No Financial Crisis
This is one of my main criticisms of central bank policy, especially the last three years when there was no financial crisis but all the central banks continued to keep interest rates at recession era levels which has incentivized inappropriate uses of capital allocation, and this money being used for yield arbitrage plays would be more beneficial to sustainable growth projects and overall growth in the economy if interest rates were normalized.Â
ECB Rates Too Low – Deflationary Capital Allocation Incentives
We see the pernicious aspects of below normal interest rates; the lower they go the more inappropriate and actually deflationary aspects in some cases of how investment capital is allocated. Take for example, the recent ECB measure to lower their equivalent Fed Funds Rate from 25 to 15 basis points, what did this incentivize? It incentivized a bunch of capital to run into European Bonds which were already at recent historical lows and chase more yield plays, so much so that the German short term debt up to two years has even gone negative on real rates. Â
When you have investors flocking to investment choices all in an effort to take advantage of ridiculously low borrowing costs, really 15 basis points, more time and energy is spent on paper or in this case electronic arbitrage capital allocation strategies, that could better be spent in other areas of the European economy which actually promoted business development projects with real returns, and not more electronic arbitrage plays where all the capital stays locked up in financial markets and does no good for the economy at large, it creates no jobs in Europe!
Japan is Prime Example of the Curse of a Low-Rate Strategy
We see it in Japan, low rates for a prolonged period of time are deflationary in a sense because they encourage the wrong types of investment choices, strictly financial yield and carry trades instead of alternative and more productive capital allocation in terms of small business loans and business development projects.
