Currency Wars and Bursting Bubbles

Mark Thornton is an economist with the Ludwig von Mises Institute, headquartered in Auburn (but not a part of Auburn University). The institute is named for the founder of the Austrian school of economics — a brand of conservative, free market economic theory with a special suspicion of central banks. Thornton is credited with publications that warned as early as 2004 of a dangerously inflated housing market, owing to Federal Reserve monetary policy.

I think the biggest macro concern right now is that the central banks around the world have been keeping interest rates at extremely low levels and — having attempted to load the world with liquidity — are engaged in currency wars. The central banks try to devalue currency to encourage exports, with the idea of creating jobs. This is a “Begger Thy Neighbor” policy, and it can have very dangerous effects. If we look back at World War I, we saw a similar attempt to engage in currency wars, and it resulted in conflicts between nations.

Central banks are blowing up bubbles all over the planet. In other countries, you see housing bubbles. Norway has a housing bubble, as well as a lot of the Nordic countries, along with Switzerland. The Japanese stock market is in a bubble, as a result of a radical quantitative easing program. They devalued the yen and they re-inflated their stock market. Here in the U.S., you have a bubble in the stock and bond markets and in agricultural land prices.

Until these bubbles hit and break up, the central banks are papering over the problems and helping out the big banks. The investment banks in New York and the hedge funds are growing extremely wealthy. But you look at the average American and the average local economy here in Alabama, you don’t see the spreading of that wealth.

People are starting to make the connection. If the central bank is manipulating our money and credit system, the big banks and hedge funds on the one hand are doing very well, at the expense of the middle class, where the family income adjusted for inflation is declining and the number of jobs is actually decreasing.

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The unemployment rate has fallen a little, but look at the percentage in the workforce and it is at a 35-year low. People are statistically being removed from the workforce, either through retirement or they have been unemployed for so long that they are no longer counted in the workforce.

People are assured the consumer price index isn’t rising. But the reason it isn’t rising is so many families have diminished incomes. Fifty million people are on food stamps, people are facing unemployment and underemployment. That’s taken the pressure off inflation. Otherwise, you’d see the effect of inflation by policies of the central bank.

Stock market prices are very high because interest rates are very low. So when investor retirees look for yield on investment, they can’t put their money in certificates of deposit or savings accounts or money market mutual accounts. All savings are being funneled into bonds and stocks in a chase for yield. And the result is that stock and bond prices are extremely high.

People are looking for yield, they’re desperate for yield. They’ve been piling into the junk bond market such that now the spread is low between government bonds and junk bonds. You’ve got all these retirees, who would prefer to have some of their money in certificates of deposit or a saving account, but those don’t yield enough. They’re looking elsewhere, and they’re taking on more risk.

Some people I talk to are enjoying the ride in the stock market. Others are very concerned with the stability of stock market prices. Nobody knows what’s going to happen tomorrow. Everybody realizes it’s an unusual environment for investment. It’s very difficult to come up with any criteria to make those decisions. In stocks, you really have to have the ability to predict the wild swings — like the technology bubble, like the housing bubble — to be ahead of the game.

The low interest rate policy and low mortgage policy has re-inflated housing prices, a mild reflation of the housing bubble. But as interest rates creep up, that’s going to limit any more increase in housing prices.

The housing bubble blew up to such an extreme that there was a total washout in the housing market. There is still overhanging supply. Conditions are OK right now because of low mortgage rates, but when rates move higher, we’re going to find ourselves right back in collapse, because there are still a lot of foreclosures sitting on the sidelines. Temporarily they have been papered over by low mortgage rates, but when they are over, you’re going to find yourself back in a declining housing market.

Hedge funds have been taking borrowed money and setting up shop in metro districts where there have been severe corrections in the housing market. This has been going on for two and a half years. They purchase 1, 000 to 2, 000 houses, single-family homes. They set up a company to fix and paint them up and rent them out. They get cash flow from those rentals, and, in the event the housing market turns around, they’ll be in a position to sell at a nice profit.

It seems like it’s inevitable that the Fed will have to curtail this quantitative easing program. But they’ve worked themselves into a corner. No matter what they do, it’s going to have big consequences. It’s going to cause economic pain.

When they cut back on the purchase of government bonds, it will raise interest rates. When they cut back on the purchase of mortgage-backed securities, the result is higher interest rates for mortgages. If they don’t cut back, it’s going to raise interest rates because of inflation expectations. That’s what I mean when I say they’ve worked themselves into a corner. If they do or they don’t do it, the consequences will be the same.

In Greece and Portugal, they couldn’t borrow their way to maintaining their budgets, so they were forced to cut back. In the U.S., we just borrowed our way to continue government spending, trillions-plus for defense for many years, hardly any cutbacks in government to speak of.

There have been three episodes where governments have tried to solve their macro economic problems by spending or borrowing or printing their way out. In the U.S., there was the Great Depression, in which Herbert Hoover and FDR tried to use the government to get us out of a crisis and just expanded the crisis. In Japan in 1990, they tried to spend, borrow and print themselves out of a crisis, and the result is an economy that is still stagnant. In this current crisis, we’re trying to borrow and bail our way out, and it just doesn’t fix the problem. It has to be fixed by market forces. It’s painful, but it’s the only way.

Chris McFadyen is the editorial director of Business Alabama.

Interview by Chris McFadyen

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