Roughly three years ago, after traversing between Los Angeles and San Francisco via the expansive San Joaquin Valley, we penned the article, Salting the Economy to Death. At the time, the monetary order was approach peak ZIRP. We found the absurdity of zero bound interest rates to have similar parallels to the absurdity of hundreds upon hundreds of miles of blooming crop fields within the setting of an arid desert wasteland.
Given today’s changing financial conditions, namely the prospect of a sustained period of rising interest rates, we’ve taken the opportunity to refine our analysis. What follows is an attempt to bring clarity to disorder.
The natural starting point for the topic at hand is from a place of delusion. That is, the popular delusion that central planners can stimulate robust economic growth by setting interest rates artificially low. The general theory is that cheap credit compels individuals and businesses to borrow loads of cash – and consume it.
Over a sample size of five to ten year, say the growth half of the business cycle, central bankers can falsely take credit for engineering a productive economy. Profits increase. Jobs are created. Wages rise. A cycle of expansion takes root. These are the theoretical benefits to an economy that central bankers claim they impart with just a little extra liquidity. In practice, however, this policy antidote is a disaster.
Without question, cheap credit can have a stimulative influence on an economy with moderate debt levels. But once an economy has reached total debt saturation, where new debt fails to produce new growth, the cheap credit trick no longer works to stimulate the economy. In fact, the additional credit, and its flipside debt distorts prices and strangles future growth.
Monetary policy over the last three decades, and over the last decade in particular, has placed the economy in the unfavorable position where more and more digital monetary credits are needed each month just to stand still. After nearly a decade of ZIRP, from December 2008 to December 2015, the structure of the economy was distorted to the point where a zero bound federal funds rate actually became restrictive. The Fed’s incremental increases to the federal funds rate since then, are now draining liquidity from the financial system at an accelerating rate. A dangerous situation is unfolding.
Moreover, applications of additional government debt, through fiscal stimulus, also serve to further the economy’s ultimate demise. President Trump’s tax cuts may have temporarily increased GDP growth. But they’ve also spiked the deficit, resulting in a permanent increase to the national debt. The fleeting burst of growth has been borrowed from the future at the expense of tomorrow’s tax payers.
