The Long and Short of Interest Rates
BROCKWAY, GEORGE P.
The Dismal Science THE LONG AND SHORT OF INTEREST RATES BY GEORGE P. BROCKWAY People are beginning to growl that recovery from the recession is being delayed by the slow growth of the...
...But what would they do with it...
...You swapped grain for silver, and then you swapped the silver for candles...
...Trade was essentially barter...
...and in that ranking it will happen that some long bonds are judged more liquid than any common stock...
...If you have ever met a payroll, you know that your costs are an inescapable factor of the prices you charge...
...The bond mar ket is a place where people buy and sell bonds in which at least the seller did not intend to invest for keeps...
...It was their expansion of employment and plant and output that made them prosperous...
...The most obvious thing would be to coin some more coins and print some more paper money...
...As Karl Polyani rather sorrowfully pointed out, goods are now produced for the market, rather than on special order...
...The point is that, regardless of the Federal Reserve Board's intentions, its actions effectively control the long-term interest rate as well as the short-term rate...
...Here, yet again, is a historical turning —one that has been missed by most mainstream economists but has been forcefully called to the attention of most businesspeople...
...In short, the price of money matters...
...But their domestic saving and their currency's flight had the same cause...
...Don't let anyone tell you that Japan's interest rate was so lo w because Japan's savings rate was so high...
...For the money that lands on our shores takes off from theirs...
...There are those whose doctrine requires them to pretend that the Federal Reserve Board has no control over interest rates, that they are made in the market, if not in heaven, by an invisible hand, and no mere mortal can do anything about them...
...After all, common stocks are "longer" than long bonds because they do not promise to return your money...
...In the second place, Japan's recent hike in its interest rate was not caused by a fall in savings but by the cold-blooded and wrong-headed decision of its central bank...
...If that is the case, why doesn't the Board say so...
...Rates had to stay high to keep the foreigners from pulling their money rugs out from under us...
...When your costs go up, so must your prices, if you propose to stay in business...
...In all cases, long-term or short-term, the traders ' question is what the market will bear tomorrow, not what will happen over the next 30 years...
...The said target is to keep the annual rate of increase between 2.5 and 6.5 per cent...
...A few years later I was a business planner myself, and I assure you that's the way it was...
...Keynes deplored the fact that most professional investors and speculators "are concerned, not with what an investment is really worth to a man who buys it 'for keeps,' but with what the market will value it at, under the influence of mass psychology, three months or a year hence...
...Hence the notion that prices depend on the money supply...
...In response to that question apologists for the present system will surely warn us about a flight from the dollar...
...They rank them according to their relative safety and relative liquidity and so on...
...Christopher Columbus (whether he discovered America or not) made a historical difference...
...A frequently cited survey, published in the Harvard Business Review in 1939, reported that businesspeople then paid little attention to the interest rate in making their plans...
...It will be seen that the customary policies of the Federal Reserve Board work to reinforce both groups...
...We have spent our credit like money, except we now are in debt to the bank that sent us the card...
...Now, suppose that the Reserve agrees that the money supply is in danger of falling through its bottom...
...If the Board did not set at least short-term rates in these ways, it would be hard to ascribe any significance to its activities...
...The long-term rate conformed then, and it would do so today...
...Unhappily, it is widely believed— even by many who agree the Reserve can set short-term rates—that long-term rates are set by the "market" anticipating what the future will bring...
...This pleasant arrangement expands the money supply, but it is limited in various ways—the chief one being the interest rate, the price banks charge us for the use of money...
...That knowledge should give us furiously to think...
...After all, the prime rate, held down by an "accord" between the Treasury and the Federal Reserve, was only 1.5 per cent...
...Some say that the market anticipates the future rate of inflation...
...While occasional shortages are far from impossible, industry is so organized that if a demand for an especially cute T-shirt suddenly develops, the supply can be replenished in a few hours or days...
...The same point may be reached from another direction...
...But may not international rates restrain those activities...
...They may be wrong, just as prophets may be wrong about what the Board will do tomorrow morning...
...The Reserve should set the short-term interest rate at least as low as it did during the 1942-51 accord with the Treasury...
...We have some credit, represented by a plastic card that we show to a shoe clerk, who makes a copy of all the numbers, has us sign it, and hands us a pair of shoes...
...It claims to control the money supply, yet all it can actually control is the interest rate...
