The Cost of Time: The Significant Impact of Low Interest Rates on Economic and Market Participant Behavior
Low interest rates subsidize borrowers at the expense of savers and lenders. By reducing lenders' income, they enable investors to lever up cheaply. People who don't borrow during this period are effectively being fleeced by those who do, further exacerbating severe wealth inequality.
Take the United States as an example: from 2007 to 2012 (the zero-interest-rate policy period), the Federal Reserve's policies generated approximately $310 billion in benefits for corporate borrowers, while ordinary citizens who tried to save money lost about $360 billion.
Lowering interest rates reduces corporate costs and puts money into consumers' hands. The impact of rate cuts and ultra-low interest rates has been enormous yet underestimated:
- The economy is continuously stimulated and maintains long-term growth, benefiting businesses;
- Investors can easily enjoy asset appreciation;
- The threshold and cost of leveraged investing are reduced;
- The threshold and cost of corporate financing are reduced; and defaults and bankruptcies are easily avoided.
Low interest rates stimulate consumer behavior
Low interest rates reduce the perceived opportunity cost. If someone considers withdrawing $1 million from savings to spend, and the savings account interest rate is 5%, they will likely realize this costs them $50,000 in annual income. But when the interest rate is zero, there is no opportunity cost. This makes transactions easier to occur.
Low interest rates stimulate investment behavior (more accurately, risky investment)
The returns investors require or expect usually do not decrease (or decrease only slightly), meaning investors face an investment gap (good investment targets, projects). Ultra-low returns on safe assets lead some investors to take on additional risk in pursuit of higher returns. Low interest rates lower the "relative threshold," making the higher returns offered by riskier assets appear relatively attractive. In other words, the willingness to achieve higher returns in a low-return environment leads to actively pursuing riskier investments.
Cheap borrowing does not improve investment quality; it merely amplifies outcomes. In an era of low returns, investments that shouldn't have been made were made; buildings that shouldn't have been constructed were built; risks that shouldn't have been taken were undertaken (especially those involving inadequate due diligence and illiquid investments). Ceteris paribus, the higher a company's (or household's) leverage, the lower its probability of weathering difficult times.
Every step in most economic cycles leads to the next.
First, interest rates are cut to stimulate the economy, monetary easing is implemented, and markets are pushed to develop positively; this reduces expected returns; which leads to a willingness to take on more risk; which results in unwise decisions, and ultimately investment losses; which brings about a period of panic, stress, and market contraction; which leads to the cycle of cutting interest rates to stimulate the economy, implementing monetary easing, and pushing markets to develop positively. That is, if interest rates are too low, credit expands rapidly, markets boom, and inflation emerges. On the other hand, if interest rates are too high, credit contracts, markets tighten, and prices fall.
Money that comes easily leads people to make mistakes; money that comes unusually easily will certainly make them err.