The Bad Consequences of Cheap Money

The great majority of people borrow money from banks to buy their homes, and banks have been marketing low cost loans very actively. The great majority of borrowers probably think that low interest rates are fine but there is a catch with these low rates and you should be aware that there are some big problems lurking behind the corner for most of us, so take please read on…

The rate of interest in Finland is seldom fixed for a period longer than three or six months even though the loan can be for 20 or 30 years. The Danes and the Americans are lucky to have long-term fixed-rate loans because they are better protected from steep increases in interest rates.

Today the rate of interest is very close to zero because the European Central Bank (EBC) thinks that it’s a very wise decision to maintain zero interest rates in order to stimulate recovery after the financial crisis of 2008.

This decision to keep rates so low may have been smart 10 years ago but now, 10 years later, this policy is best described as utter madness. The rationale then was based on helping weak governments, weak banks and weak companies to recover after the destruction of that 2008 crisis. 

But now 10 years later and we still have such low interest rates, and we still have weak growth and weak banks in the same countries. 

The result of this policy means that there is a huge transfer of profits to the banks, to investors in shares, and to companies and ordinary people who have large loans for the time being.

Unfortunately politicians, regulators and the EBC have not exercised “tough love” and forced write-downs of bad debts as was done in the USA. The result has been a Japanese-like deflationary meltdown in many parts of Europe where austerity and weak regulation have been the preferred medicine. 

The EBC has protected weak banks and weak countries for too long. Quantitive Easing has served Italy, Spain, France, Germany, Greece and Portugal well for different reasons, but the result has been that new investments by Europe’s companies that would enhance productivity has not been seen nor has key European infrastructure been upgraded. 

In fact the opposite is happening – money has been flowing into weak companies, into non-productive real estate and more risky assets by desperate investors who seek out higher returns. Infrastructure has not produced the physical and digital networks that we need. The risks of Climate Change have not been alleviated by big new investments – Germany, Poland and others still hang on to coal and fossil fuels like newly-met lovers. 

Decision makers have their heads in the sand too long and that is not good for Europe’s population.

The ones who are losing out are pensioners, ordinary savers and people who don’t have large loans… and many others…

…like ordinary Finns and companies who have large loans who will be faced with cringing loan expenses when interest rates increase and then there will be many who cannot repay what they owe… then the banks will start once more to cry out for more taxpayer support. 

—- and if this continues the whole population in Finland will be exposed to the risk of having smaller pensions because the bond markets, an important investment asset class for pension funds, are not yielding a return above inflation. You can be quite sure that your pension will be much smaller than what it should be.

… and if this continues for another decade ordinary people who have money deposit in the banks will see their savings get much smaller. There are huge amounts sitting in the banks and there is not one saver earning a single cent on these deposits in the current market.

… and when interest rate rise share prices will almost certainly start to fall…

… and house prices too…

… and many companies may go south… 

… and this but must happen even though it is politically difficult to increase interest rates.

Photo: Wikipedia Commons

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