Low Interest Rates And Unintended Consequences

In a recent article written by bond king Bill Gross titled "Going To the Dogs" Gross describes some of the current economic conditions we face. He refers to the wave of currency devaluations that have taken place across the world and points out almost all of them were promoted by policy rates that went negative. This means the short-term rates banks lend at and pay small savers have been skewed. Currently, he sees little in the way of the historic "good old fashioned" positive rates that at least offered something in return to those putting away money for their future. This also means we have downgraded risk as a factor when lending as we search for higher yields, history shows this tends to be a bad strategy.  His thoughts strongly dovetail with my concerns as to how these low rates distort and cause massive misallocation of resources throughout the economy.

Current Policies Carry Unintended Consequences

Gross states, "The universe of negative yielding notes and bonds in Euroland now total almost $2 trillion. Not even "thin gruel" is being offered to our modern day Oliver Twist investors. You have to pay to come to the dinner table and then sit there staring at an empty plate." He goes on to say, "The possibility of negative interest rates was rarely if ever contemplated in academia prior to 2014. No textbook or central bank research paper even mentioned it, although fees for safe haven "storage" have long been in existence at Swiss banks. Ben Bernanke in his famous 2002 paper titled "Deflation: making sure "IT" doesn't happen here", mentions helicopters dropping money from the sky, but nowhere was there a hint of negative yields once a central bank reached the zero bound."

The fact that such policies have unintended consequences is not lost on Gross who in his article highlights the following. A more serious concern, however, might be that low-interest rates globally destroy financial business models that are critical to the functioning of modern day economies. Pension funds and insurance companies are perhaps the most important examples of financial sectors that are threatened by low to negative interest rates. To make things worse he says, Negative/zero bound interest rates may exacerbate, instead of stimulate low growth rates in all of these instances, by raising savings and deferring consumption.

It seems the households of savers suffering from low/or even negative yields are being forced to address their inability to save enough money to pay for education, healthcare, and retirement obligations. Many of the most financially responsible people are hunkering down and saving more while many non-savers have gone on a "spendathon" and reacted by taking on more debt. Americans owed nearly $12 trillion overall in 2014, an increase of 3.3 percent over 2013. Declines in some debts, including a decline in credit card debts since 2011 is in no small part attributed to numerous defaults and  not from being repaid. These facts are more proof that we cannot depend on many of the statistics being bantered about by the media, government, or those with an agenda because they are outright fraudulent, flawed, or mask the real picture.

In between the lines of all of this information, good and bad, it is hard to find the truth. When we peel back the facade we find real unemployment is still at high levels and personal debt at unsustainable levels. This is a large part of the collapse in global demand and U.S. consumers no longer being able to support their historical consumption habits. If all this does not seem all that new it is because the trend 10 years ago of Americans using their homes as ATM machines has merely been replaced by low-interest rates and the Federal Reserve fueling questionable loans. The growth in subprime auto loans is a glaring confirmation of this and the main reason for surging sales in the auto sector. This effort to offset the dwindling buying power of the public sector by encouraging them to take on more debt by easing terms and artificially low-interest rates will not end well.


 Footnote; As always your comments are encouraged. I have written many other articles concerning bonds, debt, currencies, where value comes from, and inflation. You will find these in the archive. Below are two other articles that might be of interest.
          http://brucewilds.blogspot.com/2015/01/currency-markets-reflect-diminished.html
          http://brucewilds.blogspot.com/2014/06/the-economic-efficiency-of-credit-can.html