No Other Conclusion is Possible
Mr. McKinnon has two main theses, the first being that because banks hold bonds at very low rates of interest, when interest rates rise these bond prices will fall wiping out the capital of those banks and presumably rendering them insolvent. The second thesis, which is related to the first is that because interest rates are so low and the future prospect is that they will rise, banks are unwilling to hold additional corporate debt and so corporations are foreclosed from credit markets. This denies them the opportunity to invest. As a result, according to Mr. McKinnon expansionary monetary policy is actually restricting the economy, and if interest rates are allow to rise then that will stimulate the economy.
The way out is for major central banks—the Federal Reserve, the Bank of England, the Bank of Japan and the European Central Bank—to begin slowly increasing short-term interest rates in a coordinated way to some common modest target level, such as 2%. Coordination is crucial to minimize disruptions in exchange rates. They should also phase out bond buying so that long-term interest rates once again become determined by markets.
Paradoxically, such modest increases in interest rates could actually stimulate investment and growth in all four economies.
Only a person who is totally ignorant about how money markets and credit markets and bonds work and only a person who is totally ignorant about the state of corporate liquidity could reach these conclusions. Now it is true that a rise in rates is probably inevitable and that the rise will depress bond prices of existing bank holdings causing losses. But these losses are temporal and temporary. As the bonds mature their prices will increases and at maturity they will be paid in full. The proceeds can then be used to purchase bonds that have a higher interest rate than the ones that mature had. No real loss takes place, which is what someone who had the least understanding of the bond market would realize.
As far as the second point is concerned, the idea that companies are shut out of the bond market because banks will not buy their bonds is just sheer lunacy. Every company that has issued bonds has found buyers. The reason companies are not issuing more bonds is not that there is no ability to sell them, but because (1) the large public companies hold huge amounts of liquidity, they don’t need to borrow and (2) borrowing is driven by demand for goods and services, not supply of credit and demand while rising is still weak by historical standards.
None of this is news to anyone who has passed Econ 101, apparently it is news to people like Mr. McKinnon. Or maybe he knows this, but the desire to be published in the WSJ and be acclaimed by all of the other persons who have promoted the wrong policies in the past is so great that Mr. McKinnon doesn’t care if his analysis is silly. If we had to make a choice we think the first explanation is the right one, but we could be wrong.