How Artificially Low Interest Rates Hurt the Economy

"I think he knows what Rome is. Rome is the mob. Conjure magic for them and they'll be distracted. Take away their freedom and still they'll roar. The beating heart of Rome is not the marble of the senate, it's the sand of the coliseum. He'll bring them death - and they will love him for it."  -Graccus, The Gladiator

Some people think Bill Gross at PIMCO has a direct line to the Federal Reserve.  I don't know about that, but they do employ or consult with several former Fed officials, including the likes of Alan Greenspan.  So it's interesting that Gross tweeted the following last week:

One would think a nation that has been subject to multiple "once in a lifetime" bubbles over the past decade would wake up to the notion that maybe -- just maybe -- current policy is not only not good but might be bad.  So given that nearly everyone thinks the Fed's next intervention into the economy with "QE-3" will happen as soon as the stock market drops 15%-20%, I thought the great economist Martin Armstrong's warnings were worth noting: 

In this spirit where HOPE triumphs over EXPERIENCE, the USA is following the same demise based upon the same identical failed policies of Japan. Chronically lower interest rates destroy capital formation because they reduce the worth of capital (interest rates) artificially, removing the incentive to lend and thereby contributes to the economic destruction.

You would think that since this was the policy adopted by Japan that produced what will be a 26 year Depression that someone would wake-up and say hold on a minute. But no! We are plagued by people who only go to school and have never had a real job to see firsthand how the world really functions.

As I have warned that Communism stole the very future of the individual placing all decision making in the hands of the state. Under socialism, that same deprivation of liberty is the spirit driving the government. How they manage the economy is stripping all individuals of their liberty to plan for their own future just as sure as it was done under Communism. It is one thing to care about the poor and to try to help those in need, and another to suppress the entire population to force a centralized planning scheme to run the economy…

Artificially lowering interest rates wipes out capital formation and gives the incentive for capital to (1) hoard, (2) flee or (3) speculate. When interest rates were maintained at virtually zero, the capital migrates overseas for better returns. In Japan, the carry trade was huge, borrowing in yen at 0.1% and buying US government bonds at 7-8%. Today, money from the West can be lent fully secured into India to earn 15-17% when economic growth is 30%+.

When interest rates are kept artificially low, there is no incentive to lend even by the banks. Why take any risk for so little? Cash tends to hoard as we are watching in banks reach record levels. The elderly, who depend upon interest income, are robbed of their income to fund speculation and the exportation of capital with no economic benefit to the domestic economy.

Interest rates will naturally rise in regions on the fringe of the major economy where capital concentrates. As rates rise on the fringe, capital becomes attracted to what we might call today – EMERGING MARKETS. This was common during the Roman Republic as it is today and was so recorded in history by Cicero noting the lending of Brutus at 20% offshore compared to 8% in Rome. Interest rates decline during capital concentrations. To manipulate that to an artificially lower rate on theory of stimulating demand has NEVER been proven to work. By reducing them to such an extreme low position, this encourages capital to flee to the fringe economies seeking a decent return on capital. This causes capital to hoard lacking a rate of return domestically, and fosters speculation rather than domestic investment that would create jobs.

Consequently, capital will move both offshore and into domestic speculation such as stocks when capital appreciation offers a greater reward than interest. These are not difficult observations to make. The data certainly exists to illustrate very long-term findings as demonstrated above.

The greatest danger we face is that these brain-dead notions of how to manage the economy do more harm than good for they disrupt the natural balance within the economy. This is the same type of policy experienced in Australia where they imported a species to counteract an indigenous species that had no natural predator and disrupted far more than just the targeted species.

 

Hoarding and fleeing of capital.  Speculation in overvalued stocks and commodities.  The punishment of investment and savings ($1 million in 2-year Treasuries gets you just $6,000 of annual income; happy retirement!).  This is official policy, and it is largely cheered.