Why artificially low rates are bad for you


The disastrous era of negative rates may be coming to an end, but it is not over. Imposing negative nominal and real rates is a colossal error that has only encouraged over-indebtedness and the zombification of the economy. However, nominal rates may be on the rise, but real rates remain deeply negative. In other words, rates are still exceptionally low for the level of inflation we have.

Negative interest rates are the destruction of money, an economic aberration based on the idea that the rates are too high and that is why economic agents do not invest or take the amount of credit that the central planners wish.

The excuse for setting negative rates is based on a mistake: that central banks lower rates because markets demand it and policymakers are simply responding to that demand; they don’t impose it. If so, why not let rates fluctuate freely if the result is the same? Because it’s a false premise.

Imposing artificially low rates is the ultimate form of interventionism. Lowering the price of risk is a subsidy for reckless behavior and excessive debt.

Why is it bad for everyone to keep negative rates?

The reader may think I’m crazy because rising rates make mortgages more expensive and families suffer. However, you should also ask yourself why real estate prices are reaching unaffordable levels. Because cheap borrowing leads to higher leverage and causes asset prices to be significantly above affordability levels.

First, prudent saving and investing are penalized and excessive leverage and risk-taking are encouraged. Think for a moment about the type of business that is viable with negative rates but not with 0.5% rates: a ticking time bomb.

It is no coincidence that zombie companies have exploded in an environment of falling interest rates. A zombie business is a business that cannot pay interest on debt with operating profits, has a negative return on assets, or has a negative net investment. According to a study by the Bank for International Settlements, the percentage of zombie firms has reached historic highs during periods of low interest rates.

Zombie businesses are less productive, more risky, and can create a systemic problem. Moreover, negative rates inhibit the creative destruction essential to progress and productivity.

In the case of governments, negative rates have been a dangerous tool. They made it comfortable to go into massive debt and skyrocket deficits.

A policy designed as something exceptional and temporary was prolonged for more than a decade, leaving behind a trail of inefficiency, bad investments and over-indebtedness.

A policy of buying time and carrying out structural reforms has become an excuse to avoid them, to take on more debt and to increase imbalances.

But negative real and nominal rates mask risk, giving a false sense of creditworthiness and security that quickly dissipates with a slight shift in the business cycle. These extremely low rates generate greater problems because the risk accumulates beyond what central banks and supervisors estimate, starting with the governments themselves.

Negative rates have fueled the public debt bubble that will end in higher taxes, higher inflation, lower growth, or all of these together.

Of course, the other effect of this economic aberration is high inflation – the tax on the poor. It has generated enormous asset inflation for years, encouraging risk taking, from the real estate sector to multiples of industrial or infrastructure assets. Borrowing was exceptionally cheap, and when credit soars, it goes into higher risk assets and, of course, creating bubbles.

It is surprising. The whole economic consensus agrees that the rate cuts of the early 2000s led to the bubbles that cemented excess risk before the 2008 crisis. However, that same consensus applauds the madness of negative rates because there has a perverse incentive for statism when the bubble is sovereign debt.

After high asset inflation came high consumer price inflation, with a double negative effect for savers and real wages.

The European Central Bank has raised rates — to zero! The biggest increase in 22 years and the first time without negative rates for eight years. With inflation at 8.6% in the euro zone, this is clearly an insufficient and timid increase.

Interest rates are the cost of risk, and with these rates central bank policy continues to penalize savings and prudent investment in real and nominal terms while risk taking is encouraged.

It’s amazing to read that some think it’s unwise to hike rates all the way to zero, with core inflation at levels not seen since 1992.

Will mortgage loans increase in Europe? Sure. But it seems incredible to me that the economic debate is about whether 40-year mortgage rates are rising to 2% instead of why they were at 1.2% in the first place.

When you worry about the rising cost of a new mortgage, consider that house prices have skyrocketed far above what we consider affordable precisely because of negative rates.

Hardly anyone buys something they can’t afford by going into debt if the interest rate reflects the true cost of risk.

Credit bubbles and excesses always occur after a planned incentive such as artificially lowering interest rates and injecting liquidity above the real demand for currency.

Of course, when bubbles burst, interventionists never blame the artificial lowering of interest rates or printing money – they blame “the market”.

Cheap money is expensive. The problem for the next few years will not be to adapt to rates that will remain exceptionally low, but to become aware of the excess risk accumulated in the era of monetary madness.

These colleagues who recommend that central banks be “cautious” and not raise rates too quickly should have warned of the folly of cutting them at full speed until they reach negative levels.

If rates fluctuated freely, the creation of bubbles and excessive indebtedness would be almost impossible because the risk would be passed on to the cost of money.

The best way to prevent bubbles and financial crises is not to encourage excess risk and indebtedness by artificially lowering rates.

Fares do not have to be raised or lowered by a central planner. They must float freely. Everything else creates more imbalances than the supposed benefits they promote.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.


Daniel Lacalle, Ph.D., is chief economist at the Tressis hedge fund and author of “Liberty or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”

About Alexander Estrada

Check Also

China’s low birth rate hit by sky-high costs associated with weddings

BEIJING — China’s low birth rate issues have been further complicated by high prices demanded …