Central bank money waterfall misses mark

At this point in the economic cycle, the zero interest rate policies (ZIRP) are arguably doing more harm than good.

Global central banks, by pushing interest rates to artificially low levels around the world, are inadvertently causing deflation in my opinion.

That’s exactly the situation that central banks have been trying to avoid.

money flows

Low Returns

The torrent of low interest rate capital is flooding markets with liquidity and the money is being put to work at ever lower rates of return.  

Specifically, corporations invest in projects with lower internal rates of return and banks and other asset managers make investments in assets with lower expected rates of return.

The result has been higher asset prices and lower rates of expected future returns.

Tumbling Prices 

In the manufacturing sector, more and more goods are being produced with low interest capital. As a result, prices of manufactured goods continue to deflate.

The effects of ZIRP are apparent in commodities where the low cost of capital lead to massive overproduction and price deflation.

There are many more examples, however, the key point is that low interest rates distort world markets.

In my opinion, interest rate normalization is critical to the long term realization of global central banks’ inflation goals and investors expected returns.

Photo Credit: Stacey Gitto via Flickr Creative Commons