This column has contended for several years, based on empirical data observations from several countries, that low interest rates worldwide were killing productivity growth. A University of Chicago paper finally provides some academic back-up for this contention and suggests a mechanism through which it takes place. There are other mechanisms also, and I would suggest that the Ben Bernanke-inspired wild monetary experimentation from 2008 on has done more damage to the world economy than any other initiative in the history of mankind.
The paper,“Low interest rates, market power and productivity growth” by Ernest Liu, Atif Mian and Amir Sufi, examines the behavior of firms in a competitive marketplace as interests decline, and demonstrates that, although lower interest rates at first increase competitiveness through increased investment, they also increase the comparative advantage of large firms, thus after a time discouraging the smaller firms from investing and making the market less competitive. If low interest rates persist and approach zero, eventually even the larger firms stop investing, because they are no longer subject to significant competition and thus do not need to invest.
The paper provides theoretical backing to and a possible mechanism for the observation set out in this column on several occasions in the last few years: that ultra-low interest rates in Japan, the Eurozone, Britain and the United States were closely correlated with unprecedented declines in the rate of productivity growth in those countries. In all the high-income industrial countries where interest rates were held artificially low after 2008, productivity growth by 2016 had effectively disappeared altogether, or close to it. The worst effects were seen in the eurozone and in Britain, where inflation continued, making real interest rates sharply negative. Even in Japan, where interest rates have been held artificially low for two decades, the productivity dearth worsened substantially after 2009.
Only after President Donald Trump was inaugurated in the United States did U.S. productivity growth begin recovering towards its healthy historical levels. Undoubtedly part of this recovery was due to the Trump administration’s de-regulation policies – just ceasing to pile regulation upon regulation appears to have had some positive effect, especially in industries sensitive to environmental-regulatory harassment. However, the positive productivity signs became clearer during 2018, as interest rates climbed towards the U.S. inflation rate, albeit still below their healthy historic levels.
It has also been noted in the United States that small business formation, a key driver of productivity growth, in 2010-2016 ran about a third below its historic levels, and half the levels of the late 1970s, when figures were first compiled, even though the economy itself had moved towards recovery. This aligns with the theory postulated in the University of Chicago paper, that small businesses become discouraged by very low interest rates, and simply cease investing, or even cease being formed.
From Austrian economic principles, there is a clear explanation for the decline in productivity growth in low-interest-rate environments. Economies work best when interest rates are at or close to their natural level, that would be set in a free market. In a Gold Standard system with free banking, interest rates naturally stay close to that level. However, if as in modern economies governments have taken over the money creation and interest-rate-setting functions from the market and move rates a substantial distance from their natural level, then investment decisions become distorted and suboptimal. In such a situation, productivity growth will naturally decline; if the distortion of the interest rate curve is prolonged, productivity growth may even disappear as investments are made into entirely the wrong assets.
This is what happened worldwide after 2008 (arguably, in Japan from 1998 with a short remission in the mid-2000s). As the University of Chicago paper points out, ultra-low interest rates discouraged small businesses (that effect appears to have been especially strong in Japan, where almost no major new companies have emerged since 1990). However, there are other sources of distortion.
In the United States, vast sums have been poured by companies into buying back their stock, because the earnings cost of doing so is small at low interest rates and companies believe that if their cash flow is solid, they can survive ad infinitum without significant equity capital. They are wrong, but only the next recession will teach them so, at great cost to their employees and the U.S. economy as a whole (doubtless their foolish and greedy top management will emerge with substantial payoffs, as usual).
In London, San Francisco, New York and elsewhere, the prices of high-end real estate have soared without limit. Low interest rates reward those with borrowing capacity, and for more than 20 years now, it has been profitable for the rich to borrow gigantic amounts of money at low interest rates and invest it in high-end real estate. This bubble is now in the process of bursting, much to the benefit of Millennials, for whom the price of modest real estate has been over-elevated by the shenanigans at the high end.
Debt of all kinds has proliferated, whether in auto loans at the consumer end (less so in home mortgage loans since 2008) or in corporate leveraged loans used by the innumerable buyout artists at the high end. Default rates on all these debts are beginning to rise; they will cause massive losses before we are much older.
In Britain, Switzerland and the EU, interest rates have sunk so low that even investments without any profit at all have been attractive, provided money can be borrowed against them. I have written in the past about the possibility of a flood of Babylonian ziggurats in the major financial centers – technically religious buildings, thus exempt from local property taxes, but serving a religion with no current believers, thus making them a pure speculative asset suitable for the ultra-Keynesian New Age.
Not content with the damage they have already done, some extreme aficionados of low interest rates are devising schemes to drive them even lower, confiscating ordinary people’s cash holdings so that there was no longer any alternative to their diabolical financial schemes. Truly Ben Bernanke’s inspiration of 2002 to drop money from helicopters, uttered at a meeting of the National Economists Club at which I was present, has been among the most economically damaging ideas in all of history.
One competitor for that prize, I suppose, is Karl Marx’s Communism, so banally celebrated by the functionaries of the of the EU at last year’s bicentenary. However, that great fallacy never affected more than about a quarter of the world’s population, and eventually exploded under its own weight. Bernanke’s folly, on the other hand, shows no sign of correcting itself. Although a few more years of U.S. success with President Trump and higher rates might do the job of correcting it worldwide, our chances of getting this necessary combination are currently less than 50-50, I would say.
Another such competitor for Worst Idea was the invention of agriculture. Yes, it enabled the planet to support more people, but at what a cost! Instead of devoting only a modest portion of their time to finding and killing woolly mammoths, humanity was now forced to devote itself night and day to back-breaking manual labor in the fields. In the short term, this was truly an unspeakably bad trade-off. In the long term, of course, it led to civilization and industrialization, but it took several thousand miserable years to do so. We can however be sure that Bernanke’s brainwave will lead to no such economic breakthrough, however many millennia we wait.
Perhaps the most likely competitor to Bernanke’s contribution as a destroyer of economic value is Maynard Keynes’ “General Theory.” It unmoored us from the established truths such as the Gold Standard and balanced budgets and enabled greedy and unscrupulous politicians to waste ever more of our money in the name of “stimulus.” The California High Speed Rail scheme was just one $77 billion example of such folly; to misquote Oscar Wilde, a man would need a heart of stone not to laugh at its demise this week.
We do not yet know whether negative real interest rates or trillion-dollar budget deficits will be more ultimately destructive of our civilization, and Keynes, not Bernanke, is responsible for the latter. Unlike Marxism and like Bernankeism, Keynesianism has affected the entire planet; indeed, it seems irrefutable, the fallacy that will not die. However, Keynesianism’s effect on productivity is indirect; it merely grows government, a low-productivity activity, rather than destroying productivity directly. If I had to bet, therefore, I would bet that Bernanke, even more than Keynes, Marx or the inventor of agriculture, will be the chief destroyer of economic value in our long-term future.
By promoting ever-lower interest rates, set completely artificially by meddling bureaucrats, Bernankeism’s proponents have gone far to killing the engine of prosperity that is capitalism itself. Contrary to Keynes’ belief, the level of interest rates is the central variable in a well-functioning capitalist system. By meddling with it, politicians and bureaucrats are attempting to act as Gosplan, the central planning agency of the Soviet Union. It doesn’t work, and the attempt to meddle in this way is morally wrong as was Communism.
It is good to have some respectable academic backing for this column’s battle against the monetary folly of Bernankeism. The struggle continues!
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)