Liquidity Interest Rate Trap”
Well I don’t know why I came here tonight,
I got the feeling that something ain’t right,
I’m so scared in case I fall off my chair,
And I’m wondering how I’ll get down the stairs,
Clowns to the left of me,
Jokers to the right, here I am,
Stuck in the muddle with you,
Yes I’m stuck in the muddle with you,
Stuck in the muddle with you.
—*lyrics, “Steelers Wheel”
The provocative — and disturbing — thrust of a terrific new piece by Eugene Linden, “Has the Global Economy Been Zapped by Zirp?” is simply this: once a de facto policy of zero percent interest rates becomes institutionalized — the case in Japan going on two decades now, and in the U.S. since The Crash of 2008 — it can be difficult (if not impossible) to change course.
Call it “the interest rate trap.”
Bait and a Spring
Like a garden variety mousetrap, the interest rate trap has two components: bait and a spring.
The “cheese” is artificially low interest rates, which lull afflicted countries into overborrowing, especially at shorter maturities.
The “spring” is simply the spectre of dramatically rising interest rates, which can make all that formerly “free” sovereign debt exorbitantly expensive to service — or impossible to roll over.
Lehman Brothers vs. the U.S.
The foregoing sounds a lot like what happened successively to Bear Stearns and then Lehman Brothers in 2008.
It also characterizes the plight of Eurozone countries like Greece, Portugal, and now possibly Italy.
The difference, of course, is that unlike those entities, the U.S. Treasury can effectively fund itself if the private markets won’t.
It does that by printing more money — creating more debt — that makes the interest rate trap even bigger — and harder to escape — in the future.
How long can this go on?
Know one knows for sure.
But, in the words of economist Herbert Stein (father of Ben): ‘if something cannot go on forever . . it will stop.’
*Apologies to Steelers Wheel, who used the word “middle,” not “muddle.”