Illegitimate Interest Rates Destroy Economies


“When you look at the mistakes of the 1920s and 1930s, they were clearly amateurish…It is hard to imagine that happening again—we understand the business cycle better.”

Those are the arrogant words of N. Gregory Mankiw, professor of economics at Harvard, as adviser to presidents Bush and Obama, on December 23, 2007.

I am indebted to Daniel Oliver of Myrmikan Capital, LLC, for his brilliant use of history to help us understand that not only is the quote above by Professor Mankiw an indication of hubris, but also that in fact EXACTLY the same mistakes of the 1920s and 1930s are being repeated again, only this time in spades! Dan’s 14-page August 17 article titled, “The Edge of Chaos,” as well as many other missives can be accessed free of charge here: If you have an interest in truthful economics I strongly suggest you go to that site and absorb as much of what you can that Dan provides because it will help you understand what is really going on in the economy as opposed to what the mainstream is brainwashing you into believing.

Because I think Dan’s August 17 article is especially important in understanding why the global economy is now boxed into an inevitable economic depression that will be as bad as, if not a lot worse than, that of the 1930s, let me pass along the major points I gleaned from this excellent article.

I titled my commentary, “Bastardized Interest Rates Destroy Economies,” because bastardized rates as opposed to “natural discount rates” are what we have today. As Dan noted, “The ‘natural discount rate’ is set by decentralized markets—it is the cost of capital determined by the supply of and demand for savings. Short of Utopia, demand is infinite; rates therefore, are determined by supply. As available savings increase, the natural discount rate falls.” Not that we ever lived in a perfect world, but before the invention of the Fed, natural rates were much more of a reality than they are today when the Fed openly suppresses interest rates at the expense of savers.

The classical gold standard ensured that “natural discount rates” were mostly a reality because paper money was convertible into gold at a fixed price on demand. If banks offered interest rates less than the natural discount rate, depositors would demand their gold and redeposit it someplace else or self-invest. The only way to stop the outflow of gold was to raise rates and vice-versa. But the classical gold standard came to an end when some very wealthy elitists decided they wanted World War I. The gold standard would have gotten in the way of financing a war, so once the classical gold standard no longer existed and once we entered what I can only describe as a bastardization of interest rates, with that has come a growing demise of the one system in the world that actually creates wealth—capitalism. Following are some of the main points provided by Daniel Oliver that I can’t help but pass along to you because of their importance in understanding why we are inevitably heading toward some horrific economic times. I will divide these points into two major headings, the first being The Kondratieff Winter ending in 1949 and the second being The Kondratieff Winter of 2000.

The notation of the long wave Kondratieff cycles is from my good friend Ian Gordon and his work, which identifies the long wave cycles outlined by Nikolai Dmitriyevich Kondratieff, the Russian economist who paid with his life for truthfully identifying economic cycles and their causes. But within those K-cycles, the bullet points below are from the above-noted essay by Daniel Oliver.

Kondratieff Winter Ending 1949

• World War I—the start of this bastardized monetary system. To finance World War I, most of the countries involved in the war quickly abandoned the gold standard, which allowed them to drive interest rates down. This prompted an asset bubble in the U.S. Still believing it out of place for the Fed to pump up asset prices, the Fed pricked the bubble in 1920 by selling U.S. Treasuries, which sopped up excess liquidity. The reason given by the Fed for the restrictive policy was, “bringing about more moderation in the use of credits, which a year ago were being diverted into all kinds of speculative and non-essential channels.” Commodities dropped by 43% and equities by 47% as overcapacity created from excessive money printing during WWI found no buyers.

• The U.S. begins QE1 in 1921. It should be noted that about this time, an important new idea about central banking’s purpose began to take shape. Central bankers at the Fed and BOE started to believe that central banks should become active in increasing or decreasing the money supply to “stabilize prices.” Previously the idea was that markets should set prices rather than a statist dictate from governments or central bankers. But, with prices depressed, the Fed was happy to accept its role of printing money to create “price stability,” which in this case meant pumping them up. So in 1921, the Fed had two motives for engaging in price manipulation. First was to help hurting producers of commodities and stock investors and secondly was to help out its number one foreign “friend,” the U.K. This was essentially QE1. It worked! The Fed’s Index of Industrial Production surged 49% and commodity prices soared over the next 18 months as artificial credit once again prompted excess demand to overbalance residual overcapacity.

