17 June 2011

Low interest rates and the rentier class
Every time any one even meekly suggests that perhaps maybe possibly it's time to raise interest rates, Paul Krugman pounces on him with an in-your-face Enemy of the Proletariat, Friend of the Rentier Class column that is now so familiar to readers of the New York Times that they can probably hammer one off themselves.

So it is with some trepidation that I present two graphs.

The first one shows how the share of non-farm labour in business income has been steadily decreasing, especially since the 1980s.

The second is a graph of the Federal Funds Rate, which also incidentally has been steadily falling during the same period. [Both graphs use data from the St Louis Federal Reserve Bank site, as always a treasure house of information.]

Is this only an amazing coincidence?

Hardly. In Krugman's world-view low interest rates mean that firms producing real goods and services can borrow at a cheap rate and thus employ more people and presumably ordinary people can borrow money cheaply and live under their own roofs and so on. In other words, low interest rates pave the way to heaven. And yet the graphs lead the other way.

Actually the explanation is quite simple. The entities who really benefit from low interest rates are hedge funds and traders of financial instruments. Typically, they take advantage of mispricings of securities amounting to a few cents. And how do they parlay such tiny mispricings into incomes amounting to tens and hundreds of millions of dollars? By leveraging their equity ten, fifty or a hundred times. And of course they can do that only if money is dirt-cheap.

Equally important, this hurts the producers of real goods and services who are looking for loans. At present the prime rate is around 3.25%. What self-respecting bank would lend at 5% or even 10% and wait a whole year when they can earn more in just a few weeks by trading in financial instruments? If nothing else, the bonuses currently being paid to bankers should make this obvious -- to all but those rendered blind by ideology.

I imagine that whenever another of Krugman's Keep Interest Rates Low articles appears, financial traders gather in the centre of trading floors across the country, utter wild whoops of joy, and shout to the accompaniment of high fives: "Keep it coming, Paul!"

With enemies like Krugman, who needs friends?

Category: Economics

Philip George
Understanding Keynes to go beyond him

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