Do Low Rates of Interest Really Support Markets? On 10 September, I concluded that they don’t. This article explores one of this result’s major implications: investors can’t depend upon central banks. This is because their “stimulus” has produced artificially-low rates that are increasingly – and dangerously – divorced from reality. It’s possible, as the saying goes, that investors can’t fight central banks. Certainly, they mustn’t trust them. Today’s monetary overlords don’t dispense stimulus: they peddle poison.
What Is “Stimulus”?
The phrase “economic stimulus” refers to actions by the state that supposedly encourage private sector economic activity. Underpinning it is a fundamental – and obviously false – assumption: a few “expert” bureaucrats in central banks and treasuries know more than large numbers of buyers and sellers in markets. These bureaucrats (and their mascots in the universities and mainstream media) typically have little experience of – or even interest in – the world outside their sinecures. It’s not just that their models and theories are wrong, and that they lack practical knowledge and real-life experience; because they’re bureaucrats, they’re rewarded according to inputs (such as hours at the office, allegedly good intentions, etc.) rather than outcomes (such as beneficial results achieved in the real world).
Accordingly, bureaucrats are exempt from the consequences of their failures: they have no “skin in the game” – and thus suffer no loss when their policies do more harm than good. For this reason, failed policies beget more extreme policies – and even bigger and costlier disasters. In sharp contrast, buyers and sellers in markets do have skin in the game – and bear the consequences of not just of their own errors but also of bureaucrats’ blunders. It’s a case of “heads, bureaucrats win; tails, many investors lose.” So beware: when it comes to governments and “stimulus,” we’re most certainly NOT in this together!
Fiscal stimulus once included laudable measures such as tax cuts and deregulation; these days, however, it refers almost exclusively to policies that boost government spending. Monetary stimulus, on the other hand, refers to actions by central banks – particularly actions that suppress rates of interest – that encourage households and governments to borrow.
Why Is “Stimulus Actually Poison?
Expansionist monetary and fiscal policy provide, in effect, short-term “sugar hits.” Like sucrose, economic “stimulus” can become addictive; and like all addictions, it impairs long-term health. Monetary “stimulus,” for example,
- “drags forward” future consumption. Tempted by artificially low rates of interest (if they weren’t artificially low, why the need for “stimulus”?) and loans’ looser terms and conditions, the entrepreneur, home buyer, etc., decides today to borrow the funds that he might have borrowed at some point in the future.
- Because rates are lower and terms more lenient, sub-standard (in the sense that they perhaps wouldn’t occur at higher rates and under tougher conditions) businesses, loans, projects, etc., see the light of day. Some that wouldn’t otherwise have proceeded now receive the green light.
- Given the “stimulus,” some of the activity (hiring of labour, purchase of goods and services, etc.) that might have occurred next year instead occurs this year. Unless something counteracts it, a contraction occurs when next year arrives.
- Accordingly, central banks must “inject” ever-stronger doses of “stimulus” into the economy in order to offset the lower future activity that their previous policy has induced. As a result, they create “zombie” firms and uncreditworthy borrowers.
- By this process, “emergency stimulus” thus becomes permanent stagnation: wash, rinse, repeat.
Thanks to central banks’ frenzied interventions over the years, rates of interest have become increasingly divorced from reality. The consequences (namely sky-high and rising debt, implausibly expensive stocks, real estate, etc.) have become ever more apparent. Contrived rates emit false signals – and, in effect, throw sand into the economy’s gears, add lead to its saddlebags, cause the ship’s anchor to drag along the seabed, etc. Central banks’ and treasuries’ denial of past failure merely abets bigger failure in the future. After the GFC, their attempts to abolish the business cycle delivered stagnation; they’ve now bequeathed recession – and threaten depression.
Monetary “stimulus” clearly cannot create – or even facilitate – self-sustaining growth. It relies not upon market signals and private savings (in other words, deferred consumption); instead, it entails government intervention and slight-of-hand that conjure false signals that encourage consumption beyond consumers’ means. As a result, it doesn’t promote financial readjustment and economic recovery. Quite the contrary: it hinders and prevents them. “Stimulus,” in short, can’t create genuine prosperity: it does, however, enrich “insiders” (who own the financial assets whose prices the stimulus inflates) and impoverish “outsiders” (who can’t afford to purchase these assets). Central banks can “print” money, but they can’t produce – as opposed to induce the earlier consumption of some – goods and services.
