Let Chinese Taxpayers Pad Your Wallet

Aluminum producers got tricked by their own government!

You see, low rates mislead producers into believing there are more savings than really exist to buy their products. So they expand capacity.

This is exactly what we just saw happen in China (as we’ll explore below)…

Then, when central banks tighten — and artificially low rates rise — producers discover that demand during the period of manipulation was not artificially high. They respond by slashing prices, especially if they borrowed to expand capacity.

Finally, central banks respond to the pain of popping bubbles (which they created) with another round of easy policy. And the cycle repeats on a larger, more damaging scale…

Right now in the U.S., the Federal Reserve believes it can tighten, and that the artificial boomlet in rate-sensitive sectors will adjust without a hitch. Wrong.

Japan is much further along in the process of its central bank ruining its economy. Zero interest rates policy cannot be exited without liquidating the financial system and bankrupting the government. Simple math tells you that Japan cannot tolerate even a tiny increase in interest rates. And the longer zero interest rate policy goes on in the U.S. and elsewhere, the less tolerance the economy will have for rising interest rates.

The mainstream view says the Fed has everything under control. This view won’t even acknowledge the Fed’s central role in fueling a U.S. housing bubble that could never have grown so ruinous without manipulated interest rates. Using the following logic, Jon Hilsenrath from The Wall Street Journal chides Fed critics:

“For years since the financial crisis ended, critics have warned central bankers that their low-interest-rate policies risked pushing consumer prices much higher as they flooded the world financial system with money.

“But weak demand in many developed economies, combined with excess supply in places such as China, has hampered firms from raising consumer prices.”

As an unbowed critic of central banks, I don’t subscribe to the conventional (Keynesian) view of how money printing stimulates economies. Hilsenrath cites the excess supply of aluminum, noting that there is excess capacity and falling prices.

In his article, Hilsenrath doesn’t ask the right questions, like: Why did aluminum producers originally add more capacity than the market could realistically absorb?

To find the answer, let’s go backward in time.

At the root, we find state-directed lending in the Chinese banking system. The central bankers and politicians responsible for the Chinese credit bubble overrode the delicate information (including interest rates) that must exist between producers and consumers to balance the market. The result of Chinese central planning is chronic overcapacity in many areas of production, including aluminum.

The Keynesian view, which, remarkably, still has credibility, goes like this: The Fed injects reserves into the banking system, which in turn are “loaned out,” thereby starting a cycle of borrowing, spending and growing demand. Then, the economic “machine” overheats, and consumer prices rise. The key, faulty assumption is that economic growth causes rising consumer prices.

That narrative is hogwash. Genuine economic growth involves cost-saving advances in productivity, healthy levels of competition and downward pressure on consumer prices.

The Austrian economic view, grounded in logic and reality, acknowledges that free markets result in the least damaging imbalances. Imbalances correct quickly when the market is allowed to work.

But instead, in today’s global economy, activist governments and central bank officials change things they don’t like about markets with brute force. Why are these officials surprised when they see that their heavy-handed manipulations have consequences?

The end result explains the mass frustration with today’s economy: shortages here, surpluses there and an inflexible, stagnant global economy that’s become ever more addicted to low interest rates and deficit spending.

As for the stock market, it’s likely to remain weak until the Fed realizes it can’t taper any more, and returns with even more stimulus to prop up the imbalances it has created in the past.

Best regards,

Dam Amoss, CFA
for The Daily Reckoning

Ed. Note: Central banks the world over remain committed to “stimulating” the economy, no matter what it takes. More often than not, they believe that means adding liquidity to the system. And as they perpetuate this cycle, patterns begin to emerge… That’s where Dan Amoss comes in… For a select group of subscribers, Dan Amoss is able to navigate the turbulent markets that rely so heavily on central banks, and show them specific ways to profit no matter what happens. Sign up for the FREE Daily Resource Hunter email edition – where this essay was prominently featured – to learn how you can grab this type of advice for yourself.

You May Also Be Interested In:

Dan Amoss

Dan Amoss, CFA, tracks aggressive accounting and other red flags that markets miss. He’s a student of the Austrian School of economics and Daily Reckoning fan since 2000. Agora Financial relies on Dan for macro market commentary as well as profitable plays like his 2008 call to readers to buy Lehman Bros. puts, which...

View More By Dan Amoss