• QE2 begins in 1923. After sucking up some money in the system by selling Treasuries to tame down the boom from QE1, with prices falling by 21% as a result of this latest restrictive policy, the Fed-engaged QE2 was somewhat effective, but not as much as QE1, because some of the money began to find its way into the stock market rather than into the real economy. Does that sound familiar? Then another tightening cycle began and commodity prices began to fall, in part also because excess capacity of prior cycles was prevented from being eliminated, thanks to meddling by the Fed in QE1 and QE2. Does that also sound familiar?

• QE3 begins: Britain pegs the pound artificially, relative to gold, and the Fed prints more money. Perhaps as much for nationalist pride as anything, Britain, under Winston Churchill, decided to peg the pound sterling to the pre-war gold price, which meant interest rates in Britain were a lot lower than elsewhere. British people were no longer able to exchange currency for gold but they could use their pounds to buy foreign currencies with much higher interest rates. To alleviate this flow of capital out of Britain, Churchill, Chancellor of the Exchequer, talked the U.S. Fed into printing huge amounts of money to lower U.S. rates, which the U.S. Fed did starting in 1927. This was the money printing that led up to the boom and stock market crash of 1927 as enormous amounts of money and speculation began to take shape in the U.S. stock markets, the mechanics of which are as discussed in Dan Oliver’s essay. Even before this latest stimulation, the average Dow stock was up 127% from 1921, while more speculative stocks were up by a lot more.

The Fed tightens in 1928, sending dominoes cascading down, down, down. To try to stop runaway stock prices on the upside, the Fed tightened aggressively in 1928, not because of economic conditions or commodity prices, but because it was spooked by asset prices. With the Fed tightening, commodity prices began to plunge in March of 1929 followed the infamous stock market crash of 1929.

• QE4 begins post 1929, the system implodes beyond the control of the Fed. Unlike in 1921, when the Fed kept rates high to liquidate the market, after the 1929 crash, the Fed immediately began lowering rates and buying government bonds to prevent liquidation of malinfestments—QE4 shown in the chart above. Then in 1931, the European banking system collapsed, sending rates soaring in Europe. Capital fled the U.S. banking system, which was then forced to match the high rates overseas. For that reason, QE4 petered out. Forty percent of banks in the U.S. folded. The Great Depression finally liquidated the overcapacity in long-term capital assets, the capitalists who owned them, and the depositors who had unwittingly financed them.

• That ended the Kondratieff Cycle that Ian Gordon identified as starting in 1896. It is clear that the best and brightest minds on Wall Street did not have control of the system back in 1928-29. They can look back and say, “We should not have raised rates in 1931,” but they were acting in the context of worldwide market conditions, similar to what we are looking at now, only the conditions of 2015 with all manner of derivatives and with the amount of money printing so much greater now, make the current system far more complicated and dangerous even than that of the 1928-29 era. At some point in time the system will break down and all of the mal investment that was not permitted to be liquidated, thanks to meddling central bankers, will eventually be liquidated. And when that happens, there will be a massive deflationary event that will clear the deck for the start of the next Kondratieff Cycle, as so clearly laid out by the work of Ian Gordon. I would strongly encourage you to visit Ian’s site as well as Dan Oliver’s site to study the parallels of both the last K-Cycle that ended in 1929 and the current one that I fear is very, very, very near its horrifying end. Ian Gordon’s Web site: As noted above, Dan Oliver’s work can be accessed here:


Dan Oliver starts out this section of his essay with the following: “The parallels between Federal Reserve policy in the 1920s and today are direct, emergent, and terrifying. Current overcapacity was not brought by war [at least not yet in a world war, as was the case in the last cycle], but the cause is the same: artificially low interest rates. Every time the mal investments attempt to liquefy, the Fed lowers rates: in 1992 to manage the Savings and Loan crisis, then in 1998 to bail out Long Term Capital Management, then in 2001 after the Internet bubble collapse, then again in 2008 to manage the housing crisis; all in the name of mandate to promote ‘price stability.’”

