- - - - - ROSE SOUP - - - - -
or "An Angle Of Interest"

Imagine a tight-rope walker who regularly crosses a broad waterfall, maintaining his balance with a wide pole. Crowds pay to watch, but after a while his public become blasť and he no longer draws flocks of fawning fans. Then he hits upon a bright idea. If he holds his balancing pole to one side, like a counterweight, he can lean sideways. From a distance he appears to be walking at an angle. Once more he draws the profitable hordes! Becoming ever bolder, he pushes the pole further to one side and his angle of lean increases, as does his fame - and income! Occasionally a wind blows, but no matter from what point of the compass it blows he can still keep his angle of lean if he has some pole in reserve. Other tight-rope walkers come to study his technique and he writes books on the subject, acknowledged world-wide as the top expert. Then, one fateful day the wind blows from a brand new direction - not sideways but straight up the waterfall. It catches his pole from below, pushing the extended side up and toppling him. Unfortunately, the usual remedy of pushing the pole further out sideways means the wind topples him over more strongly. If, alternatively, he pulls the pole in to the centre, then since he is already leaning a long way over to one side, he will lose his balance. As he frantically struggles to avoid falling his only hope is to try to wrap his legs round the rope, and await an undignified rescue.

Doesn't it remind you of the world of politically controlled Finance? You know, "I've just had a bright idea. Let's use deliberately lowered interest rates to control inflation."
Surprisingly, just like pushing that pole out sideways, the technique sort of works, but beware! Unless used in moderation, any unexpected "wind" can cause catastrophe; as "experts" have just discovered - and as anyone trained in rose soup principles could have told them!

Think about it. Inflation simply means how many cups of tea you get nowadays for a hundred quid compared with last year. Although interest rates do indeed reflect risk, demand versus supply, and old fashioned greed, interest rates are mainly a function of inflation. No one is going to lend money at such a low rate of interest that by the time it is repaid the lender is going to go thirsty. Obviously, the worse the economy, the higher the rate of inflation, and the greater the rate of interest the money lender needs to charge.


Why "Rose Soup"? Because of the saying "An expert is someone who, on noticeng that roses smell nicer than cabbages, concludes that they will make better soup" !

For years this was the standard model, until tight-rope walkers (read politicians) hit upon a bright idea. Decree a low official rate of interest and, from a distance, it will appear to the masses (read voters) that they can afford just as many cuppas as ever, even if they are charging it to their credit balance. Unfortunately, finance ministers can delude themselves into believing they are omnipotent masters of the inflation tight-rope.

They are not! Those with loot to spare are obviously going to look for their best options. In the long term, stocks and shares reflect inflation just as much as they reflect individual profitability. If overall stock market indices are gaining value at a higher rate than the money market rate, they become attractive. The more the demand, the higher the price and the better the return, leading to even more "investment" (read speculation). It's a bull market and everyone loudly cheers the tight-rope walkers. Furthermore, with low interest rates, more people can afford a mortgage. (It sounds like a politician's dream.) Demand for houses will increase and property prices will rise. Everyone is euphoric. Their new house is gaining value faster than the interest they are paying on their mortgage. Even people on low incomes can buy themselves a hovel at artificially low rates. "Yippee" cry developers, as they build shoddy properties, many of which are snapped up by "investors", certain of high returns.

But consider, "inflation" is simply the fancy word for rising prices. What's more, this inflation is fanned by speculation. "Yippee" cry the money men, dreaming up all sorts of new wheezes to exploit the artificially created gaps. Folks are persuaded to exploit the difference between artificially low interest rates and "Real Inflation" for a quick buck, but supply eventually comes close to demand - and the winds of finance can also blow from below. (Read "sub-prime market".) When properties are put up for sale in expectation of a profit, but supply has started to exceed demand, it causes dropped prices. With no profit, speculators can't repay their loans. Institutional investors discover their property portfolio is made more of paper than of brick. The financial "tight-rope walkers" twiddle their bank rate levers to no avail. Lowering the already low rates rates only worsens the mess because no one is willing to lend for such pitiful returns yet raising interest rates will create even more defaulting loans. All they can do do is to cling on for dear life. Too late, the politician realises that nightmares, too, are dreams.

Perhaps because I've never taken a course in economics I understand why interest rates should follow, not lead, inflation!!


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