Gerald Epstein: The big banks will benefit from higher interest rates in emerging markets but this does not benefit the US economy. - January 29, 2014
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Gerald Epstein is codirector of the Political Economy Research Institute (PERI) and Professor of Economics. He received his Ph.D. in economics from Princeton University. He has published widely on a variety of progressive economic policy issues, especially in the areas of central banking and international finance, and is the editor or co-editor of six volumes.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore. And welcome to a new edition of The Epstein Report with Gerry Epstein, who comes to us from the PERI institute in Amherst, Massachusetts. Thanks for joining us, Gerry.GERALD EPSTEIN, CODIRECTOR, POLITICAL ECONOMY RESEARCH INSTITUTE: Thank you, Paul.JAY: Gerry is the codirector of the PERI institute there. So on Wednesday, Gerry, the Fed announced it was going to continue its--what they're calling slowing down of buying American Treasury bills. And we can quickly (I'll let you do it, 'cause I think you're going to do it better than I do it) explain the dynamic of why slowing down the Fed's purchase of Treasury bills will tend to raise American interest rates. But they did. And the reaction on the stock markets was pretty dramatic. The stock market fell hundreds of points. But more importantly, in places like Turkey and South Africa and Argentina, these markets apparently are going into a certain amount of crisis. Turkey raised its interest rates to--what?--from 7.75 percent to 12 percent. So let's start from the beginning. Just quickly, what exactly is this quantitative easing? And why does lowering the rate of purchasing of American T-bills by the Fed, why does that lead to higher American interest rates?EPSTEIN: So, yeah, the quantitative easing is when the Federal Reserve essentially prints money and then buys Treasury bills and mortgage-backed securities and other things like that. And they've been doing about $85 billion a month and are now tapering--what they call tapering it down to $65 billion a month. And by doing that, they're putting less money and credit into the economy. And when there's less money and credit in the economy, that tends to raise interest rates. And hence you've seen a big shift in financial markets here in the U.S. and all over the world as a result of this expectation that both short-term and long-term interest rates are going to go up.JAY: Now, if I understand correctly, there are several consequences to this. First of all, a lot of people that are buying stock are borrowing money to buy stock. So if they think interest rates are going up, the amount of profit or margins they're going to make on their stock purchases may go down, and they feel this is all riskier, so they start to pull out of equities, and that starts the stock market falling. Is that a correct--?EPSTEIN: Yeah. So that's one force that's going on. And the other is that with interest rates rising on other kinds of assets, they'll take some of the money out of the stock market and put it into some of those other kinds of assets and try to get a higher rate of return that way. So that's one of the things that's causing this shift from the stock market into other kinds of financial assets.JAY: Now, one of the things that was supposed to happen with all this quantitative easing and lowering interest rates was loaning money at practically zero to the big banks, the theory being that they would take that money, invest it in the American economy, except that isn't very much of what's been happening. There's been very little lending. The banks have been sitting on a lot of this cash. But one of the things they have been doing is what they call the carry trade or hot money, where they take the money and they go to the emerging markets, whether it's a Turkey or a Brazil or in Argentina, anywhere where they can get high interest rates--and it's a crazy thing: they get essentially free money here, and they go and make money over there. But those emerging markets were always so concerned that the day would come when they would just pull that money out and it would be so destabilizing that it would just--it would cause a crisis. So that day has sort of come.EPSTEIN: Yeah. That's right. So the banks have been, instead of lending to small businesses and investing in manufacturing firms and other kinds of firms that can help the economy grow and that can help generate new jobs, they've done a combination of just sitting on the money--and their excess reserves are at a historic high. But then they're also using that money as collateral to borrow other money and invest in all kinds of speculative investments, including in emerging markets. And so this flooded those markets over the last couple of years and caused their exchange rates in Turkey and Brazil and elsewhere to go up. And now, with the tapering going on and the expectations of higher interest rates, there's capital flight, massive capital flight, from India, Argentina, South Africa, Turkey, causing their exchange rates to plummet and forcing their central banks, as you said, to dramatically raise interest rates to try to keep that capital from leaving the country. So this is leading to a lot of financial instability, not only here in the U.S., but also abroad.JAY: So if you ask--and I'm going to ask the question of why did the Fed slow down these purchases. I mean, one of the reasons--I shouldn't say one of the reasons, necessarily. I'll leave that to you to say. But certainly one of the benefactors of this