Central banks and interest rate control - a quick primer on business cycles and impoverishment

If you want to discover the source of much misery in the world, we have to look at the monetary system and the incredible assumption that governments or central banks control interest rates. 

Up until the 1980s, it was generally accepted even by bankers that interest rates reflected the price of borrowing funds over time in the market place - that is, the value that people are willing to give up capital for a period versus the value that others are willing to pay to borrow that capital.

Like the price of anything, its rates (not 'rate') were set by the millions of people interacting in thousands of markets and reflected the differing perspectives and judgements of time and risk. Increases in perceived risk over time would normally raise rates in respective markets relative to those whose perceived risks were steady or falling. Increased spending relative to saving would divert fewer funds in the loanable funds markets (plural) and hence have a tendency to raise interest rates (all things being equal).

But since the use of 'interest rate policies' by the central banks, governments and monetary bodies have presumed that they can control or can manipulate 'the interest rate' to effect a macro economic goal. It's analogous to setting the price of bread. Always a disaster of course, but look at bread products available in the shops - which bread would be meant? If one priced were imposed on all the different kinds of bread, many would quickly disappear from the shops and the lowest quality would only be produced. Similarly, when central banks set the interest rate low, it encourages low quality loans to be made (to entrepreneurs and consumers who would otherwise not access loans at higher market prices); but unlike bread manufacturers who cannot produce bread out of thin air, the central banks' banks (the commercial banks who produce the loans) can do just that. They don't need loanable funds on the shelf like a shop needs bread on the shelves to sell - they can create them with a click of the mouse: a loan is created in the debit colum, and simultaneously becomes a credit when loaned out. The customer pays fees in real funds of course. Many thinkers have thought nothing about this set up - indeed, many people have not even thought about it - but those that have divide into two groups: the pro-bankers who argue such a set up is somehow necessary (it funds their profits) and the more sceptical who see either the immorality of the scam as being wrong in itself or the tremendous destruction that is created in funding projects that would otherwise not see the light of day and the resulting business cycle that is thereby created. 

Interest rates (not rate) reflect all of our perceptions of time and risk in the markets we operate - they are market driven signals that governments cannot alter or effect, except by cheating. Monetary authorities can print money and create credit (and by monetary authorities, we have to include the 'private' banks, which are an arm of the central banks, although which way the influence goes, I'll leave up to historians, as it can go both ways). This cheating causes real economic distortions, which may be missed by economists who focus solely on aggregate price indices or other macro variables, which is a bit like not noticing a stable sea level has nonetheless incredibly strong undercurrents shifting the sea bed and shoals of fish all over the place. 

When new credit is created (or money printed) it enters specific markets and alters the interest rates in that market; as entrepreneurs, customers, suppliers, etc., react to the lower interest rates, they in turn alter they purchases and a distortion is thus created in the market, a distortion that then filters into and across other markets. The speed and duration of the distortionary wave depends on people's particular reactions; its size depends on how much credit is take up and supplied to the market. How long it will last therefore and the markets that will be effected is only qualitatively accessible to economists - those industries and services that are more sensitive to interest rate changes, will naturally be more susceptible to the distortions. Hayek and other Austrian School based economists note how capital intensive industries tend to be interest rate elastic and hence will go for new funds that are made 'available' through the banking system, and which we usually see in the form of cranes above city skylines in the boom times as well as amazing projects that seem too good to be true or ahead of their time, which they often are. 

Ultimately though, in the money markets market based interst rates (not 'rate') will prevail.

To keep certain interest rates below the normal rates determined by market interaction, the monetary authorities can only keep on expanding the credit supply as Swedish economist Knut Wicksell noted a century ago. This either creates the potential for inflation and/or for a currency collapse. Such inflationism though (the policy of killing a currency whether slowly or quickly) is like an opiate - governments and their bankers are hooked on it, it's addictive, and when it's not taken, it creates a crash...or death. Governments have a great tendency to overspend and overpromise and engage in projects that current tax flows cannot sustain: the rescue button is always the banking sector with the central bank at its hub. It is there to buy bonds and to bail governments out; it is there not as a coastguard is there to rescue a ship in danger (a noble act), but there as the ultimate drug lord to deal out more hard core addictive drugs for the crashing client.

Thanks to the internet and access to independent voices - academic and otherwise, more people are beginning to understand that all is not well with central banking and the global banking system. They smell corruption and fraud but often cannot quite put their finger on it. It is really quite simple - governments use the banks to bail themselves out of overspending; academics believe that the central banks can use monetary policy to steer the macroeconomic variables they are interested in; bankers love the profits from possessing the privileges accorded them by the system. The 'interest rate' policy of central banks is a mere ploy to create an illusion that intelligent people are doing their best to 'save the economy' or 'promote growth'; they may have good intentions but ultimately they are seeking to cheat reality and the people. 

We are becoming - as a people around the world - increasingly sceptical of Big Government doing anything useful except impoverishing people and waging wars; we should also be highly sceptical of this monetary drug that the central banks play with and the corrolarly that states can somehow 'set interest rates'.

Read the media's coverage - note how people are duped into accepting the belief that governments can and ought to set interest rates. They can try, but in doing so they are destroying your wealth.

Alexander Moseley, editor of The Economics Circle