...At any given time (say, 1492) there was a certain amount of silver in circulation, and other commodities traded at more or less stable prices in terms of silver...
...When the Board sets the Federal funds rate or the discount rate, it is setting a rate at which banks can borrow (shortterm) from each other or from the System...
...In the 55 years that have passed since Keynes published this judgment, three months or a year has come to seem an unusually long time to hold an investment...
...Both were the result of their comparatively low interest rates and correspondingly high production (not productivity, but production...
...In the former case, long-term lenders think of themselves as lending purchasing power and want to get their purchasing power back, with interest...
...What do they do...
...Portfolio managers and professional traders treat long bonds and short bonds alike, and treat both as they treat stocks...
...Therefore, all interest rates respond to the activities of the Federal Reserve Board...
...The European supply of silver multiplied rapidly, while the supplies of other commodities, being agricultural products or custommade goods, expanded slowly, if at all...
...This being so, the long-term interest rate is not a separate problem...
...You may be sure that they wouldn't send apacket of the stuff to each of us by Express Mail...
...Indeed, the fact is that whenever the Reserve fears the money supply will fall through the lower parameter, it lowers the interest rate...
...Nor would they add to our savings accounts (although they firmly believe we ought to save more...
...More sophisticated observers recognize that the Reserve really and truly does determine short-term interest rates...
...Here, again, is a historical change the Reserve has failed to notice...
...In the days of mercantilism money was a commodity—gold, silver, sea shells, or some such...
...Hardly...
...Yet their economy has been outperforming ours for the past many years...
...In the latter case, longterm borrowers guess that borrowing will be more expensive in the future than in the present because the Reserve will, in its anti-inflation battle, allow (or force) short-term rates to rise...
...Treasury Secretary Nicholas F. Brady has a similar fear of flying...
...The flights to the dollar are flights from the yen...
...Even new bond issues are priced in relation to the current market, and that is priced in relation to short-term interest rates...
...Although the Federal Reserve Board seems not to have noticed, the modern economy is quite different from that of pre-Industrial Revolution days...
...Inflation, of course, is the Board's panatrophy, and raising the interest rate is the Board's panacea...
...The accord was annulled in 1951, whereupon the Reserve embarked on its long and still-continuing hunt for the inflation snark, with the result that today interest is one of the most prominent and most unpredictable costs of doing business...
...Some of the increasing supply of silver was swapped for the stagnant supplies of other commodities, whose prices rose...
...others that the market anticipates the short-term rates the Reserve will set in the future...
...Everyone knows that mainly they're the Japanese...
...Our credit has become money by becoming debt...
...The way the interest rate is managed does, however, haveaneffect on prices...
...Resolved to their own selves to be true, they have to increase it...
...The Dismal Science THE LONG AND SHORT OF INTEREST RATES BY GEORGE P. BROCKWAY People are beginning to growl that recovery from the recession is being delayed by the slow growth of the nation's money supply, which seems in danger of falling through the bottom (or "lower parameter" if you want to be fancy) of the Federal Reserve Board's target...
...The Federal Reserve Board's moneygrowth target is irrelevant...
...Instead, the Reserve would make it easier and more profitable for the banks to lend us money...
...What borrowers and lenders anticipate in the long future is that the Board will continue to pursue the policies it is pursuing today...
...When the Federal Open Market Committee buys or sells bonds, it raises or lowers the price of bonds and consequently is lowering or raising the interest rate...
...Businesses create money in the same way when they take do wn their line of credit extended by their friendly banker...
...In the first place, you have to produce a lot before you have a lot to save...
...I regret to have to tell you that it is possessed by doctrines that might have made sense in the days of mercantilism but have nothing to do with a modern capitalist economy...
...Have they outperformed us because they sent their money to us...
...Who are the foreigners whose money is so important to us...
...Since the supply of most commodities is now indefinite, if not infinite, the supply of money has no substantial effect on prices...
...The increased interest rate will reduce economic activity, and reduced savings will follow as a consequence, not as a cause...
...For 40 years now the Reserve has been idiotically trying to control inflation by inflating the cost of doing business...
...We will be reminded that former Board Chairman Paul A. Volcker was tireless in arguing that interest rates had to rise to attract foreign money to finance our budget deficit...
...You can't save what does not exist...
Vol. 74 • October 1991 • No. 11
