Imagine that our favourite restaurant suddenly stops charging for wine. At first, we are delighted. Then we order a second bottle. Before long, nobody asks what it costs anymore; the only question is why the next table has been given the better vintage.
Years later, the wine appears on the bill again.
“Has it really become this expensive?”
Perhaps it has simply returned to a reasonable price. It is our benchmark that has changed.
Interest rates are much the same. Many people regard today’s rates as high because the zero-rate years have become the point of comparison. Yet those years were a historical exception. After the financial crisis, the US Federal Reserve kept its policy rate close to zero for seven years. In the euro area, the deposit rate remained negative for eight years. Anyone taking out a first mortgage or making a first investment during that period could easily have mistaken those conditions for the natural order of things.
They were not.
Those exceptionally low rates were not the product of free markets, but of deliberate intervention. Alongside extremely low policy rates, central banks bought enormous quantities of bonds. Quantitative easing was explicitly designed to push longer-term financing costs lower as well.
What began as emergency medicine after the financial crisis gradually changed the behaviour of everyone involved: markets adapted to cheap money as though it were permanent.
Private decisions and incentives
A young couple sits at the kitchen table. In front of them lies the financing proposal for a house. The purchase price is high, but the monthly payment looks manageable. Their friends have already bought. Waiting, it seems, means losing out.
On the other side of the transaction, an owner signs the sale documents for a house bought years earlier at a much lower price. For that owner, the arithmetic has worked rather well.
Adam Smith already distinguished between a dwelling as a consumption good and capital that productively generates income. A house provides shelter and can produce rental income. But if only its price rises, no additional housing has been created and no productivity gain has occurred. The existing owner becomes richer on paper; the next buyer has to pay for that increase in value — often with more debt.
For our couple, the decisive bill may arrive only years later. When a fixed-rate period expires, the remaining debt must be refinanced at prevailing rates. If house prices fall at the same time, their equity comes under pressure. Long fixed-rate periods and adequate reserves offer protection; finely balanced financing does not.
The original purchase price remains embedded in the debt. The cheap interest rate can expire.
Companies and the logic of discounting
A few streets away, a chief executive presents a growth strategy. The profits lie far in the future. Investor enthusiasm is already here.
Low interest rates changed this calculation as well. The lower the discount rate, the higher the present value of profits expected many years from now. A compelling story about 2035 can create a substantial market value even while the present mainly produces bills.
Executives paid in shares and options benefit from that increase in the share price. The patient work of improving productivity and profitability suddenly has to compete with the next acquisition and an even grander vision of the future.
This is not a description of every company. It is a question of incentives. To understand what behaviour a system produces, look at what behaviour it rewards.
Investor John Hussman has repeatedly pointed to the uncomfortable reverse side of this process: those who justify extremely high valuations with permanently low interest rates overlook the fact that markets have already pulled future returns into the present. When the risk-free return is close to zero, investors bid up asset prices until prospective returns on those assets fall accordingly.
During the zero-rate era, the financing hurdle therefore fell unusually low even for business models whose profits lay far in the future. But the logical consequence of astronomical entry prices was correspondingly low long-term return expectations.
A simple example illustrates the principle. Suppose a share reliably pays a dividend of five euros a year. If its purchase price rises from €100 to €200, the running yield for a new buyer falls from five per cent to two and a half per cent. As the price approaches €500, the expected yield shrinks to just one per cent. In a zero-rate world, even that one per cent may be enough to justify the purchase, simply because the alternative in a bank account pays zero or even minus one per cent.
The seller celebrates the past capital gain; the buyer accepts immense price risk in return for a tiny yield advantage.
Finance ministries and the zero-rate overhang
Inside a finance ministry, the logic is similar, with one important addition. Additional spending promises an immediately visible benefit. If new debt costs almost nothing in interest, the burden barely shows up in the budget at first. Cheap money does not merely make more borrowing easier; it also lowers the hurdle that determines how worthwhile that borrowing needs to be.
