Easy Money and the Decapitalization of America

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Kevin Dowd and Martin Hutchinson have an excellent article in the Jan/Feb edition of Cato Policy Report. It is well worth reading the whole piece (and getting a copy of their book, The Alchemists of Loss) but here are a few key extracts.

On loose monetary policy causing malinvestment:

Federal Reserve monetary policy over the past 15 years or so has produced bubble after bubble, and each bubble (or each group of contemporaneous bubbles) is bigger in aggregate and more damaging than the one that preceded it. Each bubble destroys part of the capital stock by diverting capital into economically unjustified uses — artificially low interest rates make investments appear more profitable than they really are, and this is especially so for investments with long-term horizons: that is, in Austrian terms, there is an artificial lengthening of the investment horizon. These distortions and resulting losses are magnified further once a bubble takes hold and inflicts its damage, too: the end result is a lot of ruined investors and "bubble blight" — massive overcapacity in the sectors affected. This has happened again and again, in one sector after another: tech, real estate, Treasuries, and now financial stocks, junk bonds, and commodities — and the same policy also helps to spawn bubbles overseas, mostly notably in emerging markets right now.

On loose monetary policy causing a lack of savings:

We also have to consider how periods of prolonged low (and often sub-zero) real interest rates have led to sharply reduced saving and, hence, to lower capital accumulation over time. U.S. savings rates have fallen progressively since the early 1980s, falling from nearly 12% to a little over 6% by the end of the decade, bottoming out at 1.4% in 2005. It then recovered somewhat, but even after the shock of 2008, the savings rate rose in 2009 to only 5.9% — well below its long-term average of about 8% — and the most recent data suggests that it is now declining again… [I]t is manifestly obvious that such savings rates are inadequate to provide for the maintenance, let alone growth, of the U.S. capital stock (or, for that matter, its citizens' desires for a secure retirement): the U.S. economy is effectively eating its own seed-corn.

On loose monetary policy leading to lower living standards:

Hence over the long term, low interest rates are decapitalizing the U.S. economy, with damaging long-term implications for its residents' living standards: in the long run, low interest leads to low saving and capital decline, and they in turn lead to stagnation and eventually to the prospect of declining living standards as America ceases to be a capital- rich economy… [S]avings have been suppressed for close to two decades, preventing the natural accumulation of capital as baby boomers have drawn closer to retirement, while much of the country's magnificent and once unmatched capital stock is being poured down a succession of rat holes.