The Dogma of Low Interest Rates Is Wrong

by: Harry Long

In The Unintended Effects of Bad Policy (May 18th), I wrote that:

[L]ow interest rates often have the opposite of their intended effect. Extremely low interest rates can vacuum liquidity out of nations. Japan has been referred to as a nation where loose monetary policy was like "pushing on a string." There was no push. It was a pull. Liquidity was sucked out of the country as the Yen became the world's carry trade currency of choice. Borrowing in a currency is the opposite of investment. It is liquidity-draining to the carry trade currency nation. For all of the talk about using monetary policy to dampen the business cycle, no result could be more damaging or procyclical.

I concluded the article by saying:

Americans may finally realize that there is a free lunch after all--we will be supplying it as speculators borrow in our low-yielding currency to invest elsewhere.

Yesterday that debate was conclusively laid to rest with the latest numbers from the NSX on net flows into ETFs.

  • YTD, $25.264 billion has flowed out of U.S. Equity Long ETFs.
  • YTD, over $13 billion has flowed into U.S. Short and Short Leveraged ETFs.


  • YTD, over $17 billion has flowed into Global Equity Long ETFs and less than $1billion has flowed into Short and Short Leveraged Global Equity ETFs.
  • YTD, over $24 billion has flowed into Commodity ETFs and less than $0.5 billion has flowed into Short Commodity ETFs.

Capital goes where it is treated best, like customers for fine dining. When meal sizes are anemic and interest rates are low, customers leave and head for more hospitable, higher yielding environs, or commodities.

Economists take it as unquestioned dogma that low interest rates are stimulative. Of course, ultra low interest rates are not stimulative to the real economy, they just increase asset prices. Rather than accept conventional arguments using faith based reasoning, a far more scientific approach is to examine the evidence.

I would argue that extremely low interest rates suck investment funds and liquidity out of nations. You heard it here first, and the evidence is clear. Money has flowed out of U.S Equity ETFs and into Global ETFs.

Many argue that the U.S. could never share Japan's experience of a quarter century bear market in which stocks dropped over 75% with interest rates at or near 0%.

If we do not wish to share such an experience, why are we repeating the same policies which led to such results? What policies did Japan pursue? Near zero interest rates, the propping up of zombie banks, and the arbitrage of replacing of managerial competence at financial institutions with political competence aimed at securing taxpayer charity.

Does this sound familiar? Money flowed out of Japan starting in the early 90's and into economies such as ours. The tech boom was supercharged by a massive Japan-funded carry trade. We may be funding such a boom in emerging markets and commodities right now to our detriment. Liquidity and investment funds will continue to flow out of the U.S., as they have, if we do not change policies which are contradicted by logic and clear evidence.

The public needs to understand that good policies are not about slogans, or personalities--they are about sound quantitative practices based upon clear arithmetic. As Keynes said of inflation, less than 1 person in 100 may understand it, but turning the dollar into a carry trade currency is unsound, procyclical, and will suck liquidity and investment funds out of the U.S. to our long term detriment.

For the investor, global macro is about understanding the global flows of capital and the drivers behind them. Sound advice is to follow the money.

Disclosure: Long EEM, FXI, PGJ, FCHI, HAO-OLD, EWZ, GXC, GLD. Positions may change at any time.