Indeed there are many examples of mal investment that look very much like those of the 1920s that the Fed is simply allowing to fester further and further, with the result that the system is continuing to dig itself deeper into debt, relative to income. The entire monetary system is now seemingly teetering on the brink. Here are some major points made by Dan Oliver:

• Bastardized rates led to massive mal investment by publicly traded companies in the 1920s. With margin rates at around 9%, companies were able to issue their own stock at a cost of 3%, which was the average dividend rate for blue chip companies prior to the crash. They would then take the money they received from the sale of stock and lend it out on margin to investors earning a 6% spread. Margin debt rose dramatically and was one big reason for stock price acceleration to the downside once equities peaked in 1929. Currently, with rates at ZERO or near zero, corporations are spending a huge amount of money to buy back their own stock and/or buy other companies. If I’m not mistaken, over the past day or two I heard that nearly two-thirds of equity purchase values are either for the purchase of their own shares or for acquisitions. With interest rates near zero, companies are not only impairing their own balance sheets but also spending money on assets that cannot be profitable when rates begin to rise, causing stock prices to plunge. It may benefit CEOs who cash in on their options, but it will leave long-term shareholders high and dry.

• Major mal investments in housing and autos, still. Major mal investment is also obvious in the auto industry where the average car loan is now over five years long. As customers cannot afford to buy cars, auto companies simply extend terms of credit, thus allowing consumers to dig themselves deeper into “debtor’s prison.” Same is true in the housing industry where housing prices were never allowed to fully reach their natural levels, thanks to artificially low mortgage rates and any number of other government programs geared to “price stability.” When rates start to rise there will be massive consumer defaults in both the housing and auto sectors.

BofA• The Fed may be losing control of interest rates. The Fed is clearly concerned about some asset prices. Yellen has said she is troubled by biotech and social media equity prices. But from the decision not to raise rates on September 17, I have to wonder if the Fed isn’t remembering 1931, when it raised rates to try to stem the flow of capital out of the U.S. due to international capital flow pressures. In addition, under the public radar screen is an economy that is not nearly as strong as the Fed and politicians want us to believe. Hence the notion that the economy is truly strong enough now to raise interest rates is in my view more of a PR face-saving propaganda effort than reality. The work of economist John Williams, for example, clearly shows that the U.S. economy has never even risen into positive territory from the 2008-09 debacle, if a truthful CPI were used to calculate real GDP. More troubling is the fact that there are signs now that the rates are rising with or without the Fed’s policy initiatives. As you can see from the BofA Merrill Lynch US High Yield CCC or Below Effective Yield chart, rates on junk debt have risen from 8% to 13.5% over the past year. This is an enormous increase in the cost of capital for marginal users of capital and may start to lead to massive defaults in the mining and energy sectors, which could in turn start a chain reaction of defaults throughout the economy.

• China is finished! To a great extent the boom in commodity prices up to 2011 was caused by massive monetary stimulation by China, which led to the construction of what are empty cities, as well as roads and railroads leading to nowhere. That resulted in a boom in commodity producing countries like Canada, Australia, and Brazil. But those empty Chinese cities, highways, railroads, and bridges to nowhere are not providing any cash flow from which to service the debt and that is now resulting in a massive outflow of capital. So the Chinese have reportedly seen $800 billion of capital drained out of China over the past year. China itself has sold $143 billion of U.S. Treasuries in the past three months alone, which is starting to raise the whole Interest Rate Complex, just as European turmoil in 1931 forced the U.S. to raise rates. This could be the most important development of 2015. Much of the excesses of spending by Americans over the past three decades was made possible not only by excessive money printing by our own Fed but also by the willingness of first the Japanese and more recently the Chinese to buy those Treasuries. But if the savers around the world no longer are willing to continuing to save in place of Americans who have been encouraged to spend more than they earn, the Fed will have to be the lone buyer of Treasuries, at least until it allows true market rates to prevail. This little noticed erosion in the debt markets may indeed be the most important market and economic inflection point.

