Financial Distortion Dynamics

The world is awash in debt, of which nearly U.S. $10 trillion is negative-yielding. Financial instability and systemic risk loom over the economic landscape on a global scale. How did this happen and is there a path to a more sustainable future? A central thesis of this work is that sustainable credit and economic growth rely upon undistorted interest rates. Traditional approaches to stimulate growth through policy-directed low-cost borrowing have led to debt-fueled, inflationary dynamics that pose risks of asset bubbles, financial and banking crises, unjust wealth transfer, impoverishment through declining real purchasing power and financial repression on savers. Ultimately, the debt burden coupled with income disruption could threaten millions who depend on an unsustainable system. A microeconomic approach to interest rate determination is examined here: Credit-based natural rates of interest (CNRI). These rates are established in loanable funds markets and reflect adequate debt service capacity based on the underlying natural rates of return (NRR) of individual firms. These firm-specific natural rates of interest reflect natural returns, are countless in number and are viewed as key drivers of self-regulating, sustainable debt and economic growth rather than policy interest rates. Other topics featured are a historical overview of interest rate theory; an analysis of financial distortions in debt and equity mispricing; a novel accounting method to address artificially low financing costs for firms that benefit from taxpayer funds due to non-recognition of ownership; a distribution fitting exercise; fundamentals and pricing (with notes on dynamics in the crypto-asset space); and a review of policy interventions in the monetary realm. The analyses employ some three decades of financial data of a global firm in the consumer goods sector with a market capitalization of U.S. $200 billion as of 2017.