The consequences of interest rate suppression

May 9, 2024·Alasdair Macleod

Decades of interest rate suppression have resulted in debt traps in both public and private sectors which will destroy faith in fiat currencies. This leads to higher, far higher interest rates and the escape into gold is only just starting.

Throughout European history, there has been a dislike of interest rates. For the last two millennia this was reflected in Christian (and Muslim) bans on usury. But interest is charged by a lender for good reason. A lender is ceding possession of money or credit to another, losing the facility to turn them into goods for his or her own consumption. That is worth compensation, and economists call it time-preference. And then there’s the risk that the borrower might default on the obligation to repay. That’s worth something as well. The fact of the matter is that the compensation a lender of money is due can only be decided on a case-by-case basis between lender and borrower.  

The idea that this is something that should be controlled by a central bank is therefore fundamentally flawed. Not only are central banks wholly unsuited to the task by its very nature, but they act for governments in two important respects. They provide the interest rate background for the pricing of government debt. And in order to ensure tax revenues are consistently beneficial to the government, they attempt to manage economic activity in the private sector.

Consequently, central banks are under political pressure to suppress interest rates at all times. It leads to the most important distortion of all in a modern economy by encouraging the creation of debt for reasons other than its use for productive purposes. The greater the suppression, the greater the distortion becomes. We might be aware of zombie corporations which without continuing cheap debt would not survive, but the problem goes far deeper, distorting the entire economic system of production.

It also leads to a transfer of wealth from saver to borrower, which handily for the suppressing central bank cannot be quantified. And the chief beneficiary of this wealth transfer is the government.

Interest rate suppression tends to disrupt the balance between immediate consumption and savings, because savers are discouraged. Reduce the level of savings and you increase immediate consumption. Increase immediate consumption, and you increase the general level of prices. We can see that interest rate suppression begins to have unintended consequences. But perhaps the most acute problem today is in government debt.

Government debt increases as a consequence of interest rate suppression. That is the consequence of a central bank pursuing the two objectives referred to above. From a government’s point of view, so long as interest rates are suppressed, it becomes free to borrow increasing quantities because the cost of borrowing is suppressed and the funding of ever greater budget deficits is facilitated.

This creates another distortion. The funding of these deficits comes at a time of a diminishing propensity to save, due to the suppression of interest rates. Government debt becomes increasingly funded by the creation of new credit, rather than tapping into the savings pool, which is the recycling of existing credit. Inevitably, this dilution of the currency leads to a falling purchasing power of the unit in which all credit is denominated. And a declining purchasing power leads to a tendency for interest rates to rise as faith in the currency’s value declines. 

Out of interest rate suppression, subsequent rises in interest rates become inevitable.

For the rest of this article, subscribe to MacleodFinance Substack