Rising Rates Spoil the Party

Gold Standard Institute's picture

I originally wrote this in September 2013. It is just as relevant now in December.


The big news in America is that the rate on the 10-year Treasury bond has risen dramatically from around 1.6% to over 2.9% [now on December 5, 2.84%]. This is 130 basis points from a starting point of 160, or an increase of more than 80%!

Interest Rate on 10-Year Treasury Bond

So naturally, the financial media are discussing the “essential” issues. They have commentators philosophizing about whether the tapering of Quantitative Easing is “priced in” (an invalid question, as I argue in my in the Theory of Interest and Prices). They credulously entertain the view that it signals “economic recovery”. If the economy were really recovering for four years, there would be no need for such hype.

On CNBC this week, Larry Kudlow’s guest was a sell-side analyst. He worried that either the absolute level of the rate, or the speed with which it has risen, will interrupt the bull market in stocks. Why is he concerned? Higher rates may discourage companies from borrowing to buy back their shares and issue dividends. I have previously written about this madness.

It is a strange politically correct world that makes it a taboo to say the simple truth. Unfortunately, freedom of speech in America is slipping—at least on controversial topics that matter. It may still be legal, but there is a very real chilling effect. In a crony system, one’s career is at risk to say the unpopular. So the gentlemen in the club safely confine their discussion to the M1 and M2 measures of the money supply, and the number of angels that can dance on the head of one pin.

Let’s take a step back from the noise. In the real world, every change in the interest rate destroys capital. To avoid this, firms hedge using derivatives. The good gentlemen in the club do sometimes acknowledge the derivatives problem, but never the cause, never why derivatives grow and grow and grow until they are now estimated to be approaching one quadrillion dollars. Those who sell these hedges must, themselves, hedge. They can push risk around and around in a circle of the big multinational banks. They cannot eliminate it.

Historically, the Federal Reserve has exhibited what I’ll call “bipolar interest rate disorder”. They vacillate between bingeing and purging. First they try to encourage the economy to “grow” by offering a buffet of too much credit, dirt-cheap. Then with pangs of regret if not guilt, they try to “fight inflation” by raising the price of credit. This leads to a bogus debate among economists: which evil should the Fed be pursuing at any given moment. Wall Street, of course, has a strong bias towards more credit, dirtier and cheaper. So do politicians seeking reelection.

Today, these two false alternatives are called “stimulus” and “austerity”. Fans of the latter sometimes fantasize about a mythological place, like Atlantis or El Dorado, called the “Exit”. Unfortunately, the Fed cannot sell their bonds. If they reversed from big buyer to even a small seller, it would reignite the very conflagration they fought in 2008. Leveraged market players would be unable to sell new bonds to pay their old bonds when due, and would therefore be forced into default. Talk of a Fed “exit” is a smokescreen.

Let’s take a further step back. The collapse of the Soviet Union proved that central planning doesn’t work. It can’t even deliver simple goods like food. The Fed is the central planner of something much bigger and vastly more complex. Money and credit are the foundation of our economy, and everything else depends on them.

The issue is not what the Fed should do next!

We should be discussing how to transition from irredeemable currencies to a free market based on gold without collapsing the financial system. I wrote a paper proposing how to do this. There may be others with good ideas. Let’s begin the discussion. Unfortunately, few want to risk their careers. I am not sure what would be worse: the cowardice of remaining silent in the face of a Big Lie, or the fact that saying the truth would indeed jeopardize one’s career in finance or economics.

We should be talking about the evolution of the Fed. Let’s not get distracted by conspiracy theories, stories about ancient banking families and creatures from islands with unfortunate names. And no, the Fed is not a “private cartel”.

The Fed began in 1913; it was the liquidity provider of last resort. If a bank needed gold, it could take Real Bills to the Fed, who would buy them at a discount. The government should have no role in the financial system at all, but Fed v1.0 was not the destroyer of markets as Fed v8.2 is today.

Subsequently, they began to buy government bonds. Incrementally, over many decades, the Fed evolved into the central planner it is today. Some of these steps were by presidential decrees, some were Acts of Congress, and of course the Fed took new powers for itself at opportune moments.

Today, there are many distribution channels, but the Fed is the only provider of credit of any resort. Should they cease issuing new credit, every bond market in the world would seize up followed immediately by the default of every bank, insurer, annuity, and pension. Despite the Fed’s record pumping of credit effluent, some bond markets are beginning to collapse anyway, along with the national currencies backed by those bonds.

