Destabilizing interest rates
The most insidious aspect of falsifying interest rates is the way it causes capital erosion or, in a chronic case, capital destruction. The vast majority of economists consider falling interest rates salutary. However, only low and stable interest rates are salutary to the economy; falling interest rates are lethal. Regardless how low interest rates may be, businessmen are reluctant to make investments as long as interest rates keep falling. They don’t want to compete against those who make investments later, having the benefit of lower financing costs still.
Interest rates have been falling for the past thirty years. Practically all investments made during this period had to be written off as losses. Just how serious these losses have been becomes clear if we contemplate the visible consequence: the wiping out of entire industries in the United States from shoe manufacturing to the production of TV sets and beyond.
The destruction of bank capital is part of the same process. It has been camouflaged by compromising sound accounting principles by bank inspectors, aided and abetted by the government. They routinely allow banks to carry assets at the higher of acquisition and market value, while carrying liabilities at the lower of liquidation value and value at maturity, the exact opposite of what sound book-keeping demands. The distortion caused by this perversion is appalling. Banks have become insolvent and they had to be put on a life-support system through the continuous infusion of government bailout money. Poor management is only part of the problem. The real culprit is the deliberate monetary policy of suppressing interest rates. A particularly revolting example is the recent ruling that losses on the sovereign debt holdings by the banks of the European community can be ignored.