August 15 and economic culture

Publié le par Jean-Pierre Chevallier

On August 15, everyone is on holiday, or almost.
On August 15, it does not occur anything, or almost.

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On August 15, 1971  Richard Nixon decided to remove the free convertibility of the dollar in gold.

For the first time in the history of humanity, the currencies were not defined any more compared to goods, but the ones compared to the others. Their value and their parities depend on the confidence which one has or which one does not have towards them.

On August 15, 1971 was a considerable progress in the history of humanity. The economists who advised Richard Nixon were right. This measurement was criticized by others as for example by Friedrich Hayek who predicted in the Seventies that the financial American and world monetarist systems would collapse within a time lower than 20 years.

They were wrong. There are goods and bad economists, and good economists can be mistaken. The markets and the managers of central banks very well knew to finally solve all the difficulties which arose thereafter.

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On August 15, 2007,  at the end of the day, the 3-month plunged from 4.48% to 4.08%, which means that the markets very well understood that the short rates were to fall at 4.0%, the long rates (10-year) fluctuating around 4.5%.

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Figure 1: http://s3.archive-host.com/membres/up/2107676425/20070816US1FF2Y10Y06.gif

This structure of the rates is in the standards. It also corresponds to a normal growth, i.e. to its optimal potential.
The rates should fluctuate in a band from 4.0 to 4.5% like 2002 to 2005,
Figure 2: http://s3.archive-host.com/membres/up/2107676425/20070816US2FF2Y10Y02.gif

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The markets are right, the Fed is wrong, to maintain its rates at 5.25%… but with some reservations…
If the central banks did not exist, the markets would establish short rates at 4.0% what would be catastrophic because this situation would be inflationary in the long term. Indeed, the profit of the companies increase by 5 to 7% (historically, around 10% since the latter 20 quarters!), which creates a hidden inflation which becomes not easily controllable thereafter as that occurred in the Sixties (the increase in the benefit involves an abnormal increase in the money supply in M3-M2).
The central banks are right to maintain against the markets the rates higher than their neutrality to cut any risk of resurgence of inflation. The members of the FOMC are right thus to maintain high rates, but they are wrong to maintain them so high!

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By lowering their basic rate at 4.5%, the Fed would restore (will restore?) a normal structure of the rates ensuring the growth its optimal potential.

By maintaining its target at 5.25%, it maintains a risk recession which feeds the volatility of the markets and the collapse that I announced.

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The specialists in markets (analysts, strategists, economists, etc) predicted (almost) all the maintenance of rates raised in the long term. They were wrong. I was right (I was not only!). An economic minimum of culture makes it possible to control these problems…

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