You heard it from me first

Here is what I have been writing about for years, finally confirmed: Low interest rates worldwide were killing productivity growth. Of course, this was from someone at the University of Chicago and not RMIT, so there’s a chance others might take it more seriously – although there is an even greater chance that they will pay no attention to any of it. Still, this is from the report picked up at Zero Hedge reprinted by Martin Hutchison from his website True Blue Will Never Stain.

The paper,“Low interest rates, market power and productivity growth” by Ernest Liu, Atif Mian and Amir Sufi, examines the behavior of firms in a competitive marketplace as interests decline, and demonstrates that, although lower interest rates at first increase competitiveness through increased investment, they also increase the comparative advantage of large firms, thus after a time discouraging the smaller firms from investing and making the market less competitive. If low interest rates persist and approach zero, eventually even the larger firms stop investing, because they are no longer subject to significant competition and thus do not need to invest.

The paper provides theoretical backing to and a possible mechanism for the observation set out in this column on several occasions in the last few years: that ultra-low interest rates in Japan, the Eurozone, Britain and the United States were closely correlated with unprecedented declines in the rate of productivity growth in those countries. In all the high-income industrial countries where interest rates were held artificially low after 2008, productivity growth by 2016 had effectively disappeared altogether, or close to it. The worst effects were seen in the eurozone and in Britain, where inflation continued, making real interest rates sharply negative. Even in Japan, where interest rates have been held artificially low for two decades, the productivity dearth worsened substantially after 2009.

All of this, including what follows below, can be found in much greater detail in the last two chapters of all editions of my Free Market Economics, and of course, in the third edition. If economic management and good economics is of interest to you, go to the link and read it all, but here are bits that you can also find in my text, embedded within the economic theory of the great classical economists. There you will also find a discussion of the natural rates of interest discusses in the article, along with my own diagrammatic explanation of what it is and how it matters.

Economies work best when interest rates are at or close to their natural level, that would be set in a free market. In a Gold Standard system with free banking, interest rates naturally stay close to that level. However, if as in modern economies governments have taken over the money creation and interest-rate-setting functions from the market and move rates a substantial distance from their natural level, then investment decisions become distorted and suboptimal. In such a situation, productivity growth will naturally decline; if the distortion of the interest rate curve is prolonged, productivity growth may even disappear as investments are made into entirely the wrong assets.

Not content with the damage they have already done, some extreme aficionados of low interest rates are devising schemes to drive them even lower, confiscating ordinary people’s cash holdings so that there was no longer any alternative to their diabolical financial schemes. Truly Ben Bernanke’s inspiration of 2002 to drop money from helicopters, uttered at a meeting of the National Economists Club at which I was present, has been among the most economically damaging ideas in all of history.

The article then goes on to discuss who has destroyed more value than the monetary theories advanced by Bernanke while he ran the Federal Reserve, we come to this.

Perhaps the most likely competitor to Bernanke’s contribution as a destroyer of economic value is Maynard Keynes’ “General Theory.” It unmoored us from the established truths such as the Gold Standard and balanced budgets and enabled greedy and unscrupulous politicians to waste ever more of our money in the name of “stimulus.” The California High Speed Rail scheme was just one $77 billion example of such folly; to misquote Oscar Wilde, a man would need a heart of stone not to laugh at its demise this week.

We do not yet know whether negative real interest rates or trillion-dollar budget deficits will be more ultimately destructive of our civilization, and Keynes, not Bernanke, is responsible for the latter. Unlike Marxism and like Bernankeism, Keynesianism has affected the entire planet; indeed, it seems irrefutable, the fallacy that will not die. However, Keynesianism’s effect on productivity is indirect; it merely grows government, a low-productivity activity, rather than destroying productivity directly.

I’m not going to get into an argument over who was worse, as long as we can agree that Keynesian theory has been a disaster (although I think he may have been more charitable to the growth potential of government activities in the modern world).

The point though, is that if you want an economic theory that will guide you in the right direction, no textbook – other than my own – written in the last eighty years will be of any help at all.

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