Who has the most to gain from low and negative interest rates? Obviously debtors. The world’s biggest debtors are governments, with the US government number one. Debt today is like a listing ship. The objective of governments is to get themselves to the part of the ship that’s highest out of the water—the bridge—and cram everyone else below decks, submerged. The ship will sink, but governments and their cronies will let the other passengers drown before they breathe their last.
The real purpose—the only one that matters—of governments and central banks’ machinations since the financial crisis has been to finance governments. The world stood on the edge of the debt contraction abyss. Debt had reached an unsustainable level. Economies could no longer bear the load of interest payments and principle repayment. The marginal value of most debt, particularly that which funded consumption, had gone clearly negative. Even the value of debt incurred to fund “investment” was dicey, since much of that investment was actually speculation in disguise: house flipping, leveraged mortgage security arbitrage, share buybacks, and the like. The financial crisis was the iceberg rending the hole in the hull. Since then, the hole has only grown.
The bridge knows the vessel is taking on water and sinking. Sovereign debt has been monetized and interest rates driven to subzero so governments can buy themselves a little more time. Savers and those living off of fixed income investments were steerage, the first to be sacrificed. For them, the future of diminished consumption that everyone says is inevitable—but nobody seems to believe will ever happen—has arrived. They’ve been told to go to the hold and await further instructions while the central bank pumps bail away, but they’re up to their necks in cold, fast-rising water.
Chest deep and next to be sacrificed are aggregate pools of savings—pension funds and insurance companies. They have to generate a return and cannot survive if they receive no interest income on their bond investments. Underfunded pensions have thrown states, municipalities, and Puerto Rico into financial turmoil. The rates of return they had assumed, in most cases 7 percent or greater, are unavailable in any kind of prudent investment. Imprudent investments offer higher returns, but reluctance to embrace them is rational given multiple crashes in junk bond, equity, and real estate prices since the turn of the century. Insurance companies can at least raise their rates, but in many cases pension contributions are fixed by either law or contract, and can’t be changed without political push back from beneficiaries and other interested parties. Taxpayers are balking at calls to increase their support.
Mis-priced interest rates are also submerging the real economy. The artificial rate distortion produced by central banks’ cheap debt policies has led to malinvestment, glutted markets for both goods and services, and deflationary pressures that will be fully uncorked when debt finally contracts. The return on real investment has followed interest rates, it’s close to zero. The long-term trend rate of growth follows the real return on investment, so it too is falling towards zero (even by suspect official government reckonings) as the burden of servicing the mounting debt load rises.
When the economy gives up the ghost, it will be akin to the flooding of the crew’s quarters. There will still be a few high and dry on the bridge, but the ship cannot function without a crew. Washington and Wall Street are mostly high and dry, but it’s only a matter of time before the surge reaches them. Today’s anemic growth rates have been dragged down by debt. When they finally sport a negative sign (honestly accounted for, some—Europe’s, Japan’s, Russia’s and Brazil’s, et al.—already do), more debt will simply hasten the ship’s final plunge.
Expanding debt has allowed developed country sovereign bond and equity markets to reach record highs. Both, ultimately, are dependent on the real economy, so on many measures the divergence between financial asset prices and economic metrics has reached record extremes. By GAAP accounting or even by Wall Street’s preferred “adjusted” earnings, the stock market is trading at historically high multiples. Sovereign bond prices, which are the inverse of yields (higher prices equal lower yields), are at all time highs since negative yields are all time low yields.
Officially measured developed countries’ growth rates are trending to 1 percent, which is a statistical adjustment away from zero or negative growth. Most of that so-called growth is simply the debt-enabled pulling of future demand forward, which leads to less growth in the future. Cheap debt has blown up unsustainable bubbles in autos, student lending, and the housing market. Corporations have embarked on a borrowing spree, but unlike governments and central banks, they can’t manufacture fiat debt to repay their debts. Notwithstanding infinitesimal interest rates, credit quality has deteriorated to the worst level since the third quarter of 2009, and the default rate is climbing.
Cold water laps at the toes of the financial cronies. There will be more QEs, more ZIRP and NIRP, and inevitably helicopter money, but not because of any of the transparently specious reasons given for these quackeries. That includes the “cynical” one that they’re trying to keep stock and sovereign debt markets high and dry. Eventually stock markets will be sacrificed as the gap between stock prices versus earnings and economic performance grows ever wider and markets are asked to capitalize losses, not dwindling profits. Sovereign debt markets will be the last to go, because they can be supported by an endless supply of central bank fiat debt.
The cynical aren’t cynical enough. The quackeries will continue because they are the only way governments carrying unsustainable loads of debt and unfunded liabilities can be financed. It will not stop when economies improve because economies aren’t going to improve, they’re going to get worse. Look at Japan, which has journeyed the farthest down this road. Its central bank finances the government, buying all the government’s fiat debt with its own fiat debt. Just as the rest of the world’s economies are following Japan’s into zero and negative growth, they will follow its lead in finance. Sovereign debt and central bank debt exchange are all the potentates have to keep their heads above water a little longer.
Their cure is the disease. It is telling that nobody is talking about debt during the presidential campaign. Why stir up trouble? The candidates know that debt will sink the economy, and they’ve known so since at least 2008. It’s easier to find other economic scapegoats. Talking about debt would be like the bridge announcing over the public address system that the ship is sinking, the passengers are going to die, and all emergency measures will be directed towards keeping those on the bridge alive longer than everyone else. They can’t even tell the doomed to man the lifeboats. There are none.
NOBODY WILL READ A NOVEL ABOUT
THE INDUSTRIAL REVOLUTION