The risk-free rate of return: welfare for money
What if a politician proposed that all workers be granted a labor-free rate of return in which workers receive a guaranteed income without needing to work. No doubt the titans of Wall Street and the gods of efficient markets would be outraged at such foolishness. Yet is not a risk-free rate of return on capital exactly the same thing for wealth?
Since the dollar is a fiat currency, the government can spend at whatever level it desires and has no need to borrow in order to obtain its own currency. It would certainly want to limit spending so as not to exceed the capacity of the economy, but the key point is that it has no need to borrow. Borrowing by the US government at a positive interest rate, then, is a policy choice, not a necessity. And the choice is to provide holders of wealth a risk-free return on their money. One would think the very idea of a risk free rate of return would strike any devoted free marketeer as an evil to be avidly opposed. But not so – it’s accepted nearly everywhere as normal, good, and necessary.
The rate today, .147% for example on three month treasuries, is quite low by historical standards but it still represents an annual riskless reward to wealth of $1,470 per million. The Fed is widely criticized by many on Wall Street for maintaining such “meager” rewards and there’s absolutely no doubt it will raise the rate as soon as the economy begins to recover. The riskless rate of return has historically been quite high – reaching over 15% in the early 80’s, and fluctuating in the 90’s between 3% and 6.5%. We should pause and ponder this. The 1990’s were a period of relatively low interest rates, yet even then the US government provided riskless income varying between $30,000 and $65,000 per year per million dollars of wealth. These are riskless rewards that approach or exceed the median wage in the US. We can go further, however, and note that even totally private non-treasury debt incorporates within it the risk free return since it’s priced as a “spread to treasury”. Every loan throughout the entire economy, public and private, has built into its interest rate a risk free return to capital.
The policies of the Fed and the US Treasury provide this free income to wealth in two ways. First, the short term rate is established by Fed action and maintained through monetary interventions in the market. The technical mechanisms by which it does this are irrelevant to the argument. Second, the Treasury regularly auctions debt in terms ranging from 1 month to 30 years. The effective interest rate on this debt is determined directly by the holders of wealth through auction and the treasury accepts whatever risk-free yield they demand, usually some spread over the short term risk free rate. The 30 year risk free rate today, for example, is 4.54% or $45,400 per year per million.
How is this completely riskless income for wealth justified? All kinds of rationalizations are concocted by portfolio and economic theorists to justify a riskless rate of return for wealth and we should not be surprised by this. Theories can be designed to justify virtually anything. Some will claim the rate should be some spread over inflation in order to provide a real return to capital. But why should capital be entitled to a return without taking risk? Some claim a low or zero rate would be inflationary as it would spur speculation as capital strives to find some outlet for income. But this is outlandish – are we saying we need to pay holders of wealth in order to keep them from acting recklessly? That capital needs to be guaranteed some base income in order to keep them from going crazy? Why can’t we make the same argument for workers? Surely we can find ways to promote sound behavior without having to pay them to do so. Some would worry about the currency value. Capital would certainly attempt to move to other countries that maintained a welfare for capital policy but there’s no reason to think that those countries, either through self interest or democratic pressure, wouldn’t quickly be forced into ending the giveaways.
Here’s what I think we should do. We need to first remember that the government never has need to borrow and so any borrowings are an accommodation to the financial markets in that they provide them with a riskless home to park their money. Given that fact, the government should only borrow at short dated maturities (say one to three months) and never at an interest rate. What would likely happen? Asset prices would increase everywhere as money chased ever declining profit opportunities. But rises in asset prices are just the flip side of reduced interest rates. And once the influence of riskless profits were wrung from prices, they shouldn’t be expected to rise further. Regulation would certainly be needed to prevent spec in critical commodities like food and the like but such issues are fully within the capacity of government to handle.
Keynes called for “the euthanasia of the rentier”. Ending government provided riskless returns is a critical first step.
Update: At a minimum for those who insist interest rates are a valid tool for cooling an economy, we should tax the risk-free component of any debt at 100%. I’d probably have no problem with interest rate policy if we eliminated the transfer to wealth.