The aftermath

The lessons of history have been ignored by governments who have continued to maintain cheap credit and low interest rates way too long.

As an aftermath, these policies have led to gross distortions – and trouble eventually.

The economic downturn in the previous decade prevented many from obtaining funds needed for their operations or for investment or expansion. There clearly was a loss of faith in the economy and in markets, so there was a demand for assurance about the future. Borrowing dried up and existing interest rates failed to attract lenders.

When interest rates declined to almost zero, investors remained reluctant to lend. Banks subsequently unleashed a flood of liquidity, providing a bonanza for consumers buying cars on time or buyers seeking mortgages to finance the purchase of a house.

After all, if one could buy a car and not pay interest for several years or buy a house with mortgage interest rates at a very low figure, the resulting avalanche of money helped to revive the economy and gave a push to financial markets. Hence, common stocks soared to multiples, earning far above historical averages. 

Salvation appeared to be underway, but vulnerabilities started to appear.

In view of the depressed interest rate levels, investors went hunting abroad for better returns from such exotic markets as Vietnam or obscure lands.

The economic crisis became a Damascus moment as borrowing abroad at lower interest rates provided a decent return for lenders to obtain funds to finance borrowing by consumer here at home.

Placing funds in foreign land of questionable stability is fraught with risk. Even endowment funds of universities are guilty of this nonsense as, for example, Yale University has “invested”, believe it or not, in Chinese suburban development, because it supposedly provided a decent pay out.

Investors continue to do a poor job of discrimination between sound and risky financing.

Stampeding capital looking for higher interest rates fail to exercise due diligence, and are overwhelming common sense. As investment funds are placed in long-term loans or doubtful security, consumers have funds to make purchases without adequate backing.

Retailers advertise interest-free loans for extended periods, boosting retail sales for the time being.

Whether or not these excesses will entail a messy end is not easy to determine yet. However, risky participation in lending is leading to distortion that will cause a great deal of trouble ultimately.

Easy credit policies may help the economy temporarily, but are dismissing unintended consequences.

 

 

Bruce Whitestone

Comments