Re: Refuting supply-side economics

From: Larry Innes (larryinnes_at_yahoo.com)
Date: 09/15/04 

Date: 14 Sep 2004 21:31:26 -0700

bc76@midmaine.com (Some Guy) wrote in message news:<667d0677.0409141315.5815be5b@posting.google.com>...
> larryinnes@yahoo.com (Larry Innes) wrote in message news:<ccf8cf06.0409131638.66cae03d@posting.google.com>...
default.

> > The US government has been robbing blind in the last few years.
>
> Robbing who blind?

The US citizens who saw high inflation in gasoline and home price but
the government intentionally left these items out from the CPI to
underestimate the inflation. There is a thread in this forum
discussing that the residences in San Diego felt the pressure of
inflation, but the government claimed that the inflation was low.

When the Fed sets discount rates lower than inflation, it influences
the range of interest rate Banks give to the customers. When average
short-term interest rate is 1.5 while inflation is 3 to 4, the
government and the Banks as a whole robbed the people blind.
 
> But even if you borrow money for free overnight to buy a 10 year
> security, there is still the small risk that you will have to pay
> slightly more interest tomorrow to renew your loan, and substantially
> more by the time the bond matures. You could sell the bond before it
> matures if interest rates rise, but it would be worth less than before
> the rise in interest rates. You would lose money that day. Maybe
> tomorrow you'll sell the bond, renew your daily loan and buy a private
> sector loan, yeilding more interest.

Not when interest rate is falling like the last few years. The period
of time when the interest rate is falling slowly is the heaven for
carry traders. A bank can pay 2% to the deposit of its customers and
buy 10 year Treasury for 6%. When the rate falls to 5.75%, the bank's
6% Bond increases in value (since it has higher coupon). Thus the
Banks can keep conducting the carry trade in this falling interest
rate environment.
 
> That someone buys Treasury Securities by leveraging their capital
> doesn't hurt the Treasury one bit. Their money is as green as the
> next person's.

The question is how a government can get others to buy its bond at
lower than inflation rate. The following article explains how Fed was
able to do this because another nation (Japan) has lower inflation
rate.

_____________________________________________________________________

Japan Sells 1.9 Trillion Yen of 1.6% 10-Year Bonds

- Bloomberg, September 2, 2004

   Editor: The US sells 10-Year bonds to Japan at 4.11 per cent. This
difference of 2.51 per cent in interest rates provides Japan with
arbitrage profits.

   On June 30, 2004 we asked this important question: 'What yield
would a 10-year fixed rate Treasury bond need to provide an individual
investor in order to justify a purchase held to maturity?'

   Because risk over time cannot be quantified, readers realized that
this was a very hard question to answer. Correspondence I received
mentioned that 10-Year Treasury yields ranging from seven to 15 per
cent, held to maturity, would be attractive to the individual
investor. The Treasury does not pay the average individual US investor
enough yield to justify holding a 10-Year treasury bond to maturity.
The bid price is way below the ask.

   Why then would the 10-Year Treasury yield far less than the
risk-adjusted expectation? The answer, of course, is Japan. The bid
and ask prices have been set across the Pacific Ocean between borrower
government and creditor government - between the United States and
Japan.

   To the Japanese government, any rate received from US Treasuries,
10-Year or otherwise, will be much higher than the interest rates set
for borrowing money from its domestic savers. Money can be borrowed on
the cheap from domestic Japanese savings deposits.

   The deposited savings (banking liability) can be used to purchase
US Treasury bonds (banking asset). The difference between interest
earned and interest paid is profit. Japan makes a profit on every
dollar purchased via US Treasury bonds.

   Unfortunately, Japanese savers are not getting enough yield to
justify the risk of default. Perhaps for this reason, I have not seen
it acknowledged elsewhere that a profitable interest rate
differential, or arbitrage, exists between Japanese savings and US
borrowings.

   For this scam to continue to work, the Bank of Japan must keep
domestic savings rates low and the yen weak. I believe that without
Japan, the 10-Year would be yielding between seven and 15 per cent.
Long ago, individual US investors collectively had enough savings to
purchase domestic treasury instruments at a fair rate of return.
Priced domestically, the US 10-Year rate should not be anywhere near
its current level of 4.11 per cent.

   The reward-to-risk ratio has been mis-priced to risk. It has been
priced instead to the deflationary context of Japan. In effect, the US
has been importing Japanese deflation.

   The US has been living high on the Japanese savings hog. It has
been enjoying the deflation of cheap money much in the same way the
country enjoys the deflation from cheap goods from China.

   Some specifics: the government-run postal savings system of Japan
manages about three trillion dollars' worth of savings. Some unknown
percentage of those deposits (banking liabilities) eventually find
their way into US Treasury instruments (banking assets) to provide
Japan with a return on investment.

   The US runs such large deficits that it needs buyers for its
Treasuries willing to accept a rate of return that does not compensate
for risk. If the 10-Year Treasury rate were set between seven and
fifteen per cent, the US would suffer an immediate fit of bankruptcy.
The side effects of folly lurk in the background.

   Up to now, Japan comes ready made to accept unlimited amounts of US
debt. In turn the purchase of US Treasuries by Japan establishes and
buttresses demand for US dollars and weakens the yen.

   US dollar purchasing power relies almost entirely on the difference
between interest rates in Japan and the higher rates in the United
States.

   Let's recap: Japanese savings are invested in banks; banks purchase
Japanese Treasuries; the Bank of Japan buys US Treasuries yielding a
relatively high rate of interest and thereby making a profit.

   It is an intentionally contrived relationship that skims value from
savings and encourages unproductive debt and investment. It puts
Japanese savings at risk for the benefit of the US government, the US
consumer, the Japanese worker, and politicians everywhere. Everyone
gets a piece of the action. Risk is igno so the United States has
access to imported savings at below market cost.

   Not one but two major deflationary forces are at work in the world
today. These forces are labor deflation from China and (as mentioned
above) imported monetary (interest rate) deflation from Japan. The
side
effects are showing because these deflationary forces are stripping
jobs away from the United States and compressing global economic
activity and interest rates. The global economy has become more and
more 'finance' centric as a result.

In summary, interest rate differentials:

   (1) allow the United States to tap Japanese savings;

   (2) provide the Japanese treasury and banking system with the
opportunity to make arbitrage profits;

   (3) weaken the Japanese yen, which in turn provides the domestic
Japanese economy with jobs;

   (4) establish Japan as the only buyer capable of absorbing US debt;

   (5) put an artificially low cap on US long-term interest rates,
thereby enabling the US to borrow obscene amounts of money and service
its debt;

   (6) enable finance-based US economic activity, including
artificially low long-term rates, to be used to facilitate mortgage
lending;

   (7) make the United States an importer of Japanese monetary
(interest rate) deflation, and;

   (8) support the US dollar.

   Can this monetary (interest rate) price-fixing and skimming
relationship remain in place indefinitely?

   I don't think it can, because risk will surface over time - the
same risk that has not been priced into US debt. Governments cannot
manage the bids and asks of free markets without causing systemic
distortions that eventually break (see communism).

   But in the meantime, I believe the JPY/USD relationship and carry
trade can provide clues as to the global financial outcome.

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