Rewind. Idiocy of the zero interest rate policy

The model of ‘stakeholder capitalism’ followed in the 1980s by countries like Japan and Germany, in which the interest of all stakeholders — employees, suppliers, providers of capital or consumers — was given heed to, was replaced, primarily in the US, by ‘shareholder capitalism’ in which the interests of other stakeholders are made subservient to those of providers of capital.

This shift helped the US to regain its economic hegemony, which was threatened, in the ’80s and ’90s by a rising Japan and Germany. The shareholder capitalism pendulum has swung to a far extreme and the need to generate a good return for the providers of capital means that corporate management has to increasingly take a short-term view. It was this short-term view, and the focus on growth at all costs, that was responsible for the 2008 global crisis.

The 2008 crisis led to an easy money policy by central banks in a futile bid to generate growth through a monetary drip. Initially with zero interest rate policy (ZIRP) and later with negative interest rate policy (NIRP), central bankers dissuaded savings and encouraged consumption in order to stimulate their moribund economies. It is surprising that capitalist economies debase money, the very pillar on which they stand.

The chickens are now coming home to roost. David Stockman writes about ‘A Scam Called Valeant’. The market cap of Valeant Pharma has crashed from $90 billion last August to $12 billion now. Why? Because the management followed a policy of growth through acquisition, in order to give a better return to providers of capital. Valeant thus made 150 acquisitions, at a cost of $40 billion. Its debt grew from $400 million to $31 billion, made possible because of ZIRP and NIRP.

Company sales increased and this growth drove up the company’s market cap to $90 billion. But the interest of other stakeholders was not served. Thousands of jobs were slashed. The company’s spending on R&D is just 3 per cent of sales, compared to 12-18 per cent for the industry. Nor did Valeant consider its customers; it hiked prices of 88 per cent of its products by an average of 66 per cent. The company was spending far more cash on acquisitions than it was generating. But, this could not last.

Yet, in a recent speech, US Fed Chairman Janet Yellen called for caution in the interest rate hike process, thereby continuing the stock market party with cheap booze.

Similar quantitative easing in China, fuelled by cheap money, led the Chinese steel industry to expand ferociously, growing 60 per cent over five years, to hit a capacity of 1.16 billion tonnes a year, in anticipation of the construction boom continuing. Now that the boom has ended, China is left with about 700 million tonnes in excess steel capacity and is dumping steel in the global market.

One Chinese steel company chairman, unable to repay his company’s debt, recently committed suicide.

Tata Steel has decided, wisely, to shut down its UK steel operations. When it acquired Corus it had not expected the insane ZIRP and NIRP-funded steel expansion in China to lead to large-scale dumping.

Perhaps the chairman, had he been in India, would have been able to effectively stall his day of reckoning because of the leniency and slowness of our judicial system. Unless the law and the government crack down hard on white-collar crime, investors will be loath to invest in paper assets to fund India’s growth story.

So, the consequences of ZIRP and NIRP are being felt long after easy money was first introduced, and it is, therefore, advisable for central bankers to realise the foolishness of debasing money.

Other than industry, the true sufferers are senior citizens who are finding the return on their retirement savings to be totally insufficient.

Investors should look out for bursting of more bubbles like Valeant. It is high time central bankers realise that money deserves respect.

The writer is India Head, EuroMoney Conferences

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