Negative rates: an economic curse?

Companies that don’t pay interests on their debt are a like these students who never sit an exam: they somehow scrape by without any notable successes or accomplishments. The current level of rates should be encouraging investment because companies’ margins are much higher than the cost of capital, that is itself negligible. Even the least profitable projects should in fact get explored in such an economic climate because tiny debt costs are meant to encourage risk-taking and entrepreneurship. However, this era of excessively low interest rates that has been going on for many years seems to be negatively affecting the world of business and consumption, that is reacting contrarily to economic theory – and common sense.

In such an era, behavioural economic theory is precious to study attitudes throughout the chain of actors, with business leaders resting on their laurels, perhaps even going nuts, whereas an environment of higher interest rates would have forced them to restructure and streamline. Investors, for their part, tend not to be selective when the cost of money is modest and therefore have an increased tendency to put their capital into certain not-so-viable companies, thus monopolising precious resources that would have been much more wisely allocated to others. Financial institutions – whose margins find themselves extraordinarily compressed due to zero rates exacerbating their intrinsic fragility – are also falling into the trap by veering to the side of granting loans, even inundating debitors with credit, to those who are the least solvent. It is indeed a sort of “zombification” of economic actors who find themselves being favoured, even ardently promoted, before and above everyone else by the banking system that is keeping many unproductive companies on life support, and these companies in turn tend to sustain other weak links in the chain.

This is why many economists – and lots of bankers – are staunchly against negative rates: because, by making dangerous reductions to banks’ margins, they are literally being pushed into risky behaviour that weakens them, all the while taking precious resources away from the most efficient companies. In a certain way, negative rates tend to favour monopolies and unfair competition that are, as we well know, harmful to growth and to confidence. Myself an ardent defender of negative rates and of our central banks’ current monetary policy, I can however no longer ignore this phenomenon of zombie companies now deeply infecting our system, and seriously threatening our economy with spontaneous combustion as so many of these living-dead companies are proving difficult to detect.

It also brings with it a snowball effect of liquidation for these zombie companies that we could potentially be confronted with, likely brought on by a relatively anodyne event. Let us not forget the subprime crisis that, in the summer of 2007, exploded after a small rise in US interest rates. Our system has turned out to be weakened by these zombies – themselves the collateral effect of negative rates – so much so that the slightest of sparks will set it ablaze. In summary, our central banks – and us along with them – are facing a Cornelian dilemma: keep interest rates at their current levels and cause the system to rot, or raise them and paralyse our economies that are extremely vulnerable to a financial crisis like the one we still haven’t gotten over ten years on.