They Make A Low Interest Rate Desert And Call It Prosperity

Charles Hugh Smith nails it:

[L]et's examine the incentives built into the Federal Reserve policy of super-low interest rates and loose lending ("easy credit"). The fundamental idea here is straightfoward: consumers have limitless desires, and all we need to do to reinvigorate consumer spending is make borrowing more money both cheap and convenient/easy.

But what about the hidden incentives and disincentives? This policy is incredibly perverse in several profound ways:

1. it provides a powerful disincentive to saving (accumulating capital)

2. it offers a powerful incentive to speculate with "free money" provided by lenders

3. it provides a powerful incentive to leverage a small amount of capital/cash into gigantic bets via "easy money" (3% down payment mortgages, etc.)

4. it rewards risk and destroys moral hazard because the losses incurred by the borrower deploying massive leverage are extremely modest (3% down isn't much to lose, so why not gamble that housing with rise 30% from here?)

5. it incentivizes a feedback loop of ever-expanding bets, leverage and borrowing (i.e. housing speculators buying a second, third and fourth home because they made a killing on their first house) which "rewards" the speculative mania with ever higher assets prices as this specious "demand" grows with expanding leverage and debt.

6. In a financial system which actively suppresses interest rates, then capital earns virtually nothing. Entrepreneurs have no incentive to be prudent in their borrowing, and holders of capital are left with no choice but speculation in risky assets lest their capital melt away in an engineered environment of "benign" (slow steady erosion of capital) inflation. Recall that "low" 2.5% inflation will rob you of a third of your capital every decade.

This is exactly the trap into which pension funds fell: required by actuary models to earn 6%, faced with a Fed-manipulated yield of 2%, they were forced to speculate in real estate, stocks and derivatives to reach the 6% yield they needed.

Is any of this remotely related to capitalism in the sense of encouraging capital formation, prudent risk/return, productivity and enterprise? No. An environment in which savers are punished is not capitalist, for capitalism is in essence a system which rewards the accumulation and productive investment of capital, not the leveraged borrowing and wild speculation engendered by the super-low rates and loose lending policy of the Fed and Japanese central bank.

Young people may be forgiven for not knowing that interest rates of 10-12% for capital and mortgages were the norm in the 1980s--a period of strong "real" growth in the U.S. Reasonably high rates of return did not suppress organic growth--they encouraged it by incentivizing productive use of capital.

Simply put, if your business makes no sense except if you can borrow money at 3% or less, then your business is not viable. If you can't put 20% down, and the house isn't affordable at a rate of 10% interest on the mortgage, then the house is too expensive and you shouldn't attempt to buy it.

If capital formation (savings) is actively punished by manipulated low rates, then a nation soon degrades to a state in which no one bothers saving capital; following the built-in incentives of low yields and easy credit, they borrow and consume beyond their means. (That is, the U.S. in the past decade.)

If leverage, easy credit and speculation are all heavily incentivized, then a nation disintegrates into an economy dominated by and obsessed with asset bubbles. (That is, the U.S. in the past decade.)

...

Super-low rates and easy credit are not panaceas--they are in effect demolition machines which will destroy any economy which is seduced by their siren-song of "easy growth." There is no such thing as "easy growth" based on low rates and easy credit; "growth" based on artificial demand rises to the point that income no longer services the interest costs, and at that point then the collapse of asset prices and government revenues is guaranteed.

I rest my case. The U.S. economy is doomed to implode, just as the Japanese economy will implode, and so too will any economy anchored only by low interest rates and exponential expansion of "easy credit."