is the people in the carry trade. If you're trying to make money out of the Turkish bond market, you're just going to--you just made a killing. You went from seven and change to 12. So, I mean, it's certainly going to benefit those people. But why did the Fed do all--why are they doing this? EPSTEIN: Well, I think there are a couple of reasons. One is--really has to do with Ben Bernanke and politics. I think, you know, this is--he's leaving and Janet Yellen is taking over, and this is his last Federal Reserve meeting. And I think he just wanted to leave as his legacy the idea that he could pump up the economy, but he could also be responsible--according to the common views of economists and bankers--be responsible and start the reversal of this massive increase in Federal Reserve credit. So I think he didn't want to go out without having started the tapering, just for his own legacy. But that's probably a minor factor. But I do think that is a factor. The main factor, I think, is that there's been a huge fight among different sectors of the financial sector, between those who have benefited from the quantitative easing and those parts of the financial sector that have really lost out. The ones that have been benefiting have been the banks, as you said, that have borrowed at zero interest rate and engaged in all kinds of speculative lending and investments and so forth. But there are longer-term investors, insurance companies and so forth, who have to pay out insurance policies at relatively high rates--3, 4, 5, 6, 7 percent--pension funds who have obligations that they have to pay out. And the very short-term interest rates have actually been severely hurting them. And so this is really a fight within the financial sector about what is the right course for interest rates. And I think what the Federal Reserve has been doing is reflecting this struggle among the different finance groups and has marginally moved now to try to raise interest rates to satisfy these longer-term investors who've been losing out. But as you correctly said, the other side--the hedge funds, the banks, and the others--they can figure out ways to do well in this new environment, so, for example, through the carry trade as well. None of this has anything to do with what's good for the overall economy or what's good for the workers or what's good for the emerging markets. It mostly has to do with what is going to continue to bolster one sector or the other's financial profits, and it's not going to do anything at all for the real economy.JAY: Now if one of the things that was supposed to be part of the Obama administration's plan for recovery was to boost exports--and while they never admitted to it, a lot of people saw quantitative easing as a straight currency manipulation, you know, a deliberate way to lower the American dollar in relationship to other currency, 'cause all this money rushes to the other places, and their currency worth--their currencies go up. Now we're going to have a bit of the reverse: it's now going to make American products a little more expensive in terms of export. So that actually seems like it would hurt the economy. On the face of it, you hear people say, well, they're worried about long-term inflation. But where the heck is that? I mean, there's no sign of that, is there?EPSTEIN: No, no. There's no inflation at all. And I think you're right that it's very difficult to fine tune this economy through central bank policy. And so, yes, the dollar is likely to go up to some extent, and certainly relative to these other currencies, and that's going to hurt our economy's ability to generate jobs through exports, but let's not blame the Fed for all of this. They certainly have a lot of blame on their side, but the other piece of this is that the central bank is not all-powerful. It cannot solve the crisis that we're in. We need more aggressive policy from other parts of government, the fiscal policy. We need longer-term public investment from the government, both here--in Europe it's the same thing. Austerity is the norm. The central bank there can't solve the problems there either. So the political process, which has decided that austerity is going to be in the long-run interests of capital--they're going to raise--keep unemployment high, get concessions from workers, lower taxes--this is going to deliver more benefits to the capitalists. But at the same time, then it puts more pressure on the central banks that simply can't solve this problem.JAY: What's it going to do to the countries that are going to wind up with double-digit interest rates? I mean, this is a recipe for deep recession.EPSTEIN: That's right. So Turkey, for example, doubling its interest rates, as you said, what they'll find is that the companies have to pay double in order to borrow to invest. Moreover, a lot of companies are already highly in debt. And so when interest rates go up, they're not going to be able to service those debts. So you're going to start seeing more bankruptcies within countries like Turkey. And the foreign investors are going to see, well, countries--corporations are going bankrupt, so they're not going to want to lend money to them. So this leads to a vicious cycle, a vicious cycle of financial crisis, which is then going to be contagious. It's going to start affecting countries that aren't even weak. We're already seeing a bit of contagion. So this could--it won't necessarily, because the world's complicated and we could get out of this, but this could lead to a further downward spiral, which could lead to a worsening of the financial crisis rather than any kind of