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re: Can anyone defend ZIRP going into 2013?
Posted on 12/22/12 at 2:58 pm to BennyAndTheInkJets
Posted on 12/22/12 at 2:58 pm to BennyAndTheInkJets
quote:
There is a huge amount of opportunity cost to parking capital? Did you mean to say something different?
No. In a relative sense, the costs of having a bunch of capital and not doing much with it are very low right now. As far as I know, they've never been lower. That's the whole crux of my argument. It's why I say the interest rate mechanism has broken down, which is what happens when there are negative real interest rates for an extended period of time. Everything has low returns right now.
You've probably heard the following famous quotes before:
"Equity is soft, debt hard. Equity is forgiving, debt insistent. Equity is a pillow, debt a sword." -- G. Bennett Stewart & David M. Glassman (1988)
"After all, you only find out who is swimming naked when the tide goes out." -- Warren Buffett (2001)
Well, debt is no longer a sword, and the longer it stays this way, the more people who will be found swimming naked years down the road.
I agree that Japan is mostly a separate discussion. I agree that historical precedents can largley be thrown out the window, because we're in uncharted waters. I agree that there are external factors pushing the needle the other way beyond the Fed's control. I agree that fiscal policy has been uncooperative. I agree that developed and developing economies are converging.
What I disagree with is saying that ZIRP is blameless. There is a strong case to be made that ZIRP is actually depressing economic growth, giving lawmakers strong incentives to bow to huge political pressures to keep building ever bigger and more unsustainable debt levels, and generally screwing around with the basic capital market mechanisms that are supposed to efficiently allocate resources.
It's not just quacks saying this. These thoughts have been echoed by Bill Gross, David Einhorn, Andy Laperriere, David Malpass, Mark Snyder, etc. Not that any of those persons should be trusted per se; each has his own interests and agendas to push. But just look at what's happening. There is ZIRP, and the more inflationary pressures do not occur, the more Bernanke continues to call on more ZIRP as itself being the only remedy for the failure of ZIRP.
I must admit, I do not understand the details of recent Fed manipulations as well as you do. I don't even know what "static ZIRP" vs. "threshold ZIRP" actually means.
But I think the heart of our disagreement lies with our appraisal of the relative risks of a deflationary spiral in 2013 vs. a larger calamity down the road.
I think you are vastly overestimating the risk to the system in 2013 that might arise from a recession, potential deflation, and the ongoing fiscal cliff negotiations. I simply don't take these things very seriously. If prices drop 2% in 2013, we can handle that. I even think that the Fed can in fact halt a deflationary spiral once it has taken hold, but in any case, that won't even be necessary, because a deflationary spiral cannot take hold within a period of less than 6 months. That's just not enough time, and if the the government could successfully halt the cliff that occurred from September 2008 to January 2009, then it sure as shite can do the same for anything that might happen in 2013.
Now here's what I consider an even bigger point--I think you are also vastly underestimating the long term risk to the system that is being continually accelerated the longer we remain in ZIRP mode. A sovereign debt crisis in Italy or Spain is just not the same thing as a sovereign debt crisis in both Japan and the USA. But that is exactly where we are headed.
There are two things necessary to avoid this crisis: (1) political will to privatize entitlements, and (2) strong economic growth from the private sector. Now I've pretty much conceded defeat on (1), and it's not worth talking about on this board anyway. But however you feel about (1), it's undeniable that ZIRP is helping to kick the inevitable reforms further down the road. As for (2), it's become cliche for everyone to say that we can only grow our way out of the federal government's long term debt crisis, and that's certainly true. But the longer we stay in ZIRP, the more private sector growth gets kicked down the road as well.
ZIRP is like an ICU ward for systemically important sectors of the economy that need emergency life support. While it allows repairs to occur to the gaping holes that have been blown into balance sheets, it does so at the expense of allocative efficiency and economic growth everywhere else. This is simply a reflection of the "no free lunch" rule. So while I supported Bernanke for conducting ZIRP when it was necessary to save the financial system and prevent the collapse of asset prices, I just don't see that as a danger anymore (since these asset prices have already bottomed), and I don't see how a mild recession or mild deflation could possible trigger a panicked deflationary spiral that would make the public think a bubble was collapsing.
The bubbles that are being built today are being built elsewhere, and they are being built with the help of ZIRP. In my view, the totality of the evidence suggests that we would be in a much better condition now if the fed funds rate had been raised by about 1.00-1.50% over the last year or two. (This would provide more flexibility to respond to fiscal cliff problems in 2013, for one thing.) I genuinely believe that doing so would have spurred greater business investment and would not have had any significant disinflationary effect on consumer prices. But that's not what happened, so here we are, heading into 2013, with people starting to believe that the ZIRP implemented in 2008 could end up lasting for a decade or more. Any way you slice it, that just seems like insanity to me.
