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A Central Bank Clot
by Bill Bonner

21-08-2007

The financial industry, most of the time, operates under false pretenses. The

business of true

capitalism is to destroy them. The two are natural enemies.

"Central banks seek to unblock markets," reported the Financial Times on

August twelfth.

The gist of the story was that the financial industry seemed

to be having something akin to

a cardiac infarction and central bankers,

rushing in like heart surgeons from the golf course,

were attempting a by-

pass. If successful, we were led to believe, Bernanke, Trichet and the

lot

would get their mugs on the cover of Business Week and TIME, and soon

join the great

assembly of capitalism's saints.

In fact, what the bankers were up to was the exact opposite of what the FT

reported. At the

end of that week and the beginning of the last one, central

banks all over the world were

engaged in a vigorous attempt at price fixing

and market manipulation; that is, they were

trying to block markets from

doing what they needed to do.

As we mentioned two weeks ago, no man worships capitalism. Instead, if he

has any sense,

he fears it...and aims to put a stop to it as soon as he is able.

In any economy, mistakes are

made. People invest in projects that don't pay

off. They pay too much for a stock. They lend

to people who can't pay the

money back. If these errors were to go unpunished, the mal-

investment and

misallocation of resources would continue. Eventually, the whole shebang

would collapse into a heap of unwanted products and un-performing assets.

That is why we

have corrections...bear markets...and panics; they are an

economy's equivalent of natural

selection, eliminating the weak and unfit.

The key variable in capitalism is the cost of money – the interest rate, which

establishes a

"hurdle rate," against which to judge all financial transactions. It

is the natural environment

in which capitalists must survive. If a new project

will return 5% per year and the cost of

money is 6% per year, the proposed

investment doesn't make it. But if the cost of money

drops to 1%, all of

sudden even the most absurd and clownish investments get to

reproduce.

Soon, the world is full of them.

In a free market, the 'hurdle rate' is set like all other prices – based on supply

and demand.

But central banks meddle with interest rates – typically

pushing down on the short rates,

and thus lowering the hurdle rate for all

borrowers. In fact, most of the freaks now

crowding the financial world are

the spawn of central bankers who held down rates too low

for too long.

Corrections can take many different forms. Occasionally, speculators panic;

they stop

worrying about the return ON their money all-together; instead

they fret about the return

OF their money. Then, it becomes hard to borrow

at any rate.

Over the last few weeks, capitalists have become edgy and disagreeable.

Lured by an

artificially low lending rate, maybe they lent a little too freely.

Maybe they spent a little too

much. Maybe their speculations weren't as

good as they thought they were. Mistakes were

made; they needed to be

corrected. As a result, markets began to wobble. Stock prices came

down,

with more than a trillion dollars trimmed from U.S. stocks alone. And credit

markets

began to constrict; banks on both sides of the Atlantic were stuck

with nearly a half a trillion

dollars' worth of corporate loans that investors

refused to take.

These were the facts when, on the ninth of August, the capitalist cops were

doing their job.

They were beating up homeowners who had bought houses

they couldn't afford. They

were taking their cudgels to the lenders too...and

to CDO speculators, hedge fund players,

imprudent bankers, and whiz-kid

mathematicians. And once their blood was up...they were

whacking away at

everyone who came into range– including stock market investors,

pension

fund managers, City investment banks. Rich, poor...smart, stupid...they were

giving them all a good thrashing.

But then, along came the central bankers.

On August ninth and tenth, the Bank of Japan, the European Central Bank,

the Bank of

Canada and the Fed all began to intervene. One report said the

ECB had 'injected' $215

billion into the system. Others said the Fed had put

$38 billion to work. By Monday, the

Bank of Japan and the ECB were still at

it...colluding to knock down the hurdle all together.

The BOJ put in another

$5 billion, which was already having a "calming effect" on Asian

markets,

said the papers. On Monday, too, the ECB put in another 47.7 billion euros.

Whatever the final numbers turn out to be, it is a lot of new money in a short

period of time

– more than at any time since the days immediately following

9/11 in 2001. Lending by the

New York Fed was so vigorous that the fed

funds rate fell to the lowest rate since 2004.

The purpose of all this lucre was said to be to provide "liquidity". What is

liquidity, you may

wonder? Lo...it is the same cheap money that got markets

in trouble in the first place! It is as

if they had opened a new mortgage

lender in Santa Ana, California, offering no-money-

down, teaser-rate, no-

document adjustable rate mortgages.

If we're lucky, borrowers won't fall for it and the cops can get back to work.

(

Note: Bill Bonner is the founder and President of Agora Publishing Inc. and

author, with

Addison Wiggin, of Empire of Debt: The Rise of an Epic

Financial Crisis .

)

ATRTICLES