The author describes the concept of ZIRP (zero interest-rate policy) and risk-free rates, and how these are applied in the current (2023) economical crisis.
It’s hard to find a more expensive risk-free rate of return than the one you can get today.
Risk-free rates reflect how much risk investors are willing to take on and how much liquidity they require. That’s why they’ve always been usually below the inflation rate – in an inflationary environment, the real rate is zero.
But what happens when interest rates are so low that they approach zero? A zero interest-rate policy (ZIRP) is when a central bank maintains a 0% nominal interest rate. Banks weren’t making any money off their deposits (or even paying negative rates), so why not lend it out at a higher rate? ZIRP opens up an entire class of uses for money that wouldn’t exist in most other monetary environments.
But as Warren Buffet says, “Only when the tide goes out do you discover who’s been swimming naked.” So, as rates have risen, the deals that looked great under ZIRP are no longer profitable. On the surface, that’s things like SPACs and meme stocks. But we’re getting more data on what else was enabled by access to cheap capital.
Maybe a more interesting question than what was due to ZIRP is – what did the bubble get right?
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