The Tip of the Financial Iceberg

0:00It's been a fiery week full of pressing, some would say depressing, economic issues, with the Fed talk of tapering, scaring down the markets, then strategic press releases talking the markets back up again. We have the saga of Edward Snowden, and that has glued us to our seats as we try to figure out just how much Uncle Sam has the goods on all of us. And just when you thought MF Global was no longer a household word, the Goldman Sachs-led CFTC finally, and can I emphasize finally, goes after the very man who threw the entire futures industry into disarray. This would be John Corzine. To talk about all of this and more is Senior Fellow at the Ludwig von Mises Academy, Mark Thornton. Mark, thank you for joining us. Good afternoon, Bob. It's great to be with you. Thank you. Well, let's jump into this note and affair. We have a critical trade agreement right now that Ecuador has renounced, and what implications does this have for the financial markets, if any?

0:58Well the implications for financial markets in the general economy are all negative, of course. The fact that NSA has invaded our rights and invaded our privacy and the fact that Congress, who has seen the NSA testimony, says that we've only seen the tip of the iceberg means that this is a triple negative for the economy. Look at the strong arm tech companies

1:50in the private company like Edward Snowden can access your email, can read your email, can look at your phone records and listen in on your phone calls. This opens up things like the possibility of insider trading on a massive scale. And then, of course, in terms of foreign relations, you have major implications here regarding trade regulations and interactions between countries. We're already involving the United States, China, Hong Kong, Russia, Cuba, Ecuador and other countries are involved in all this and of course we're spying on our enemies which can be expected but we're also spying on our friends that's been released by Snowden. So this is going to hurt foreign relations and trade relations and it could lead to increased The US, the European Union, China and other countries, especially Japan, are massively inflating their money supply in an attempt to drive down the value of their currency in order to increase trade, so these are all tied together, it's all negative, it's going to have a negative impact on the economy as well as foreign relations and trade relations.

3:05Well, let's talk about this currency war. Japan in particular is aiming to double their monetary base within two years, and initially it had a devastating effect on the yen it was going down, but that's actually what they wanted. I mean, is that what central bank policy should be doing, is to devalue the currency, and why would they aim to do that in the first place? Well, no, it shouldn't be done that way at all. It's called beggar-thy-neighbor policy, where you try to make your neighbor worse off by inflating your money supply and driving down the value of your dollar, so it makes your exports look better. And initially there's a positive response, and Japan has received this positive response to the falling yen, and their stock market initially went up tremendously, almost doubling. Now it's fallen significantly.

3:55they're getting the small increases in industrial production in Japan and small increases in GDP but look you know they also have to import goods as a matter of fact Japan has to import virtually everything all the raw materials that they use to produce those exports and so in the long run it doesn't do any good in terms of exports and GDP and things of that nature it just creates tensions in Financial Markets, Uncertainty in Financial Markets, Bad Relations between Trading Partners, it could lead to real protectionism where tariffs, quotas are imposed, it could lead to actually military conflicts. I mean, protectionism, whether it's through your currency or through tariffs, is a prelude to war. Bastiat told us that if goods don't cross borders, armies Well, you know, and that's where those were important factors in the American Revolution, the War of 1812, the American Civil War and other wars around the world. So these look like small issues and small problems right now, but they have a way of getting out of

5:04control where the policymakers lose control of what's going on and things devolving into chaos. Well, Bastiat certainly did have a lot to teach us. And let's talk about what What might be a cataclysmic moment, not only for the United States, but also for the world, which is when short-term interest rates, long-term interest rates, the Fed is keeping them down, what happens when they rise? Well, the Fed is engaged in reckless policy. The mainstream media would have it that the Fed is trying to fix our problems, but look, they caused the housing bubble, they have reckless monetary policy that's hurting our ability to recover from that crisis, it's hurting retirees, and it's allowing Congress, Because the Fed is buying all these long-term government bonds from the Treasury, it's allowing Congress to spend recklessly and without any checks on their spending.

5:55And so they're allowing that to take place, and so they've hurt us in the past, they're hurting us in the present, and they're going to hurt us in the future. And look, they're also hurting themselves because they're buying up all this long-term debt, all these long-term bonds, which traditionally they never did. They usually bought short-term government securities. And with short-term government securities, the interest rate doesn't really get out of whack because the securities last only 90 days and so they're turned over very quickly. So changes in interest rates doesn't hurt the position of the Fed balance sheet. But with long-term bonds and assets that the Fed has loaded up on, what they have is a scenario where if long-term interest rates were to rise, which they are now currently doing, In a position where it would be technically bankrupt, where the assets would lose value and the liabilities...

6:55I want to get to this. Is it possible for the Fed to go bankrupt and we only have about 30 seconds left here? They've changed the rules so that they don't have to operate according to market prices. They can operate at the prices that they bought those things. So, technically they've changed the rules, the rules that you and I have to obey in their favor so that technically they can't go bankrupt, they would just be borrowing more money from the Treasury essentially, adding to the national debt, which I'm afraid that's likely to happen. Mark, thank you so much for joining us. This is Mark Thornton, Senior Fellow at the Ludwig von Mises Institute. Thank you for your time. Thank you, Bob.