Negative Interest Rates Destroy Capital

According to “mainstream” economics, low interest rates “stimulate the economy”. That is false. Negative interest rates encourage the destruction of capital. With negative interest rates, a capital-destroying project can be profitable!

Mainstream economics considers the CPI to be an “accurate” measure of inflation. They are wrong. The CPI is biased. The “shadowstats” website calculates the CPI using the old method and comes up with an inflation range of 5%-10%. I use the price of gold, which leads to inflation of 20%-30%+. I also track the price of some things I buy. A half-gallon of apple cider, of similar quality, increased from $3 to $4 over the past year, an inflation rate of 33%. I consider the price of gold, over a several year period, to be the least biased inflation measure. To me, that’s a definition, because gold is money.

Mainstream economists use the CPI instead of more accurate inflation measures. This causes them to not notice negative real interest rates. Currently, the CPI is in the range of 0%-1%, which doesn’t seem bad compared to a Fed Funds Rate of 0%-0.25%.

The Federal Reserve is a fraud. The CPI is a fraud. One fraud requires other frauds, lest people see what’s really happening. The CPI fraud helps cover up the Federal Reserve negative interest rate fraud. If the CPI were more accurately reported, people would get offended by a Fed Funds Rate of 0%-0.25% while real inflation is much higher.

Traders at big banks can borrow at the Fed Funds Rate, giving them a huge advantage over everyone else. The CEO of a large corporations can borrow at a couple percent more than the Fed Funds Rate, say 4%. Everyone else must pay a much higher interest rate, or can’t borrow at all. Negative real interest rates give insiders a huge economic advantage over everyone else.

What do I mean by “negative interest rates”? The real inflation-adjusted interest rate is the nominal interest rate minus the real inflation rate. A clueless economist uses the CPI, 1%, leading to real interest rates of -0.75% to -1% for big banks, but large corporations pay a positive interest rate of around 3%. If you use the shadowstats figure of 10% inflation, then interest rates are -10% for banks and around -6% for large corporations. If you use my inflation statistic of 20%-30%+, real interest rates are negative 20% or less, giving a huge incentive for insiders to borrow and load up on as much leverage as they can, destroying capital in the process.

I’ll give an explicit example. Suppose a CEO is considering a project that will yield a nominal return of 7%. The CEO borrows from a bank at 4% to finance the project, leading to a profit of 3%. The bank borrows at 0-0.25% and lends at 4%, making a profit of 3.75%-4%. Suppose that real inflation is 10%, but the project only has a return of 7%. The CEO actually is destroying capital at a rate of 3%, while he makes a profit of 3%. If you use my inflation figure of 20%-30%, then the CEO is destroying capital at a rate of 10%-20%+ while he makes a profit of 3%.

The real return of the project (7%) is less than true inflation (10%-30%+), which means that the project actually destroyed capital. Negative real interest rates made the capital-destroying transaction profitable. The economy as a whole would be better off if those resources were invested elsewhere. However, the CEO made a nice profit from his capital-destroying transaction.

In the above example, the CEO makes a profit while destroying capital. Large corporations use 10x or greater leverage, so he’s actually destroying capital at a rate of 40%+ while making a profit of 30%+. Negative interest rates gave the CEO and the bank the incentive to finance a capital-destroying project. Negative interest rates gave the CEO the illusion that he’s creating wealth, when he’s actually destroying wealth.

If the CEO made a profit while destroying capital, then who paid for his profits? His profits are paid by everyone else in the form of inflation. When the bank financed the CEO’s bonds, they created new money to buy the bonds. The real economic value of the project was less than the amount of new money created. There are more goods and services due to the new project, but the amount of inflation is even greater than that. It’s the “seen vs unseen” fallacy. People see the new project that had a 7% return, but they don’t see the other projects that don’t get financed due to inflation. Someone else who was saving to buy a house or bootstrap a business lost out due to inflation.

The “housing bubble” is another example of negative interest rates leading to destruction of capital. Mortgage interest rates were 5%/year, but housing prices were going up 10%-20%/year, because that’s closer to true inflation. This false price signal tricked people into leveraging and buying the biggest house they could, or buying multiple investment properties with leverage. During the housing bubble, more houses were built than were actually needed, a tangible destruction of capital. Negative interest rates also lead to bubbles and busts.

Negative interest rates distort the economy. With negative interest rates, it’s more attractive to finance a business with debt instead of reinvested earnings. Large corporations grow with debt and leverage and financial tricks. Small businesses usually grow with reinvested earnings, because they don’t have access to cheap capital like banksters and insiders. Negative interest rates give large corporations a huge economic advantage over small businesses, because large corporations can borrow cheaply and non-insiders can’t.

That’s one answer to the question “Why do large corporations control most of the economy?” With negative real interest rates and access to cheap capital, large corporations can easily buy out smaller competitors. With negative real interest rates, leveraged buyouts are very profitable. One example is Yahoo’s purchase of Tumblr, paid for $1.1B all cash (i.e. debt). Then, the CEO also buys some Congressmen, passing regulations that make it hard for someone to start a new business that competes with his established cartel.

Literally, interest rates are the price of money. The government and the Federal Reserve distort the price of money. With negative real interest rates, capital-destroying transactions are profitable. As long as real interest rates are severely negative, the economy cannot recover, because insiders are “tricked” into making investments that would otherwise be unprofitable.

3 Responses to Negative Interest Rates Destroy Capital

  1. I really appreciate this article. The best part was describing exactly how regular people could solve a problem without the annoying complicated government ‘solution.’ Also that you explain how the government makes it worse. I think capital choices are still made relative to the alternatives, since the company destroying value is probably still making the best investment given the situation. We are at the point where we can easily map out the pieces of the state that are the strongest of its foundations. I think the next step for us is to map out the pieces of the free market which we can found it on.

    • The capital-destroying investment really destroys capital. It is profitable for the person who makes it, but a net loss for society as a whole.

      Due to severe negative interest rates, almost all “investments” made by CEOs are actually capital-destroying.

      It’s amusing to read CEOs bragging in their annual report “We grew earnings by 15%-20% per share last year!” My reaction is “That’s nice, but that’s still less than true inflation.”

      As long as you use State money, you’re financing capital-destroying investments via inflation and loss of purchasing power. The only way to avoid theft via inflation is tangible assets, mostly gold and silver, taking physical delivery.

      I don’t have access to cheap capital at negative interest rates, so they only way I can grow a business is via reinvested earnings. However, when I save my salary or earnings to start/grow a business, I get robbed via inflation, which is used to finance banksters and insiders.

  2. Anonymous Coward May 29, 2013 at 6:17 pm

    Perhaps you could measure inflation by the massive increase in the cost per click on Google Adwords.

    Back in the year 2005, you could pay between 5 to 15 cents per click.

    Now it is well over one dollar per click.

    Consider selling software: the classic metric is 1 sale every 100 downloads.

    I recently launched a little piece of software, almost just for fun. 10% of people visiting its web page go on to download the software. Of those 10%, 10% that download it end up buying a copy. So the sales rate is 1% per web-page visitor.

    I have a main piece of software and the statistics for it are a little better, but not out by a staggering amount.

    That means if you advertise with Google Adwords (and don’t get many natural search ranking visitors) Google wants at least $100 per sale. That is shocking.

    So say the cost per click was 7 cents in 2005.

    In 2013, the cost is 100 cents.

    In the exalted land of greedy Google clowns, the inflation rate per year is 40%!!!!!

    Well they need all that money to buy Android and give it away free! Ha! Well, they do make a lot of acquisitions and all their projects – other than Adwords – can’t be that profitable. They probably all lose money.

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