… All on money, loaned for free by FED, that the American People have to pay the interest on.
Liquidating Civilization, Report 22 Apr 2018
In a normal world, borrowers cannot run a loss-making enterprise indefinitely. Though even in positive-rates America, they can get away with it for a long time if the Fed creates a permissive credit environment.
However, Fed or no Fed, losses are written on the financial statements. A business that destroys investor capital at -1% per year will run out of cash, sooner or later. This is in a normal world. What if the world is not normal?
Let’s consider that. Losing Corp. loses money at -1% but borrows at -2%. Earnings before interest is negative. But after interest, “earnings” is positive. Unlike the former case where the company reports loses while other companies are presumably reporting profits, and thus the money-losing company will eventually repel investors, in this case it is sustainable. At least so long as the interest rate is negative. Which it will be (and falling) for all the reasons we have been writing for years.
Of course, it’s not sustainable. It will end, but the central banking regime has made it much more difficult to liquidate losing businesses (while ensuring more and more businesses will lose). Large scale business liquidation can only occur when it is no longer possible to slowly liquidate civilization.
Let’s defend that statement. The interest rate is the single most important price in the economy, because every other price and every investment and every enterprise depends on it. And the central banks have created a system which has driven it down to zero and beyond.
The interest rate is the expression, in the market, of a universal in the human condition. Time itself (we will revisit this idea in a future essay).
When interest sinks below zero, it means that the return to be earned on capital is negative. It means all savers are doomed to slowly lose their capital. It means any other better opportunities have, for one reason or another, gone away. No one would lend at -2% if he could get +3% obviously. So the market being moribund at -2% means the marginal enterprise sees no better opportunity. They are willing to borrow only if the rate is that or lower.
As an aside, this is a good way to think of the dynamics of a falling interest rate. There is little demand for credit, other than on a downtick in interest rates.
By the time it gets to the terminal phase, where businesses are borrowing at -2%, the marginal business is not able to bid higher than that. It does not want credit, except when the price is -2%. A business will always seek to borrow at lower than its return on capital (or else there’s no point). A bid of -2% means the business wants credit to finance wealth-destroying activities.
There is no mechanism to deprive one particular wealth-destroying enterprise of capital, when large numbers of them are losing. There is not one bad company showing losses on its financial statements, slowly running out of cash. There is a whole economy full of them—showing profits! If something is profitable, businesses will scale it up until it no longer is.
In a free market, only wealth-creation is profitable. But in this terminal stage of the unfree market based on the forced feeding of credit, borrowing at -2% and destroying capital at -1% is profitable. This trade will be scaled up.
Perverse Incentive → Perverse Outcome
Inevitably, people will blame free markets, business, and the profit motive itself. They will not question the perverse outcome that comes from the perverse incentive of a falling interest rate and the heat death of the economic universe. So the for-profit business will take the blame that should go to the Fed and the legal tender laws and the rest of the whole edifice of our monetary regime.