Thomas Tooke

The unique purpose of low interest rates: Fund the government debts, concept of risk free upside down, usurpation of interest rates mechanism

In Inflationary Period of 1913-1920, Unreserved Banking on April 27, 2012 at 2:31 am

As Kemmerer further explains in 1920, the main purpose of low interest rates was to fund the government and it was dearly paid by the citizens of the United States through steep inflation.

[…]

In their laudable desire to keep interest rates low on bank loans to essential war industries, and more importantly, to make possible the floatation of large government war loans at excessively low rates of interest, the federal reserve authorities adopted a policy of low discount rates for the federal reserve banks and of preferential rates and great liberality for advances made on the security of government war obligations. Throughout the entire period of our belligerency the loan and discount rates of the federal reserve banks were below the market rates, and “the market was in the federal reserve banks.” Funds received by banks for the government through the sale of liberty bonds and short-time certificates were usually left for a time on deposit with these receiving banks at the low rate of 2 per cent interest and without reserve requirement. This policy greatly expanded deposit credit. When the deposits were called by the government the funds for meeting the calls could readily be obtained by the bank´s borrowing from its federal reserve bank either by the rediscount of war paper, or by a direct loan collateraled by government security; and the rates charged for these loans were usually enough lower than the rates paid to the banks by the customer for his advance used in buying the bonds to yield the bank at least a small net profit. The result was the piling up of many billions of dollars of liberty bonds and certificates of indebtedness in the commercial banks of the country and the federal banks, particularly the latter, in the form of collateral for loans.  Federal reserve banks loans so collateraled provided member banks with a continuously increasing supply of legal reserves for further loan and deposit expansion; and the expansion of federal reserve loans, with resulting increase in federal reserve deposits and issues of federal reserve notes was continually reducing the percentage of reserves held by federal banks. We bough our low interest rates on government paper at the price of very high prices for commodities. We kept interest rates down by a policy that kept pushing the price level up.

[…]

I will add a few personal comments here. This paragraph is important because a lot falsehood commonly held as “truth” are revealed here.

First on the issue of central bank as an independent entity. It appears that without re-discount from a federal system there would have been no demand for war bonds (treasuries), hence the conclusion is that the Federal Reserve was there to facilitate the low borrowing costs of the government.

Second the idea that the Fed must set interest rates is heavily fought by this author in 1920 as we will see later. He actually complains that “the market is in the Federal Reserve banks” instead of being in the real market.

The great fallacy of risk free rate on government bonds has the following origin. In order to maximize the flooding of government bonds in the banking system, the reserve requirements are 0. The legal requirement has nothing to do with the risk.  It is an upside down concept ignoring the agenda of the government.

The Federal System by treating government bonds very liberally without regards to the good bills doctrine but purely by political imperative, results in expansion of credit based on the re-hypothecation of government bonds with artificially low rates.

 

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