Why Milton Friedman Was Right and the Fed Is Wrong
High rates, not low rates are a sign of a healthy and functioning economy
If the US regional bank crisis, the failure of Silvergate, Silicon Valley Bank, Signature Bank, First Republic, and 2022’s Crypto Crash (Digital Currency Group/Luna/Celcius/BlockFi/Bitcoin) teaches us anything, it’s that Milton Friedman was right and the central bankers and Federal Reserve Bank are wrong.
High rates are indicative of a healthy economy. Low rates are a sign of a weak economy.
They [central bankers] were supposed to only lend in extreme circumstances, against good collateral, *at high rates*, for short periods of time and pay it back. That’s not what happened.” - Lawrence Lepard
This logic is backward to how Central Bankers see the world and it’s backward to how the design of our inflationary central banking system works. In a central banker’s world. The one that’s currently breaking one bank at a time. Low rates are healthy. Low rates are the solution to the problem. Low rates fix everything… But, they don’t.
Instead, whether you’re an everyday citizen, a banker, or politician low rates encourage gambling and degenerate behavior. There I said it and rates are the proof.
The amount of leverage built up across the financial system. The amount of gross personal consumption. The amount of debt built up on corporate and household balance sheets over the last 20 years, it’s all proof that rates at or near zero is the danger. Not the solution.
Milton Friedman’s view is the correct view. The one that should have been taught to all.
“After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.” -Milton Friedman
When rates are high it means that if someone is going to borrow, they have ample capital to:
A) Pay the high interest
B) Fund the project through to delivery - in the face of high interest expense
C) View a high rate barrier as one that a worthy project can exceed
With low rates, the opposite is true and it fills the system with unnecessary globally systemic risks. It creates and encourages bubbles rather than preventing them.
A) Low rates are easy hurdles to overcome
B) Allow projects that make little economic sense to be funded
C) Because of B, the point is to fund and sell quickly. Don’t be left holding the bag.
In a system designed around encouraging drunken risk taking, the goal is not to be productive but rather to be reckless.
Low rates tell us that the market expects growth to be low. You know the music will eventually stop, so your goal is to make sure you’re out first. The goal is not to deliver value but to deliver the appearance of value in order to get out and let someone else deal with the problem. A la the “unicorn”.
Take the profit and run. That’s how you dance to the music.
Rates, as explained by Knute Wicksell way back in 1906 tell us a lot more than what the FED and other central bankers around the world chirp about.
“The natural rate is never high or low in and of itself but only in relation to the profit which people can make with the money in their hands” -Knute Wicksell
Every choice we make is a trade off. In order to choose one thing over another we have an expectation of gain. An expectation of profit. So, in good times the rate of profit is high. In periods of depression, it’s expected to remain low.
The natural rate is and wants to remain low in depressions, not high.
When the economy is booming, in order for banks to get people to store money with them they need to pay a high rate, one that is competitive with other projects and uses of money. However, our modern central bankers attempt to do the opposite. They try to use high rates to slow the system down and low rates to speed it up and encourage borrowing.
Over time, this behavior has broken the money and distorted its supply.
Think about it. If bankers don’t pay high rates and instead pay low rates, no one will deposit their money there. Instead, participants will seek to gamble in other parts of the market where they get a return that matches their level of greed, or needs. Jeff Snider does a great job of breaking this down in the last 4 or 5 minutes of his podcast here.
The long and short of it is that modern day central bankers have it backward and the chaos in the market is proof. You can only kick the can so many times.
Additional Readings:
https://www.aier.org/article/against-interest-rate-reductionism
https://www.econlib.org/library/Columns/y2013/Hummelinterestrates.html#footnote2
Exactly, persistent low rates lead to a mass of inefficient, capital destructive projects getting financed. Misallocation of capital on a grand scale.
It's one thing to make an argument to temporarily reduce rates for a period of months to "jump start" a lifeless economy. But it's another to find justification for holding real rates deeply negative for a decade.