Was just trying to explain to someone why everything is going to shit, specifically companies, and realized, I don’t fully get it either.

I’ve got the following explanation. The sentences marked with “???” are were I’m lost. Anyone mind telling me, if they’re correct and if so, why?

The past few years, central banks were giving out interest rates of 0% or even negative percentages. Regular banks would not quite pass this on, but you could still loan money and give it back later with no real interest payments.

This lead to lots of people investing in companies. As long as those companies paid out more money than those low interest rates, it was worthwhile. But at the same time, this meant companies didn’t have to be profitable, because they could pay out investors from money that other investors gave them???

This has stopped being the case, as central banks are hiking interest rates again, to combat inflation???

  • possibly a cat@lemmy.ml
    1·
    1 year ago

    But at the same time, this meant companies didn’t have to be profitable, because they could pay out investors from money that other investors gave them???

    It sounds like this got oversimplified. In finance there’s a thing called the Risk Free Rate. When the rate is at 10%, banks can make 10% without taking on risk. And when the rate is at 0%, they have to take on risk to make any money.

    When the rate is at 0%, everyone is in stocks and corporate bonds. It’s higher risk than US treasuries and repo windows, but you aren’t making any money through those so you have to take on risk. Therefore everyone is pouring their money into the stock market when the RFF is 0%.

    If the rate jumps from 0% to 10%, banks can make 10% without any of the downside risk of stocks. Not many stocks are an easy pick for 10%, and stocks need diversified. Money gets pulled out of stocks to go to safer investments.

    The effect when it is at 0%, is that investors are throwing away their money and businesses can burn through it without turning a profit for years, if ever.

    This has stopped being the case, as central banks are hiking interest rates again, to combat inflation???

    The Fed’s approach to combating inflation is to constrict the wealth of the working class. Employment and wages are key indicators. They are trying to push these numbers down to fight inflation. The economy was too hot. They are tempering it, using a macro shift of rising rates.