May 02, 2013

Distortion is not free, current low public interest rates are an illusion and could be the highest real rates ever

Sir, during the two years I had the fortune to have a voice as an Executive Director at the World Bank, 2002-2004, there were a lot of discussions on the issue of debt sustainability for poor developing countries. I hated those. They always sounded like a torturer calculating how much he could go on before his victim fainted. No doubt much of the ongoing, and I would have to say much less civilized debate between the austerians and the profligarians, reminds me of that.

And I also remember when some years ago some environmental austerians fouled up some research, which was immediately interpreted as a great go ahead by the environmental profligarians.

I do pity Kenneth Rogoff and Carmen Reinhart, for probably having been too interpreted by vested interests, hand having to end up in the eye of the current storm on debt. They do a good job of fixing their positions in “Austerity is not the only answer to a debt problem” May 2. Of course it is not a question of either or… and it is not even necessary for them to call on Keynes to testify in their defense.

That said, what they entirely miss, probably because it has never been an area of research or concern to them, is how current bank regulations, which so immensely favor sovereign borrowings, leads to the illusion of low rates.

Just one example: Banks in Europe lending to Germany do not need to hold any capital, something which implies an authorized infinite leverage of their equity. But, if they lend to a German small or medium business or entrepreneur, then they need to hold 8 percent in capital and can only leverage the risk-adjusted returns of that loan on their equity 12.5 times to 1. 

Anyone who does not understand that translates into a direct subsidy of Germany´s borrowing rate, paid by taxing the more “risky” and the real economy losing out of opportunities, has little idea about how banking and capitalism work. 

If some real game changing opportunities are thereby lost by Germany, it could in fact currently, and quiet unwittingly, be paying they highest interest rates ever on their public borrowings.