Negative rates, Negative Outcomes

There has been much head-scratching of late as to why, with interest rates lower than they have been since the Universe first exploded out of the Void, businesses are not undertaking any where near as much investment as that hoped for beforehand by the academic cabal whose ‘effective demand’ and ‘transmission channel’ fixations have helped drive rates to today’s mind-boggling levels.

This is obviously a complex topic in which there are many different factors at work – not the least of which is that the prevalence of overly-low interest rates for much of the recent past has meant that all too much of such investment as is now desired has not only already been done, but done in what has turned out to be so misguided a fashion, that there is less appetite – as well as fewer means, in many cases – to undertake much more of it today.

If the cure for higher prices – as the saying in commodity markets goes – is higher prices, then the cause of lower rates is almost certainly lower rates!

Be that as it may, on a more fundamental level, it might also be possible to tease out at least one aspect of the answer to the conundrum with the aid of a little straightforward logic, as we shall now attempt to do here.

In theory, positive interest rates reflect the primal truth that goods fit for our enjoyment today are worth more to their potential consumer than those same goods which are only available tomorrow. Moreover, since producer goods are otherwise inedible, unwearable, uninhabitable, etc., in their present form, they only derive their value in respect of their quality of being innate consumer goods-to-be.

Hence, the means of producing the day’s goods for some future date are always to be discounted back using that same ratio (which is none other than the natural rate) as the one which prevails between consumables-now and consumables-then. Doing so gives us a positive IRR (or, if you prefer, assuring that NPV>0) for the process.

Here it goes without saying that since the natural rate is inherently unobservable, the market interest rate will be used in its place – an unavoidable substitution which demands that this latter quantity be subject to as few falsifications as possible (a vexed topic suitable for a forthcoming, much deeper treatment).

This calculation therefore presents the entrepreneur with his bare minimum hurdle – one which, in practice, he will routinely wish to exceed in order to earn that additional surplus which constitutes his true economic, rather than his accounting, profit, as well as to compensate him for the risks he must run and the uncertainties he must bear along the way.

Negative rates, however, tell our man the converse to the above: they implicitly prize tomorrow’s goods more highly than today’s. This means that a productive combination today should command a HIGHER price when assembled than will the combined cash value of the stream of goods and services to which it is expected to give rise over the course of time.

That being the case, why on earth would any sane company boss make sizeable new expenditures whose IRR is deemed to be negative in cash terms – and which will therefore both deplete his equity and sap his means of paying dividends to the firms’ owners – when he can, as is becoming widely bemoaned, make alternative use of the same financial means to boost the price of his shares by swapping some of them for an obligation which he is effectively being rewarded for taking on, so making his hapless bond-holders pay his wages for him instead?

Madness!

Source: http://truesinews.com/2016/02/11/negative-rates-negative-outcomes/