Central Bankers Are Intellectually Bankrupt

May 11, 2012 – Congressman Ron Paul says that “central bankers are intellectually bankrupt”.  This is actually the title of an excellent op-ed article he wrote last week for London’s Financial Times in which he clearly explains that controlling interest rates is a form of price fixing.  We know from monetary history that price fixing has always been harmful to economic activity. Yet “control of the world’s economy has been placed in the hands of a banking cartel” even “while socialism and centralised economic planning have largely been rejected by free-market economists”.

It is an excellent article, and I highly recommend it. But I do want to comment on one point.

Congressman Paul accurately explains how artificially low interest rates engineered by central banks have distorted economy activity. Yet by saying that “These interventions are intended to raise stock prices, lower borrowing costs for companies and individuals, and maintain high housing prices”, Congressman Paul misses what I believe to be the most important reason central banks are keeping interest rates abnormally low. It is because governments around the world cannot afford to pay a true rate of interest.

They have taken on too much debt. They are over-leveraged, and interest expense payments on their debt has become one of the largest components of their outlays, even at these abnormally low interest rates engineered by central banks. Thus, if governments paid a fair interest rate that reflected the real monetary and credit risks, they would quickly go bankrupt.

For example, the US government now owes $15.6 trillion. If interest rates on that debt rose just 1%, its annual interest expense would rise by $156 billion, which is 6.8% of annual revenue. If we assume 6% is a fair rate of interest on its debt – which no longer is triple-A rated – to reflect the risk, its annual interest expense would be 40% of its revenue, which is a rate that we know from monetary history is unsustainable.  Would you buy the bonds of a company paying 40% of its sales revenue just to service interest on its debt – and not any principal?

Of course not, which explains why central bankers have fixed interest rates at artificially low levels. If they didn’t, the fiat currency bubble would pop, ending the big governments made possible by seemingly unlimited spending. Central bankers and their paper money would be swept onto the garbage heap.

So central bankers are intellectually bankrupt, but they know enough to understand how their bread is buttered. Rather than letting interest rates rise to a normal level, their only aim is to keep the fiat currency game going, and thereby perpetuate their existence.