When the Price is too High

In a free market, the price of a product or service will always find an equilibrium where offer and bid meet and the market clears. Imbalances are always met with price changes that serve to re-balance offer and bid. However, we don't have a free market, so things don't always work this way. Certainly not when it comes to money, which is centrally planned through central banking.

What is currently happening in money markets illustrates quite clearly how a centrally organized economy fails to balance. Determined to keep interest rates artificially low, the FED is offering to buy government bonds at prices that are higher than what the free market is willing to pay. Consequently, banks and other institutions that hold such bonds flock to the FED in order to get the above market price. The free market has dried up, and there's suddenly a shortage of bonds.

The right response to this would be to let the price of these bonds fall so that the free market can return to equilibrium. But this is not the remedy that the central planners have chosen. They have instead decided that the federal government should issue more debt so as to replenish the supply.

This sets up a free and guaranteed way for banks to make money, because the federal government is required to issue their bonds to primary dealers that get the bonds on their books at a lower price than what the central bank is willing to pay. All that is needed for these banks to make money is for them to buy the debt from the government and then immediately sell it into the hands of the central bank. The difference in price between what the government is selling their debt for, relative to the price offered by the central bank, is pure profit conjured out of nothing.

Once the profit is locked in, banks can go out and buy stuff, preferably stuff that the central bank is willing to buy. The banks are in this manner in the privileged position of being the only entities that can sell stuff directly to the central bank. They can offer almost any price for certain assets, knowing that the central bank will buy the assets for a higher price.

What happens next is that there is a flood of cash entering the market. This is cash that originated from nothing at the central bank, and which has made the primary dealers rich on its way towards the free market. This pushes up prices of all things. The average person will see prices rise. Everything gets more expensive. Bankers become rich while the average person becomes poor, all thanks to the unholy trinity of government, primary dealers and central banks.

By © Citron, CC BY-SA 3.0, Link