A disturbing thought about low interest rates

Thoughts in Sweden on lower interest rates

 Lower interest rate – press the accelerator. Now! The pressures central banks are under to fix the economy have rarely been greater. But what if low interest rates are not the magic solution, but part of the problem

 Anyone who follows the merciless criticism of the Governor (Governor Stefan Ingves), led by the likes of former colleague Lars EO Svensson, may begin to wonder. Perhaps the explanation is that Stefan Ingves plays the lead role in a monetary equivalent of Fifty Shades of Grey, a sadist who finds enjoyment in high unemployment and the sight of closed factories in a darkening Swedish countryside.

 There was a time when Sweden’s central bank monetary policy protocols could be prescribed as an anaesthetic. Today the bank is a besieged institution where every breath is strictly monitored. The cause of the anger toward Stefan Ingves is that he is blamed for sabotaging the Swedish economy with (what the critics consider insanely high) the key interest rate at 1 percent. This policy has created a slightly bad mood when things now are going shaky. The hard truth is that growth in much of the industrialized world is still far below what we have been used to.

 Lars E O Svensson and others were supported when the former US Treasury Larry Summers recently held a widely publicized speech. In brief, Larry Summers theory is that something is essentially sick with the world economy. The sickness started long before the financial crisis and the world economy has been in a semi depressive condition and need large doses of uppers just to function somewhat normally.

 In such situations old dreary measures, like managing state finances and ensuring that banks do not engage in irresponsible lending, become obsolete. In fact counterproductive, says Larry Summers and even Paul Krugman, who runs the thesis. That is the reason for central banks to continue “stimulating the economy” by printing ever more money (i.e. QE = Quantative Easening).

 These men may well be right. (If so we have a problem, more on that shortly).

 But there is also another possibility. It's just the opposite. The anorexic economy is not due to high interest rates, but at too low for too long. So says Bill White, who for 40 years held a number of top jobs in central banks around the world, and already in 2003 warned of a coming crisis.

 He notes that central banks, especially the Federal Reserve, since the 1987 stock market crash cut interest rates at the slightest sign of economic downturn. But cuts in bad times have not been followed by corresponding increases in interest rates in good times.

 Bubbles have barely cracked until they have been replaced by new ones. And for every slump, central banks have been forced to cut rates even more to achieve the same stimulating effect. Why? According to Bill White, an explanation may be that whole economies weakened as depressed interest rates for a long time lead to wrong investments that never get corrected: debts are not written down and zombie companies are kept alive at the expense of more viable projects. Read Japan since 1990 and in Europe today.

 Unfortunately former Fed Chairman Alan Greenspan and others considered that it was not their job to prevent bubbles, but only to clean up afterwards. Interest rate increases were not needed: There was no inflation! However, this was an optical illusion, according to Bill White.

 The low inflation was not due to central banks' ability or the absence of overheating but on globalization and a tsunami of cheap goods from Asia. THIS productivity shock according to Bill White should have been met with increased interest rates instead of lowering. The result: a dramatic increase in debt and the mother of all bubbles bursting in 2007. And this crash has been handled with even more extreme lows. This has given very meager dividends, except that inflated stock markets made the rich even richer. According to Bill White the old problems remained unresolved and some new were added. The medicine that should have cured the symptoms became one of the causes of the disease.

 Which brings us to the sad part of all this. Bill White may indeed very well be wrong. But if he is right the dependency on low interest rates must be broken sooner or later, otherwise we are threatened by a long period of depression and unemployment, not to mention the risk of another crash. Moreover, it is high time for reforms and other unpopular measures that are otherwise easily pushed into the future as long as there's an easier way. Nothing indicates that this is going to happen.

 If Krugman & Co. are right, we are however not much better off. Should interest rates really lie well below the minus mark (technically impossible?) and the world's major countries turn around and ignore the rampant indebtedness (politically unlikely)? Whichever analysis is correct, it looks then like a historical mistake is about to be committed.

 It would be nice if these economists could get into more agreement with each other and then brief an occasional politician on a better solution. Those who will eventually have to pay the price, our young ones who spend their time in the world kindergartens and primary schools, do not at all care about who is right, if he is called Krugman, Svensson, Mr Ingves or White. They will be busy with other things.

 One of the laws of life that seem to be most forgotten is that when changes (like financial policies of interest rates) are introduced into societies, the population adjusts accordingly.

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