MarketWatch | Satyajit Das

Since Lehman Brothers went bankrupt in September 2008, the world’s central banks have injected more than $12 trillion under QE (Quantitative Easing) programs into financial markets. More than $26 trillion of government bonds are now trading at yields of below 1% with over $6 trillion currently yielding less than 0%.

These policies, according to policy makers, have been crucial to the “recovery.”

Stock market valuations have increased but remain reliant on low rates and abundant liquidity. The effect on the real economy is less clear. Policy makers argue that without these actions to support growth, employment and investment would have been weaker. It is a proposition that is, of course, impossible to test.

Whatever the initial benefits, low rates and unconventional monetary policy are increasingly counterproductive.

And now there is increasing confusion about future interest rate policy.

Markets expect that stronger U.S. employment numbers will drive a rate rise in December. Puzzlingly, Federal Reserve Chair Janet Yellen has also hinted that more QE or negative interest rates are also possible, should conditions dictate.

There is little agreement among Fed governors about the appropriate policy path for the U.S.. Meanwhile, other central banks are cutting rates.

In Europe, ECB President Mario Draghi has hinted that he will consider lowering rates further soon. European central banks are already operating negative deposit rate policies. The ECB is at minus 0.20%, Swiss policy rate is minus 0.75%; Sweden’s policy rate is minus 0.35%.

In October, Italy sold two-year debt at a negative yield for the first time. Investors are now paying to lend to a country which has one of the highest debt-to-GDP ratios in the world.

The Bank of England has suggested that U.K. interest rates may not increase until 2016 or even 2017. The Bank of Japan has promised additional easing if necessary “without hesitation.” The People’s Bank of China, China’s central bank, cut benchmark interest rates for the sixth time this year to a record low of 1.50% in a bid to support an economy that is forecast to grow at its slowest annual rate in 25 years.

Further interest-rate cuts are forecast in Australia, New Zealand and many emerging countries.

Central bankers argue that the case for increasing rates is limited. Despite record levels of monetary stimulus, growth remains lackluster. Forecasts of economic activity have seen regular downgrades over the past few years. Disinflation and deflationary pressures remain, with low commodity prices, especially in the energy sector, likely to continue.

Central bankers dismiss criticism that the policies are at best ineffective and at worst damaging.

Low rates have created problems for savers and retirees around the world. Pension funds are in trouble with rising levels of unfunded liabilities. Debt levels continue to rise from unsustainable to even more unsustainable. Low rates have distorted financial markets and created asset price bubbles in shares, property, and other investments.

In Japan, for example, interest rates have been around zero for almost a decade. The Bank of Japan has undertaken nine rounds of QE. The central bank’s balance sheet is approaching 70% of GDP. It owns a significant proportion of the outstanding stock of government bonds and equities. But the policies have not restored growth.

The effect of further rate cuts is also diminished by continuing trade and currency wars. Each individual cut is increasingly offset by competing reductions elsewhere in the world. Despite denials by policy makers, countries are using monetary policy to devalue currencies to gain competitiveness and capture a greater share of global demand. Individual nation’s actions are now redundant in a nugatory race to the bottom in interest rates and currency values.

Maintaining interest rates at low “emergency” levels for an extended period also makes it increasingly difficult to increase them to more normal levels. Increase in debt levels, made possible by lower rates, means the financial impact of higher rates is attenuated.

This is evident in the concern that a potential 0.25% increase in U.S. rates has created.

In the U.S., a one percentage-point boost in rates would increase U.S. government interest costs by around $180 billion from its present level of around $400 billion. Unless offset by increased economic activity, this would increase both the budget deficit and government debt levels. The normalization of rates to say 2.50%-3.00% may prove financially and economically destabilizing.

Low rates and QE have also reduced the political appetite for needed policy changes. Lower interest costs have sapped the willingness for fiscal reforms, debt reduction, and structural reforms.

Asset markets, especially equities, have rallied repeatedly on the continuation of low rates. But low rates reflect slower economic activity and economic weakness, rather than strength. This means, at some stage, a dramatic reassessment of asset prices is now inevitable, either as result of higher or lower rates.