Moreover, “stimulus” faces diminishing – and eventually negative – rates of return: ever-larger doses are needed in order to induce the same “high;” yet large doses enfeeble and extreme doses kill the patient. More and more businesses and borrowers become addicted to artificially-low rates; but when reality finally intrudes, default – and thus recession and perhaps depression – occurs. Memo to central bankers/planners: if you really want to do good, then spare us your artificial and false rates. Instead, step aside, let market forces – and genuine and true rates – prevail. Only when that happens, and not before, can proper economic calculation (distinguishing zombie from sound firms and households), sensible investment and proper recovery (the liquidation of zombies) commence.
Our Rulers Have Become “Stimulus Fetishists”
“We are all Keynesians now” is a famous phrase coined by Milton Friedman and attributed to U.S. president Richard Nixon. It is popularly associated with the embrace at a time of financial crisis of Keynesian economics by individuals who had formerly advocated less interventionist policies. The phrase is once again apposite: virtually all economists, journalists, politicians, etc., don’t merely tolerate – they now demand – unprecedented extreme fiscal and monetary stimulus. To put it mildly, some have drastically changed their tune. Their stance mimics Keynes: “when the facts change, I change my mind. What do you do, sir?”
Yet key facts haven’t changed: time after time, “stimulus” has produced far more long-term harm than short-term good; today, however, our rulers too obtuse, myopic or panic-stricken to care. But fads and fetishes can’t change fundamentals: money must come from somewhere, and this “somewhere” is ultimately productive individuals and businesses. A government raises revenues either through taxation, borrowing or inflation. Stimulus thus begets some combination of higher taxes, bigger debts and deficits and an even more inflated supply of money. Regardless of its source, not only does stimulus fail to create genuine wealth: the money that the government spends or (re)directs is money that, in private hands, might have created real wealth. Stimulus, in short, creates the illusion of prosperity rather than the real thing. (Perhaps that’s why politicians flock to it like moths to a flame.) This conclusion was once orthodox. An editorial in The Wall Street Journal (19 October 2001) rightly concluded
It’s pretty much impossible to find an introductory macroeconomics textbook that recommends … fiscal stimulus. If Keynes appeared in any of the heavy-duty academic centres around the world, he would find his idea referred to as a “classic fallacy.” Most economists have moved on to other models.
Today, a feisty few remain resolute. In Canada’s Financial Post (“Don’t Fight the Fed? Why Investors Should Be Wary of Market Manipulation,” 17 June), for example, David Rosenberg stated:
What we have now is nothing short of market manipulation. Reducing the cost of overnight funds is one thing. Extending the intervention to Treasuries or high-quality securities is something we became accustomed to in the aftermath of the last Great Recession. That’s when the Fed became a duration bond manager.
But the central bank is now becoming a hedge fund. Adding low-quality corporate credits to its balance sheet is a whole different game: keeping zombie companies alive, rendering fundamental analysis and price discovery obsolete, and leading to a complete misallocation of resources. Capitalism has taken a semi-permanent vacation … And what it means for the future of society, to be running such reckless and feckless fiscal and monetary policies, is troublesome to say the least …
This market is rigged, pure and simple. So why shouldn’t equities command the richest multiples since the dotcom bubble of two decades ago? But just remember that the bubble came crashing down, and there was nothing the Fed could do about it.
What Should Be Done?
We live in a world in which virtually everybody supports ever more extreme fiscal and monetary “stimulus.” Given its inevitable and immensely costly failure, what will governments and central banks eventually have to do? They would do well to recall the actions of the U.S. Government and Federal Reserve exactly a century ago. Have you ever heard of the Depression of 1920-1921? In the U.S., it was extremely sharp but mercifully short. Why have so few people heard of it? It ended much more quickly than the Great Depression of the 1930s and 1940s. Why did the Depression of 1920-1921 disappear so speedily? The U.S. Government resolutely slashed expenditures and taxes, and removed myriad regulatory shackles from the economy; and the Federal Reserve relaxed its interventionist grip, allowed the market to operate – and let rates of interest rise. These actions quickly purged the rottenness that had accumulated during the Great War. They were the diametric opposite of the damaging policies in vogue today; as such, they qualify as true stimulus. In my next article, I’ll elaborate.