Why Low Rates are Bad But Here to Stay

A number of people write about the state of Interest rates in the US. I’m not the first or the last. Many speak to the un-sustainability of current monetary policy, unintended consequences, perverse incentives and inequitable redistribution of wealth that is resulting from unprecedented dovish ness by our central bank and those around the world.

Those who need credit still have a hard time getting it and those who don’t need it have unfettered access to free money which only expedites the wealth gap as leveraged returns on risk assets far outweigh prudent conservatism of middle class fixed income investors.

The real issue with low rates, however, to the end they were intended which was to stimulate real economic activity and create a sustainable economic recovery, is that the longer rates remain depressed, the more capital is at risk of massive misallocation. What this means is that with cheap money available to most corporate borrowers, the investments being made wether in R&D, capital expense or M&A is going places that may not lead to sustainable job creation absent extremely low costs of capital.

The jobs that are being created today are at real risk of disappearing tomorrow if interest rates rise to far too fast.

There may be a few areas that do benefit and transform in the current paradigm and those would be new capital intensive industries whose very existence would be impossible with higher costs of capital such that they are able to achieve scale more quickly with cheap money. The may include biotechnology, emerging clean energy technologies, and ubiquitous computing technologies like cloud computing or next generation communication networks. These new opportunities may lay the groundwork for 21sr century transformation but they are unlikely to become profitable enough this decade to kick start a real sustainable growth spurt at historical funding costs. All of these developments will of course be at risk of abandonment when interest rates finally so rise.

Furthermore any meaningful increase in inflation will double pinch most working class people who have not seen significant wage growth and who will be facing higher living costs.

Additionally any meaningful inflation increase will ultimately be met by the fed, albeit and most likely late, by rising interest rates which will increase the costs of everything from home ownership, rents, durable goods financing and likely suppress or even damage investment portfolio performance. Higher costs of homeownership will likely result in lower home prices (the high end will be immune where cash buyers lurk). Lower home prices will in turn put many homeowners back underwater and the massive wave of refinancing that has occurred over the last five years into cheap adjustable rate mortgages will only add insult to the injury being laid by current fed policies if those mortgages reset higher as we head into a recession.

The Fed, I believe knows this, and some pundits argue that rates won’t be moving far for a very longtime.

When one considers the recent and consistent actions of the ECB and Japan, it does seem that the developed world has dug itself into a hole of carry trades built on the debased currency du jour.

Today the Euro is supporting low US rates as it is financially smart to sell euros and buy dollars. Tomorrow it could once again be the yen that support US dollar assets.

It will be hard to get US interest rates to move far from here as long as a cheap funding currencies exist in a world where dollar payments rule the day and without risking a major shock to global currency markets which would further disrupt the current equilibrium and balance of payments. Relative dollar strength seems here to stay as we are the best house on a terrible block. But if central bank leadership were to turnover or pivot the ensuing US dollar strength would likely unwind everything from global commodities and emerging markets to the earnings power of large US mega cap exporters.

Just because people hate current central bank policies does not mean that there is any amount of effort that will stop the current train from rolling along.

We are in a new paradigm, a Pandora’s box of unsustainable opportunity that will absolutely end with a bubble bath of assets popping around the world, but most likely not until most every doubting Tom has dipped his toes in the water and felt the joy of free money.


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