Do Ultra-Low Rates Cause Ultra-Low Growth?

In mid-June the stock market was down almost 25%. Searches for “recession” on Google reached their highest level since 2008. And what happened to the market’s view for future interest rates? They fell.

That’s no surprise – we all know that lowering interest rates is the right way to respond when the economy weakens.

But in my latest interview for Top Traders Unplugged, the esteemed British financial historian, Edward Chancellor, controversially challenges this thinking.

He says ultra-low interest rates, the kind we’ve had since our Great Recession in 2008, have done a great deal of harm.

Do Low Interest Rates Harm Businesses & Individuals?

His new book, The Price of Time: The Real History Of Interest discusses the long history of interest, and the emergence of low rates. But more provokingly, he believes that ultra-low interest rates set by central banks since 2008 may actually be responsible for the slow economic growth since then. And he shows that low interest rates impact companies and individuals in ways that are often missed.

Low Interest Rates Encourage Zombie Companies

One possible conduit from low rates to low growth is through corporate “zombies” – low productivity firms saddled with high-debt. They are the walking dead, unable to grow because of their poor productivity but unable to be killed either because low rates keep their debt repayment manageable, allowing them to avoid bankruptcy.

Chancellor notes that after the Euro debt crisis the lowest rates of insolvency were in Greece, Spain and Italy – exactly where the crisis was most acute and where one would expect the greatest need for restructuring. New research from the San Francisco Fed suggests that banks might keep these unproductive firms afloat by rolling over loans if they feel this increases the chances of recouping their original investment.

You might think that more efficient companies would eventually drive zombies out of business. But why enter an industry with over-capacity where incumbents are being subsidized by their banks? Chancellor believes a feedback loop develops with unproductive zombies lowering growth and inflation, which incentivizes central banks to keep rates low, which in turn keeps the zombies “alive” and starts the cycle anew.

Low Interest Rates Encourage “No path to profitability” Unicorns

He also discusses another odd corporate creature spawned by low rates – the “no path to profitability” unicorn.

With capital both abundant and cheap, firms like Uber and WeWork were able to raise and spend tens of billions on unproductive endeavors. He quotes one Financial Times correspondent: “These companies are using the talent of engineers and coders, and marketing specialists that could be used in more productive enterprises”.

In the same way zombies keep resources trapped in low productivity areas, unicorns channel potentially productive resources into areas that generate little tangible capital and almost no prospect of return.

Cheap Financing Causes A “Globalization Bubble”:

Cheap money plays an important role in what Chancellor calls a “globalization bubble”. Global supply chains require capital to support them, and that finance is provided in US dollars. Ultra-low dollar interest rates mean it doesn’t cost much to tie up money in long and complex supply chains, the most elaborate of which span more than five countries and multiple continents.

The long chains allow goods to be produced where labor is cheapest, keeping inflation low, in part by pressuring manufacturing wages in countries like the US. And once again a cycle appears – low inflation encourages central banks to stick with ultra-low rates, which allows these long supply chains to be operated profitably, which feeds back into lower inflation.

A decade ago most people, myself included, were not worried about this.

We were wrong.

Complex supply chains are fragile – subject to break when things like pandemics and Russian invasions suddenly materialize. Even global supply chains that don’t break aren’t costless – at least to US taxpayers. We still have to pay for the US Navy, whose policing keeps the shipping routes open. And social fragility builds too as low wages contribute to inequality and disenchantment.

Low Interest Rates Drive A Wedge Between Generations

Very low interest rates also impact individuals, often in ways that are missed by standard theory. In Germany and Japan, where bank deposits are the most important household asset, low interest rates act like a tax, forcing people to save more for retirement.

On the other hand, low rates do increase home and equity values, which is why US households are often thought to benefit because they own relatively high shares of both. But ownership of those assets is skewed toward older and richer households. There are plenty of people in the US who own neither stocks nor homes, many of them young.

As I wrote last year this engenders a dangerous sense of generational nihilism and a desire to mess with things.

What Can We Do?

Chancellor’s ideas are controversial. Some people either disagree with his conclusions or think the benefits of low rates still outweigh their costs. But even those critics would be hard pressed to disagree with his view that interest is a fundamental part of human society, a bridge between the present and the future.

Given the long list of potentially negative effects documented by Chancellor, prudence suggests we should avoid setting rates at or near zero, lest that bridge be weakened or washed away. After all, as Chancellor says in his book – capital consists of a stream of future income discounted to its present value using interest rates.

Without interest, therefore, there can be no capital. Without capital, no capitalism.