Tuesday, August 7, 2012

Negative interest rates spell defeat for current economic policies

As negative interest rates spread from Germany to Finland to Switzerland and are now approaching the US and the UK, it becomes crystal clear that current economic policies have failed.

As your humble blogger predicted, savers have cut back on their consumption and tried to increase their savings.

As your humble blogger predicted, investors have not repeated the mistake of chasing yield.  Investors are far more concerned with the return 'of' their money than the return 'on' their money.

As your humble blogger predicted, low interest rates have not spurred business investment.  The most important factor in the discounted cash flow models used to assess a business investment is expected revenue that results from the investment.  When businesses see no demand, they don't see expected revenue and the cost of financing the investment is a moot point.

What your humble blogger did not predict is just how stubbornly policymakers would pursue their failed economic policies.  I figured that policymakers would look at the example of Japan and realize they need to try a different solution.

What your humble blogger did not predict is that policymakers would pursue economic policies that put pension funds and the real economy into a death spiral and announce that they have no intention of changing their policies for the foreseeable future. I figured that policymakers and central bankers had read what Walter Bagehot said about central banking and understood that 2% was the absolute minimum for interest rates to keep a functioning capital market and real economy.

Despite the evidence that policymakers and central bankers are not going to change course (particularly the central bankers who are behaving like members of a religious cult (as the Bank of England's Andrew Haldane observed there is an element of 'theological doctrine' here)), I remain optimistic.

My optimism stems from the fact that there is a simple solution for fixing both the financial system and the real economy.  The solution was tried successfully to break the back of the Great Depression and end the financial crisis in Sweden in the 1990s and Iceland in the 2000s.

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