Hemera Technologies
The International Monetary Fund has issued a timely warning about ultra-low interest rates. Just as the Federal Open Market Committee signals the need for further easing, a new report from the Fund on Wednesday lays out the multiple threats created by such loose monetary policy. In rich nations, small firms suffer while in emerging markets, capital inflows produce bubble conditions. Ben Bernanke and his colleagues should pay heed.
For starters, the IMF's "Global Financial Stability Report" identifies, rather significantly, how the credit cycle has been dangerously disrupted with the abundance of money. Real interest rates historically track at around 1 per cent whenever spreads on investment-grade corporate bonds hit current levels. Given how much lower rates are today, investors are struggling to meet their return hurdles.
This revives the need for excessive leverage in the quest for yield. It also pushes borrowing into the shadow banking system, a shift exacerbated by added regulation of more traditional lenders. Though the current economic recovery is lagging the trajectory of the last 14 credit cycles, according to the IMF, no other stretch has seen corporate spreads narrow so quickly since the 1930s. Moreover, as markets trump banks for funding, the fortunes of small firms, the primary engines of job growth, increasingly diverge from those of larger rivals.
In developing countries, meanwhile, the rapid influx of money created by ultra-low rates jolts asset prices upward. Chinese real estate companies, for example, have been particularly active in international bond markets as domestic credit conditions have tightened. The phenomenon is compounded when domestic monetary policy is similarly loose. Even without any shock, the IMF forecasts a sharp rise in non-performing loans in Asia and Latin America – and a correlating decline in the capitalization of local banks.
This backdrop should help frame the Fed's contemplation of fresh ways to intervene, including by possibly trying to reduce long-term interest rates. But as U.S. central bankers fixate on helping America recover, the broader consequences of their actions, both at home and abroad, deserve considerably more attention.