Inflationomics

What Happens When Governments
Manipulate the Markets?

In today’s world, where market information serves not only as a signal to buy or to sell, but also as an overall indicator of economic health and direction, accurate information is more important than ever. Of course, that hasn’t stopped almost every country in the world from meddling in the calculation of indicators and the economic affairs of its citizens.

The United States (primarily by means of the Federal Reserve Bank) manipulates interest rates, buys and sells financial instruments, and carefully defines (and re-defines!) words to make decision-making metrics like unemployment look better. The European Union goes a step further, with negative interest rates. China takes it even further, openly telling its brokerages what they should do while instructing them to monitor their clients and prevent “unusual activity.”

What happens when governments manipulate the markets? Let’s look at a few recent examples of government intervention.

In the United States, we have the bailout of GM. I wrote about this earlier in “Too Big to Fail,” but essentially, GM was consuming more than it was producing, and market forces would ordinarily have driven it into bankruptcy. The government intervened with tens of billions of taxpayer dollars to keep it from going bankrupt, subsidizing a company that was providing negative value with money that taxpayers could otherwise have spent on companies providing positive value. If you believe the Center for Automotive Research, the bailout “saved 1.2 million jobs and preserved $34.9 billion in personal income and social insurance (Social Security, Medicare) payments,” but they fail to note that all that took place at the cost of an unknown number of jobs and incomes/tax revenues that could have been created elsewhere instead if the bailout money had remained in private citizens’ hands.

Second, there was the housing bubble of 2008. The government had issued a regulation called the Affordable Housing Act, requiring banks to meet a quota of subprime loans (read: loans to people who wouldn’t otherwise qualify for loans). The government increased enforcement of that regulation through Fannie Mae and Freddie Mac, and proudly claimed responsibility for taking home ownership to historic highs. Then, as soon as everything crashed, it stepped back and let the “free market” take the blame for “predatory lending.” An economics professor examines the crash in more detail here.

Our examples show that whenever a government tries to “manage” or “steer” economic activity, it often succeeds in bringing about not only its goal, but a host of unintended consequences as well—consequences which may or may not wipe out any good caused by the original intervention.

Consider the EU and what this concept means regarding interest rates, the rates that tell the market how much future money is worth.

A high interest rate makes it expensive to borrow money and focuses on long-term gain, putting an emphasis on saving now and spending money later. A low interest rate makes it easy to borrow money, putting an emphasis on spending now and (if one is smart) using that spending to create more money to pay the loan back later. But what happens when interest rates are negative, and you have to PAY a bank to keep your money? If you realize what’s going on, you’ll do one of two things: either you’ll spend as much money as you can RIGHT NOW, because having money costs you money, or you’ll stop using banks because at least keeping cash under your mattress doesn’t cost you anything.

If you’re really clever, you’ll even go to the bank for loans, because then they will pay YOU to spend money you borrow from them. Unlike before, there is no incentive to spend that borrowed money on something that will create more money to pay the loan back, because again, having money costs you money. In fact, negative interest rates incentivize being poor! Unless you have strong feelings against being in the red or believe in paying your debts, you’ll probably just keep spending for as long as they let you borrow. Borrow enough, and you might even create some income you can spend on other things!

How is that sustainable? We’ll most likely see, sooner or later, that it isn’t. But it may take a crash to actually see it, because another false metric is our use of Gross Domestic Product as a measurement of economic health, without regard to how much the government is spending beyond what it is taking in.  This obfuscates the economic health issue until it is too late for people to prepare for what is coming.

And then there’s China. China’s approach to markets is, in many ways, antithetical to the United States’. In the United States, you’re assumed able to do something unless the law forbids it; in China, you’re assumed forbidden to do something unless the law specifically allows it. China carefully tries to control its entire economy, and unlike the United States, doesn’t limit itself as to the kinds of interventions it makes.

It not only controls interest rates and currency valuation, but freely tells key players in the market what they should or should not do. Most of the people will do what the government wants, and will hesitate to do anything it does not expressly allow. The government, of course, can only act on the metrics it collects information about, and in aiming for certain metrics, can have the same problem the United States had in 2008.

So, what does this tell us about the United States, the EU, and China? All of them are meddling in forces they cannot truly control, and all of them are going to cause their citizens untold economic trouble and disruption. In trying to manipulate metrics and look good, they will disrupt indicators (be it interest rates, unemployment rates, or prices) that citizens use to determine what they should do.  This causes malinvestments that eventually need to be “corrected” by the market–often in the form of a crash—or multiple crashes.

What can we do? Reduce the government’s control over our economic lives as much as possible. Don’t vote for people who want more regulation. Buy things the government can’t easily control, such as gold, silver, and crypto assets. Most importantly, pursue financial education (buy books by rich, productive people and read them), so that we can become wealthy instead of being dependent on our government. If we take financial advice from one or more other people, make sure they’re going the direction we want to go financially, and that they practice what they preach.

Remember:  government statistics are not accurate indicators of economic health.  And governments meddle in economic affairs, generally with unintended consequences, usually to the longer-term detriment of their citizens.

Roland F. Sennholz

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