If so, given that real rates have been negative how can you commend that offered rates were to low.

If not, then presumably you would advocate that credit be restricted in volume and offered at a higher rate, but with the highest of diligence by the lender. However this kind of credit restriction would be deflationary, further increasing the real negative rate. To which you would further restrict credit and raise rates further I presume?

What is the end game of that?

The debt explosion that had occurred in recent years and subsequently proved unsustainable was by definition a proof that interest rates generally were too low. Official bank rates or official interest rates and not mortgage rates are normal reference rates for standard economic discourse.

“For recent years, interest rates and the cost of capital were far too low, which encouraged “borrow to spend”, “borrow to invest” and “borrow to speculate”.”

My understanding of recent rates (at least here in the UK) for typical mortgages have varied between 3 and 6% for typical loans. Pu whatever figures you like on what your define as ‘rates to low’, they’ll still be massively higher the the real underlying negative rates so you have not managed to answer my question.

The “out of context” statement:

“offered rates recently between 3% and 6% have been to low”

is certainly not mine.

I believe it is exactly the opposite of what you say. For recent years, interest rates and the cost of capital were far too low, which encouraged “borrow to spend”, “borrow to invest” and “borrow to speculate”. The mountain of debt led to over-consumption, asset bubbles (dotcom, property, commodity etc.), mal-investments and sheer waste of resources. The “fact that CDs have outperformed the US equity market over the last 20 years or so”, as you said, is a statement by the market that the US economy had been an unproductive failure, as exemplified e.g. by its bankrupt motor industry, once a proud symbol of US industrial dominance.

Much of the blame goes to bad economic teaching and bad policies. There has been a lack of understanding of the limitations of monetary policy, which is a blunt instrument, full of unintended consequences. Profound ignorance of how the world really works, together with unchecked powers of central banks and governments, have led to the current mess. Fiddling with interest rates while the city burns will not prevent the fall of the empire.

Serious mistakes have already been made by those in power and they want to compound the serious damage done with still more serious mistakes. People have been living beyond their means and now they recognize this and they are trying to live within their means. This is the “much feared” debt deflation, which is declared by the corrupt oligarchs to be a crisis to avoided at all costs. This “shock doctrine” enables them to assume still more unchecked powers and steal more money from the savers and taxpayers. Debt deflation is far more preferable than the chaos of Zimbabwe, which is the real “hell in a handbasket”.

This has manifested itself in inflation, which in turn has been driven by an increase in leverage. A contraction in the economy will always result in inflation if the money supply remains stable.

The key problem is that offered rates have not reflected the real cost of capital. Recent rates have been _too high_, which should be obvious from the fact that CDs have outperformed the US equity market over the last 20 years or so.

The problem has been that people have borrowed money at inappropriately high rates looking for growth that was not there and as a result we now have a huge debt overhang.

The key enabler of this was massive leverage. It is my contention that it is leverage well above the level that growth rates can support that leads to speculation (i.e. the availability of credit), not the actual offered cost of capital.

Therefore I suggest that as long as leverage returns to sensible levels a transition through the 0% interest even horizon will not lead to uncontrollable speculation. In such a secnario the banks will restrict themselves to productive loans such as well collateralised mortgages, sensible business plans etc.

A rush to PMs can be prevented by taxing transactions on them, but even this I don’t think is really required, at least not once an equilibrium position is reached during which rates may cross the 0% level several times within a decade. A -1% rate would only imply a smallish bounce in gold or a currency fluctuation similar to that which might be expected from a move from +2% to +1%.

Secondly, we should consider what classes of investors we are talking about. Low net worth households will not rush to gold. They’ll just take the discount on their mortgage and spend it. Higher net worh households will likely retain some cash as the normal safety net and perhaps spend the cash on home improvement of something. These are the calss of people we’re worried about right now. If they don’t spend we all go to hell in a handbasket.

The hedge fund managers and very high net worth people I’ll discuss in a subsequent post.

As a long-ish time reader of and poster at that most austrian of blogs – mish, I’m quite well aquainted with austrian theory and typical objections from this school of thought. I’m not going to identify myself with neo-classicist thought because I agree it is bankrupt. Having said that I believe the same of austrian theory, mainly because they deny the paradox of thrift and think that full reserve banking is appropriate for a modern industrial economy.

So with my cards on the table, back to the issue at hand.

A very good summary. I did not know about negative interest rates affecting the economy in such a manner. I wonder what Steve’s view on negative interest rates being the norm for over a decade as the Austrian link above claims.