• The U.S. and China in the same sinking boat? This brings the U.S. into a position very similar to the sinking boat as China is in. If the U.S. has to print money to prop up asset prices because there is no one left to buy overvalued assets (think stocks and bonds), that is exactly what the Chinese have been doing. China has the largest money printing bubble in history. That debt bubble was used to build ghost cities and the steel and cement plants that built them. They are worthless assets and so are the financial assets that represent them. Authorities announced they have organized $800 billion in private and public money to buy stocks to prop up the market. Just like a company, the government can buy up worthless assets by buying shares, but that doesn’t change the value of the asset. The Chinese government or the Fed can buy 50% or 90% of the assets, but that doesn’t change the value of the assets underlying the stock or U.S. Treasury and in the process undermining its own solvency. And with that insolvency will come a loss of confidence in the currency and the existing financial infrastructure.

• The case for gold. I’m not saying we are there yet, and I hope and pray we are never there because it will result almost certainly in a hellish environment. But I think the signs of the possibility of insolvency in the minds of Americans may be much closer, given the Fed’s refusal to raise rates this week. It is almost an admission that it is losing control as quarter after quarter it refuses to raise rates, for one excuse after another. As Daniel Oliver stated in his August 17 article, “When the entire credit system unravels, gold becomes the only refuge. Dollar holders can no longer redeem dollars for gold, but they can buy it in the market. When the Fed decides to ‘support’ the market by holding rates low—per above, rates define the market—and, as in 1927, they coordinate with other central banks to make sure money doesn’t leak out, the difference between the natural discount rate and the rate at which the Fed decides to peg rates will be the measure of how high gold will go in nominal terms, assuming it is still legal to own. When the $1 quadrillion derivatives pyramid starts to wobble, and the full cost of intervention becomes clear, the central banks abdicate, that is when gold will fly.” How high could gold rise? Daniel postulates a value anywhere from $5000/oz if we went back to the point where 29% of the Fed’s liabilities were backed by gold, to $22,700/oz based on the gold price of 1981 when with a gold price of $850, 133% of the Fed’s assets were backed by gold.

• A reason to own quality gold stocks. I believe it is entirely possible that we may not be allowed to own gold in the future because the government may want all the gold in the country to back a new currency that will be required when the system collapses. That is one major argument for owning gold mining companies of high quality. In the 1930s, when not turning in your gold to FDR’s fascist America was a felony punishable by a $10,000 fine and 10 years in jail, gold’s real price had risen dramatically, making mining companies like Homestake rise dramatically while the stock market was losing 90%. History never repeats but it rhymes. And the way things look to me as we end this current Kondratieff Cycle, gold shares may be absolutely the best asset class for the next several years. That’s not to mean you shouldn’t own gold and silver bullion as well, because unlike the 1930s, very few Americans own much gold and most of what the government and the Fed claims to own I believe may be in China, India, and Russia.

The bottom line for me is that while gold and gold mining shares are about as far out of fashion as any asset class now, when confidence in the system breaks down, gold and gold-related assets are likely to result in the most massive transfer of wealth from the Wall Street Casino crowd to those of us who still believe in the barbaric relic that the world has ever seen. The handwriting is on the wall. By disallowing price discovery for capital, the Fed and other central banks have destroyed the one economic system that has proven to create wealth rather than destroy it as fascism and socialism do. We can hope and pray that somehow the truth is discovered by existing policymakers. Indeed, Ron Paul did a masterful job when the was on Bloomberg this past Thursday with Tom Keene and Kathleen Hays to explain basically what I passed along here with the help of Dan Oliver and Ian Gordon above. But the odds are against that happening. Egos and entire careers would be ruined by admitting wrongful policies. And so most likely we are going to have to face some very important issues in the near future, for which we want to be prepared both materially and spiritually. Financially we want to be debt free and have cash, gold, and silver and, I believe for reasons noted above, we want to own quality gold stocks. Spiritually, we need to be in touch with our Creator who has given us life, liberty, and happiness. Even if that is no longer a goal of our government (it has chosen to “keep us safe” over allowing us life, liberty, and happiness), it can be attained through a relationship with our Creator. For that, consult your priest, pastor, or rabbi, who will be glad to help you.

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.