The world’s dominant power tends to think its financial strength will never drain away. But Spain, having absorbed all that gold and silver from Latin America, still defaulted on its debts in the 16th century; Louis XIV, the sun king whom other monarchs dreamed of emulating, set France on the road to financial ruin; and Britain started the 20th century with a huge empire and piles of overseas assets but was rationing food in peacetime by the late 1940s.

The debt in the system has not been eliminated — it has merely been moved from banker to taxpayer:

We can see where this is headed. Just as people hoard old toilet tanks and old washing machines that actually use water to wash clothes, so too people will now have to hoard their old refrigerators because they work. We are becoming like the Cubans with their 1950s-model cars, holding on to them for dear life if only to preserve some elements of civilization in the face of government attacks.

Policies favoring short-term financial performance over long-term performance in the corporate sector have seen the supply of equity capital shrink while the use of debt capital has increased. Blame for this phenomenon once again falls at the feet of the Fed. By bailing out the likes of Harley Davidson, Verizon, Caterpillar, McDonald’s and Toyota with emergency funding during the financial crisis, the Fed sent a message to investors and corporate managers that the equity capital “buffer” need not be large. Furthermore, the zero interest rate policy allows the corporate sector to borrow cheaply, providing another powerful incentive to issue debt rather than equity.

I’ve always thought of morality as coming from one of two sources: driven either by religion or philosophy. Morality based on religion requires a leap of faith while morality based on philosophy makes my head hurt. But Hayek suggested a third basis for morality: market based morality, which I take to mean a morality which evolved over time based on trial and error. I find this idea enormously appealing.

The Fed’s zero interest rate policy has created a problem for pension funds’ defined benefit plans and for insurance companies offering fixed annuities: collectively, they have promised their beneficiaries a nominal rate of return that they cannot achieve without moving out on the risk curve or increasing the duration of their portfolios. The result is a mechanical appetite for any asset that clears a risk/reward hurdle which has been lowered, if not knocked over completely, by the Fed.