We face a bitter dilemma. Without credit, large-scale production is not possible. The economy would devolve into medieval villages, with subsistence production done on family farms and workshops. On the other hand, continuing a system based on ever more counterfeiting will destroy more and more capital until the economy collapses.

Markets are being slammed back and forth between “austerity” and “stimulus”, between credit contraction and credit expansion. The number of units of the Fed’s credit paper required to buy an ounce of gold has long been rising. In other words, those units of credit were falling in value. But in the past few years, one has needed fewer of them to trade for gold. One day, traders are borrowing freely to speculate in the markets, driving prices up. The next, they are squeezed in a vice, desperate to roll over their liabilities, or if they cannot, to sell assets, especially assets that do not have a yield.

In conclusion, here is what I think the Fed should do. The Fed should go on buying bonds and doing what it has to do to keep the system going. No one wants the system to collapse. We should all be clear that the Fed is doing nothing more than buying time.

We need to use that time to transition to the gold standard, to begin the process of gold and silver to circulate, to develop a market for lending and borrowing gold. We need to repeal the capital gains, VAT, GST, and any other taxes that make it impractical to use gold. We need to repeal laws that force creditors to accept paper as payment in full. We need to develop the institutions such as gold banking and Real Bills.

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Tinpony92's picture

"What would the 10 yr rate be without QE I wonder?"

Ironically the answer to that Q is quite possibly lower. The yield on risk assets however would have been much higher..In a normal, unmanipulated market where debt was written down and/or restructured properly, and where markets were allowed to clear at equilibrium prices, the resulting deflationary shock would have been $ positive and the US treasury mkt would have benefited from safe haven staus and the resulting flight to quality (no sarcasm intended).

Unfortunately that cannot be allowed to happen as it would ruin Wall Street, the highly leveraged, and those with access to power and money (high sarcasm intended). Much better to re-inflate asset prices and keep the party going while presiding over the increasing polarisation of society from a safe distance

We know where this ends. Article below published in The UK Telegraph recently and really worth a read...



deerhunter's picture

but will you trade your venison for a half hour dentist visit or will the dentist accept your venison in trade?  As it is lillegal to sell wild game in most states I imagine the powers that be would quickly eliminate the ability to barter said venison with my dentist.  I have exchanged silver this year for some services performed with a pool service and some internet work for my business.  I am heading to the woods this afternoon to increase my venison supply for the winter with my bow.  It is long john weather here in the midwest but hormone and anit biotic free meat,,,, priceless.  Also,  sitting in the woods is my escape from market madness.  

mess nonster's picture

If you are even thinking about getting dental work done outside of Obamacare, you're already deep into the black market for medical care, so, at this point legality is only a matter of making sure you and your dentist don't get caught.

That means that you keep your mouth shut (no pun intended) about who fixes your teeth. No bragging, because the guy could go to jail, and so could you.

if you are at a party and yawn, and someone says, "Holy cats, I haven't seen that kind of quality dental work for years! You have all of your natural teeth, no gaps or stainless steel! Where did you get it done?" 

If that happens, you'll have to demurr. Tell them you don't know what they are talking about. That you have been on the list to see a govt dentist for seventeen years, and all you can say is that you have good genes and practice very good dental hygiene.

dcj98gst's picture

Ten year getting close to 3.0%.... tick tock.

Skin666's picture

Nice article.


I think the answer is here already.


Cryptographic money, and then once the governments are destroyed, a free competition between crypto, electronic gold, silver, and other free market monies...


Crypto even ties in with FOFOA's freegold thesis. If you'r looking for a scrip system to facilitate free-gold, you need look no further than crypto. Trade in crypto, save in Precious Metals

PeakOil's picture

Yes decent article. The only thing I would argue about is the "bitter dilemma" part. It's not a "bitter dilemma". Rather it's a matter of survival and inevitability. The expand forever debt money paradigm is quite simply over. Done. Finished. A return to asset backed deflationary money is inevitable.We are destroying our home. this beautiful planet, with a monetary system predicated on endless growth. This is insanity! And not sustainable as the usury "endless growth" model was built in the era of cheap plentiful fossil fuels and relies upon "cheap" (in EROEI-terms) and readily usable energy. That time is no more. The 20th century was an aberration.