solution of it.JAY: And one of the reasons, if I understand it correctly, for this quantitative easing--it's not one of the stated reasons, but it seems to me it's one of the important reasons--is that the big American banks are sitting on assets which are essentially toxic. You know, the value of much of their assets are not really--is far lower than what they're showing on their books. So you pump all this cash into them at zero percent interest rate so it makes them look extremely solvent.EPSTEIN: That's right, and they're going to keep doing that. We can't overstate the tapering. They're going to still pump in $65 billion a month, keep interest rates very low despite the tapering. And so they're still going to be trying to deliver cash to the banks that they can get zero percent interest rate without any pressure from the Fed or the Obama administration or anybody to get the banks to actually lend to the real economy. Obama didn't say anything about that in his State of the Union address.JAY: Yeah, not a word. And, I mean, isn't this still very much a house of cards, that it's kind of being propped up with this gush of Fed money, you know, funny money in some ways, and to make this financial system look stable? But if it's dependent on the Fed and even just small pullbacks of the Fed sends the global economy into--they're using the word jitters and more--then this whole thing is like--it's so fragile that a much more serious crisis could be happening at any time.EPSTEIN: That's right. We're five years into the crisis. Nothing has been solved. What the Fed and the other central banks have tried to do has been at best a temporary palliative. But it's creating other problems, and it's mostly delivering benefits to the banks and the financial institutions. The fundamental problem is that the global financial system has not changed at all since the crisis. So they can still leverage their financial balance sheets into trillions of dollars of cash, which they can just slosh around the world, speculating through the carry trade against Turkey and in favor of the U.S., or against the United States in favor of Turkey. And it's their ability to move this massive amounts of money is the same as it was five years ago before the crisis. There has not been one regulation that's been put into place that has limited their ability to do this. And what we're seeing now in this turmoil is just a manifestation of that.JAY: Yeah. And President Obama's the state of the union is "strong" is more than disingenuous, in the sense that he doesn't discuss anything we've just talked about, which are actually the real issues facing the economy.EPSTEIN: It's wishful thinking at best. It's whistling past the graveyard.JAY: Okay. Next time we talk, let's talk more about what should be done. I mean, maybe just a quick thing I'll ask you. But let me ask you this as a final question quickly. This whole elite, you know, the financial elite, the political elite, they've had years to face up to the seriousness of this, and it's the train is going on towards the cliff or another cliff as if, you know, nothing had happened in 2008. So what does that leave people to do? I mean, you know, you can keep talking about what they should do, what they should do, but they seem way too interested. I mean, it occurred to me just the other day--I was talking to some of my colleagues here. You know, when you see this thing that I think it's now every member of Congress is now a millionaire and most of them are multimillionaires--there's probably a few exceptions, but I don't think many, if--maybe a few in the House. But that means they look at the world through the prism of an investor.EPSTEIN: That's right.JAY: And when you look at the world through a prism of an investor, then, you know, it's great if interest rates in Turkey go to 12 percent if you can figure out a way to cash in on that 12 percent. You know, it's got--you know, your prism has nothing to do with what's good long-term for the economy.EPSTEIN: That's right. So I think at this point, given the political situation in Washington--and you and I have discussed this--a lot has to be focused on the regional and the local level, experiments in the regional/local level for decent wages, community investment, public banks. And there's--we can't depend on the elites at the federal level or at the national level to bail out the people, 'cause they are only going to be bailing out the banks.JAY: Yeah. Yeah. I mean, I think there's almost nothing nothing more cynical than this $10.10 minimum wage. I mean, listen, if you're making $8, getting to $10.10's great. I hope they get to $10.10. But do the math. Ten-ten is what? Twenty-one thousand dollars a year. I mean, you can't say, you know, people with a kid or two, making $21,000 is getting out of poverty. It's really hypocritical.EPSTEIN: Well, there are people to whom this will make a difference. And also, if it does ratchet up the whole wage structure, it can make a difference. But you're absolutely right. It's not nearly enough.JAY: Yeah. I mean, if they're going to be honest, they've got to start using the language living wage. It seems to me the minimum-wage fight is good positioning for an election. Perhaps it's good positioning. That's their theory. If you're talking about, you know, reducing, eliminating poverty, then you've got to be talking about a living wage. Anything short of that is hypocrisy, I think.EPSTEIN: I agree.JAY: Okay. Thanks for joining us, Gerry.EPSTEIN: Thank you, Paul.JAY: And thank you for joining us on The Real News Network.
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