This is where Milton Friedman’s observation about public spending becomes relevant: when people spend other people’s money on other people, neither price nor value tends to receive the same scrutiny. Falling financing costs gave governments substantial room to borrow — while also encouraging programmes whose cost-benefit calculations would have faced far more discipline had financing carried a meaningful price.
The result was a zero-rate overhang that still weighs on many economies today: the debts accumulated during the era of near-free money remain, while the interest bill rises. The fact that some governments have barely adjusted their spending path even in the new rate environment shows how deeply the old habits have become embedded.
At least, did this extraordinarily cheap financing restore the growth rates of earlier decades?
Between 1950 and 2000, the real US economy grew by roughly 3.6 per cent a year. Between 2000 and 2007, the rate was about 2.5 per cent. From 2007 to 2019, real growth averaged only around 1.8 per cent a year. The financial crisis depressed that average significantly; the recovery followed, but the earlier dynamism did not return.
This does not prove that low interest rates caused the slowdown — they were also a response to it. It does show, however, that cheap financing alone cannot substitute for productive investment and economic renewal.
After the financial crisis, central banks expanded their balance sheets dramatically and pushed interest rates to exceptionally low levels. The most visible immediate effect appeared less in a renewed surge in real economic growth than in rising prices for financial assets and property. Lower discount rates increased their present value while real trend growth remained weak.
That distinction matters: higher asset prices do not automatically create additional productivity. At first, they merely change the valuation of assets that already exist.
During the pandemic, the picture changed abruptly. Monetary policy was joined by exceptionally expansionary fiscal policy as governments supported households and businesses directly through large transfer and relief programmes. At the same time, strongly supported demand collided with pandemic-related supply constraints and, later, energy shocks.
Here the meaning of Milton Friedman’s dictum became clear: more money does not automatically create more goods. If nominal demand grows faster than real supply, pressure on prices increases. In 2022, consumer-price inflation accelerated sharply. Central banks had to respond by raising interest rates.
The wine was back on the bill.
Competition for capital and the new economic map
But the story does not end there.
On an American construction site, foundations are now being poured for a data centre. It will need chips, power generation, networks — and capital, long before the first revenues arrive.
Announcements of large financing platforms for AI infrastructure, measured in the hundreds of billions of dollars, show the scale of the investment requirement. This creates a structural reason for higher capital costs: companies want and need to invest enormous sums. At the same time, governments need capital to finance ongoing deficits and refinance maturing debt. Both are competing for the willingness of investors and lenders to supply ever larger amounts of money.
In parts of Europe, the same interest-rate arithmetic is colliding with a less dynamic economy. Where weak growth meets large inherited obligations, adjustment becomes more difficult. The zero-rate overhang of the past decade is particularly visible here.
The United States is by no means free of that overhang. It too combines large fiscal deficits and substantial refinancing needs with a higher level of interest rates.
At the same time, however, something else is happening. Companies are investing enormous sums in data centres, semiconductors, energy supply and networks. Technology investment and productivity growth are giving the US economy an additional source of expansion.
The distinction, then, is less between an indebted world and an unindebted one. It lies in what is being created alongside the old obligations.
Where higher capital costs meet weak growth, they become a burden. Where new capital creates additional productivity and cash flow, those costs can be carried more easily. The returns, however, still have to be earned.
This is beginning to draw a new economic dividing line: between economies that must primarily finance old promises at higher interest rates and those that are simultaneously trying to generate new productive investment fast enough to grow more quickly than their cost of capital.
What this means for investors
It is therefore too simplistic to describe interest rates merely as “high” or “low”. What matters is what the borrowed capital earns.
What began as emergency medicine was treated as normality for too long. Financing costs determined more by the market can restore some of the discipline that near-free money weakened: capital has to justify its use again.
For investors, this brings the ability of companies to generate genuine cash flow, finance growth from their own resources and deploy capital profitably back to the centre of the analysis. Where current cash flow is still absent, future returns must be all the more convincing to justify a high valuation when capital costs have risen.
The new rule is simple: Follow the Forward Cash Flow.
And back at the restaurant? When the wine is back on the bill, we order more carefully. A good vintage will still find its buyers.