Cryptocurrency is an idea whose time has come. Never mind waiting for the "powers that be" to get their shit together to decide on "the next world monetary system". Who cares? The market is deciding in real time as we speak. National currencies and indeed the current notion of the bloated "nation state" are in for a radical overhaul. Yes I also see future "money" as a combination of crytpocurrencies and good old PMs. The latter returning to their rightful place as exchangable stores of value once the jackboots of the state are removed from their throats.

mess nonster's picture

Oh my God! Another voice of sanity, and all in the same day!

Ying-Yang's picture

"Bring on the medieval villages!! I'll trade my venison for your fresh fish. Oh and I am putting in a new gate to the farm replete with spikes topped with banker's heads."

Ah yes.... we yearn for better times. Will zombies eat dead heads?

cro_maat's picture

We are the zombies and yes we will eat dead heads. I have a special recipe and sauce that I secured in Chinatown for just such delicacies.

cro_maat's picture

"We face a bitter dilemma. Without credit, large-scale production is not possible. The economy would devolve into medieval villages, with subsistence production done on family farms and workshops. On the other hand, continuing a system based on ever more counterfeiting will destroy more and more capital until the economy collapses."

Bring on the medieval villages!! I'll trade my venison for your fresh fish. Oh and I am putting in a new gate to the farm replete with spikes topped with banker's heads.

ItsDanger's picture

What would the 10 yr rate be without QE I wonder?

mess nonster's picture

16-18%, only no-one would care, because we'd all the wandering the smoking, abandoned ruins of our civilzation, looking for scraps of food, and evading the roaming packs of cannibalistic zombies.

Fishhawk's picture

The use of unbacked money substitutes (endless zero-cost credit) has allowed the current cycle of boom/bust market manipulation which facilitates the harvesting of real assets using no-cost paper leveraging.  This process must continue until the banksters own everything (/s).  If the banksters succeed in robbing the world of all its productive assets, thus perfecting the ultimate nirvana of living forever on the interest extorted from all production, the producers will all leave for Galt's Gulch, and the system will collapse (see Soviet Union 1991).  So we need to do ourselves a favor here and begin to introduce some real money (bitcoin, free gold, whatever) to loosen the death grip that debt money has on the real world.  The author understands that the criminals running the current scam will not look kindly on those who suggest it is not a sustainable system, but someone has to step up and call bs on the current crime scheme.


moneybots's picture

"In conclusion, here is what I think the Fed should do. The Fed should go on buying bonds and doing what it has to do to keep the system going. No one wants the system to collapse. We should all be clear that the Fed is doing nothing more than buying time."


The housing bubble bought time.   CRASH.  No one wants the system to collapse, except those who want an end to the financial fraud and criminal prosecution of those who participated in it, as a collapse is the only thing that will bring about needed change to "fix" the system.

Ongoing financial fraud is unacceptable, as it IS destroying the system. 

mess nonster's picture

Finally an article that harkens back to the good old days on ZH, before po-up ads for Beyonce perfume littered my screen.

This was a evry good article. Of curse the Fed is buying time, and I'm all for it. Look, if youre dying of thrist, and you stumble upon a parasite infested waterhole, what are your choices? You can die now of thrist, or take your chances later with dysentery.

Like the man said, what is the diference between a derivatives hedge that is essentially insurance on an abandoned house full of bare electrical wires and oily rags, and speculation based on credit- speculation that depends on higher prices tomorrow to pay yesterday's debts? But the speculator doesn't care because he's hedged himself, and all he has to do when things get dicey is turn the power on in his abandoned house.

Frankly, I'm putting my time into making my village self-sufficient in food production and in making sure we will be able to have subsitence levels of production, so that our basic needs, food, clothing, and shelter, can be met with local skills and local resources. It's called "community resiliency", and it's harder to make it happen than you'd think. 

Overfed's picture

LOL! Recovery! Yeah, right.

falak pema's picture

when ze taper of ze taper beeekums zee zipper of the interest hike ve kan zen reeeelly taper...furst ve muzz ze zipper to klose-eh.

SAT 800's picture

Good time to short the 30yr. T-Bond contract on the CME. It's a contract on price, the price goes down as the interest rate goes up. It's in a well established bear market; on a kind of plateau; might be trending all next year. Hard to see how it could not be. Closest thing to a market saying "here, have some free money'; that I've seen in awhile.

Chris Jusset's picture

With Treasurys are at 2.8% and crude oil at $99/bbl, this party is winding down!

Chris Jusset's picture

So when will all these bubbles begin to pop?