Since the financial crisis of 2008, interest rates have been maintained by central banks at a historically very low rate, or even negative in some European countries, Japan and Switzerland. Not only is the level of rates exceptionally low, but the duration of this monetary policy is also particularly long. If rates have been excessively low since 2008, in reality they have already been declining for almost 40 years. The "neutral" rate, supposed to neither promote growth nor a slowdown in the economy, has been falling for decades, driven by powerful and slow forces such as the aging of the population, the decline in productivity and the savings of households and businesses.

Consequences

This prolonged phenomenon of such miserable rates has helped to avoid a period of deflation following the financial crisis, and has subsequently lowered unemployment rates, eased the financial burdens of borrowing on companies, governments and individuals, and initiated a historic bull market in stocks. With the return on money becoming increasingly low, investors are having to turn to riskier assets and pay more and more for them. The price/earnings multiples of companies are exploding.

Large companies are taking advantage of low rates to issue debt and buy out their competitors directly rather than innovate. The market is becoming more concentrated, the giants are becoming bigger and bigger. On the other hand, poorly managed companies are being artificially subsidized by low interest rates. In normal times, they would go bankrupt. Not to mention that their prices are being kept alive by ETFs that invest in the entire market, without distinction. Low rates and index funds thus encourage mediocrity. Growth companies are clearly favored by low interest rates. Value companies, on the contrary, have been struggling for a long time, which represents a historical anomaly.

Treasury bonds, especially long-dated US bonds, have performed as well as stocks since rates began to decline in the early 1980s. This too is an anomaly from a historical perspective.

While the economy has recovered and unemployment has fallen to a very low level, interest rates have paradoxically not returned to their pre-crisis levels. Despite the massive injection of liquidity, the economy is growing slowly and inflation is barely positive. The mass of money created by central banks has benefited the stock market and loan repayments more than the real economy. Unemployment has certainly been reduced, but wages are not taking off and working conditions have become more precarious. Employees are therefore unable to stimulate domestic demand.

Not the desired effect

In a normal economy, a large influx of money into the system leads to growth and inflation. However, you can't make a donkey drink if it's not thirsty. Companies took advantage of this easy money to digitize, robotize, buy out their competitors, in short, invest in capital rather than create jobs. Reasonable governments took advantage of this to write off their debts, but we hardly saw any Keynesian policies. Boomers rushed to buy bonds, considered low-risk, to provide their pensions with income. Similarly, pension funds are required by law to hold large quantities of bonds. This strong demand in a supposedly safe asset class has helped to further weaken rates and inflate bond prices, making financing pensions even more expensive. Today, bonds are clearly in a bubble and risky.

Few other solutions

Central banks don’t have many monetary tools left in a recession. They can push rates into deep red territory, but that will make it even harder to fund pensions and endanger the banking sector. So they’re unlikely to go very far with this approach. There’s also the famous helicopter money, which consists of distributing money directly to individuals, either in the form of tax cuts or through government spending, financed by central banks. This is a theoretical approach that has never been tested. So the only credible solutions are fiscal policies, via increased spending and/or tax cuts financed by governments. Very low interest rates undeniably make this easier.

With stimulus packages added to years of abundant liquidity and low unemployment, there is a good chance that inflation will start to rise again. Central banks could then gradually raise their rates again, but one dares not imagine what this will do to financial markets that have become accustomed to accommodative policies.

The Consumer Price Index

In the US, since 2010, the consumer price index has been stable. We can even say that the bulk of the downward trend that began in the early 1980s has stopped since the beginning of this century. The last time it was sustainably stable and low was just after the Second World War. As for the interest rate, the only time it was this low was also after the war, but for a much shorter period. After that, it only rose for 30 years. The rate has never been sustainably lower than the price index, as has been the case for more than ten years.

A future that could be eventful for some

The further we get from the last recession, which was already more than eleven years ago, the closer we get to the next one. It may even have already started, against a backdrop of protectionism, trade wars and viruses. Cycles usually last 7 to 8 years, but we are already well beyond that. If governments have to implement Keynesian policies to compensate for central banks, inflation will resume as soon as the crisis is over and rates will rise.

Investors who are mainly invested in growth stocks will be the first to suffer from this situation, just before those who are positioned in long-term bonds. Conversely, investors positioned in value stocks are likely to do well in the future.