We have had eight, nearly nine years of zero interest rates and negative real interest rates. You don’t have to be a convinced Austrian economist to believe that in this length of time an extraordinary amount of “malinvestment” – investment that is not justified by economic reality – has grown up. Now that interest rates seem to be rising, that malinvestment will collapse, losing lenders’ and investors’ money. This column therefore surveys the various forms that malinvestment may have taken, and where the greatest value traps lie.
It is amusing to examine the antics of Janet Yellen and the current Fed Governors, all of them appointed by President Obama (the Presidents of regional Fed banks, appointed partly by local bankers, are a different story.) They spent the whole of 2016 finding excuses to renege on their intention to raise interest rates four times that year, which had been announced in December 2015. Then within the space of two of the eight-per-year Fed meetings, they completely reversed themselves. Not only are they determined to raise interest rates at least three times in 2017, but the first of the three rises will almost certainly come as soon as March 15.
In this area, as in many others, the unexpected election of President Donald Trump has revolutionized the Fed’s thinking. Suddenly an economy that had been thought too fragile to bear the burden of interest rate rises is thought strong enough to bear them at a rapid clip. Nothing has changed, other than a stock market boom that to Obama-followers is totally irrational and unexplained.
For devotees of the policies of the last decade, there is no reason to suppose the abysmal global productivity performance is about to change, or that businesses, free from the blight of endless new regulations, are about to embark on a bout of capital investment – after all, the regulations were carefully designed by the finest minds; they cannot possibly have had any blighting effect on the economy, right?
One is left with the suspicion that the Fed’s inner circle, who believe their decade of “funny money” revived the economy, now want to normalize interest rates to crash it on Trump’s watch. By so doing, they believe they can instill in the electorate a deep regret for ever having elected another Republican after the follies of President George W. Bush.
Whatever the Fed’s motivations, their core belief that the decade of “funny money” was beneficial for the economy is mistaken. It has destroyed productivity growth, in the U.S. and around the world. It has also left us with a massive overhang of investment that was encouraged by the endlessly available cheap money, but is hopelessly uneconomic once interest rates return to a market level. Thus, even though the Fed cynics are wrong about what higher interest rates will do to the economy, they have left us a gigantic booby-trap of malinvestment that will collapse in value once interest rates are restored, inevitably causing economic disruption as it does so.
