By Henrique Schneider

In the last couple of weeks, a scandal about banks rigging the Libor, London’s interbank interest rate, has made its rounds.

In other places, local authorities have begun to analyze their own countries’ lending rates, too. So is the Korean Fair Trade Commission (FTC). The Libor is said to be one of the most important indicators, since billions of dollars of transactions every day are based on it. However, how does this rigging affect us non-financial investors and ordinary citizens? The answer is simple: it does not. Why then, should we still care about it?

Let’s first develop the idea that the Libor does not affect ``the real world” and then, say something about why it matters nonetheless.

The Libor, or in Korea the KORIBOR, Korea interbank offered rate, is the average interest rate at which term deposits are offered between prime banks in the Korean wholesale money market or interbank market. It is a fixed interest rate, which means it is not the product of a market (like a price) but the result of a panel of banks agreeing on an average.

It is very easy to influence this average, for example by handing in bids that are too low or too high or by reporting rates that exist but are not applied. The main thing to understand is that each bank reports whatever it wants and that this in itself is part of the ``clean” rate.

The rate being fixed everyday can only provide 24 hours for speculation, therefore the banks rigging the rate gambled on its change and/or its volatility, not on its value, because every time the panels sets the rate, the game begins again. So, the ``dirty” rate making the news is what happens within these 24 hours of speculation. For whom is this kind of trade interesting?

Banks trading on short markets, overnight yields and other ultra-short term vehicles can arbitrage the difference between the ``clean” and the ``dirty” rate. This might lead to slight pricing differences and these can profit investors dealing on similar time frames. Apart from banks and major investors, almost no other market agent takes part in those trades. Thus, it is fair to say that Libor rigging only affects the banking system.

However, it does not follow from the above that we should turn our backs to the Libor-scandal. The true problem is not the rigging of the 24 hour speculative timeframe, but the vehicle itself. There is yet another challenge, and this one goes much deeper than Libor or KORIBOR: Worldwide, all interest rates are being set not by the markets but by cartels.

To the Libor first! The very concept that an interest rate is fixed by agreement is profoundly uneconomic. Interest rates are the price of money and only the markets can reveal these prices. If banks sit together and work upon a price that is used for the whole market, logically they will set a rate that gives them a lead. In other words, financial systems are telling the real economy how to behave.

To the cartels second! The Libor-setting banks, however, are not entirely free to stipulate the rate. It has something to do with the interest-rates set by central banks. These too are not the result of free markets but a political agreement between banks and politics.

Interest rates are supposed to be the value of money shown by revealing the risks associated with a given currency. Today, the world is an insecure place. Almost all countries are heavily in debt (Korea being an exception). Instead of reflecting the huge insecurities in the central bank rates, these institutions decided to lower the rates. By this, they are depriving all investors of real signals on the economy and at the same time lowering all capital gains for investors.

There are far more people being taken advantage of the low central banks interest rates than by Libor-riggers.

At the end, both are symptomatic of the ardor of the financial markets. We seem to live in a world in which finance is far more important than industry, services or agriculture. On the other hand, looking at the last five years, these three sectors generated real value ― and finance destroyed it. The question remains, why is finance always privileged?

Henrique Schneider is a traveler in Asia as well as a political analyst. He works as a consultant and analyst in Vienna, Austria, and publishes regularly in German and English on economic and security issues related to China and other Asian countries. He can be reached at hschneider@gmx.ch.