation is totally our of control as is the corruption. Look for a military coup next year. You really need to do better research in economics and politics.