Distortion in Large Portions

Out of the blue and into the black
You pay for this and they give you that
And once you're gone, you can't come back
When you're out of the blue and into the black
--Neil Young

In unhampered (a.k.a. free) markets, interest rates signal the state of savings supply and demand. Low interest rates reflect high supply of savings available for investment relative to demand. Borrowers are motivated to borrow at attractive rates. Entrepreneurs use these borrowed funds to lengthen the capital structure of industries.

Individuals are less motivated to save when interest rates are low. The market's 'invisible hand' diverts economic resources away from savings channels when the returns associated with savings are perceived as small. 

Over time, fewer resources allocated toward investment pressures interest rates upward. After all, savings have become more scarce--less inflows from savers, more outflows from borrowers. On the demand side, fewer projects are likely to look attractive from a risk/reward standpoint because the cost of funds is higher. Demand is likely to be limited to only the most attractive projects.

High interest rates signal a low supply of savings relative to demand. The invisible hand is at work once again, this time encouraging individuals to allocate more economic resources toward savings channels.

Because standard of living is directly tied to level of saving and investment over time, interest rates constitute one of the most important price signals on the market. In order to ensure the most effective allocation of economic resources possible, then the interest rate signal needs to be as true as possible.

In today's hampered system, however, it is difficult to imagine how much more distorted the interest rate signal can be. Central banks have been manipulating money markets for decades, primarily by suppressing interest rates below 'free market' levels.

The low interest rate signals have had predictable effects. Borrowers have borrowed $trillions at low borrowing costs. Capacity in many sectors has exploded higher.

Savings, meanwhile, have been in secular decline, as individuals have little incentive to set economic resources aside.

We now face a situation where there is little or no savings to support real capital investment for the future. And our incomes are not large enough to service payments on what we have borrowed.

Default seems immenent. And with it, collectively lower standard of living.

A sad state largely attributable to senseless distortion of the interest rate signal.