2
Posted on 12/24/12 at 9:39 am to Doc Fenton
First of all 
for the discussion.
Now I see what you're getting at with opportunity cost and I can agree for the most part if you're looking at things from an investor's perspective. I think there is still higher opportunity cost being left on the sidelines from businesses that are keeping their capital parked, simply because on the flip side investors that want to finance these projects are not getting high returns yet they are still soaking them up anyways.
In regards to Gross talking about low rates undercutting economic activity, I think you missed his biggest point. He was also looking at it from an investor's perspective, and new-normal theory may suggest that low rates should discourage investors from investing but the sheer supply/demand mismatch over the past year and very likely next year has and will overwhelm this. The universe of "safe" assets is decreasing and corporations are not going to issue enough to saturate demand next year either. So the idea of low rates suppressing economic activity from the point where we are now is moot simply because there are greater forces at work in the market.
By static versus threshold, I mean whenever the Fed said "rates will stay low until mid 2015", this is a static statement that does not have conditionality. Threshold ZIRP is what they did recently with "rates will stay low until unemployment is below 6.5% or inflation is above 2.5%". These are data thresholds that zero interes rates are conditional upon. That's what I mean when I say they are moving from static to threshold ZIRP, which adds more volatility to the market.
98% of net job creation comes from small business, and almost all innovation. Orcale and Cisco haven't innovated anything in a long time, but they buy small businesses and use their distribution networks and infrastructure to profit. The unintended consequences of policy usually always hits small business the hardest because they don't have the same compliance, legal, or accounting departments that can adjust smoothly to new policy. People ask me what the fastest growing job in finance today is and my answer is always compliance, and it's really not even close. If small businesses become strangled from tax hikes from going over the cliff, then readjusting to new deals that get done over time it really strains them and in turn the economy. Out of all of our arguments this is one I just can't see from your perspective, I don't understand why you can't take this seriously.
You have to understand we're growing at 1-2% real growth in a leveraged economy, the leverage portion is what makes this idea of "stall speed" for an economy very important. Nobody really knows what stall speed is, but if prices drop 2% in 2013 I can almost guarantee you we will be under stall speed and the Fed will come with any other form of easing that it can, and I can almost promise you that. The difference in '08 and now is that in '08 we actually had policy tools that had not been exhausted, which is not the case now. Think of it as trying to defend an outpost, right now the threat of an attack isn't as strong as it was four years ago but our ammo is much more drained now.
We agree on one thing, we have to have entitlement reform. There is just no way around it. However, we disagree that ZIRP is continuing to kick the can down the road with it. Politicians wouldn't have the political will to reform entitlements whether interest rates are 0% or 100%. It's going to take a SERIOUS funding crisis for politicians to even look at real reform to entitlements. So you're telling me as a Fed chairman, Bernanke should speed up a serious funding crisis? That's absolutely assinine. He's supposed to make his decisions independent of politics, but unfortunately he's been having to make decisions in spite of fiscal policy. Also, we can't grow out of our current debt. It just can't happen either when you add all unfunded liabilities into the equation. However, I fully disagree that private sector growth is also delayed from ZIRP for reasons I have outlined so far. Growth is currently being delayed because of fiscal policy, monetary policy is currently set up to enable growth.
Asset prices have hit a bottom because the foundation is monetary policy (less so for housing). If you take away current easing policies then we are nowhere near where risk assets should be priced. There is a chance a mild recession (not deflation) is going to take hold in 2013 regardless of ZIRP, but if you took away the easing programs I doubt there would be anything mild about it. Then businesses would have demand uncertainty with no incentive to borrow and invest in projects cause of higher rates.
for the discussion. Now I see what you're getting at with opportunity cost and I can agree for the most part if you're looking at things from an investor's perspective. I think there is still higher opportunity cost being left on the sidelines from businesses that are keeping their capital parked, simply because on the flip side investors that want to finance these projects are not getting high returns yet they are still soaking them up anyways.
In regards to Gross talking about low rates undercutting economic activity, I think you missed his biggest point. He was also looking at it from an investor's perspective, and new-normal theory may suggest that low rates should discourage investors from investing but the sheer supply/demand mismatch over the past year and very likely next year has and will overwhelm this. The universe of "safe" assets is decreasing and corporations are not going to issue enough to saturate demand next year either. So the idea of low rates suppressing economic activity from the point where we are now is moot simply because there are greater forces at work in the market.
By static versus threshold, I mean whenever the Fed said "rates will stay low until mid 2015", this is a static statement that does not have conditionality. Threshold ZIRP is what they did recently with "rates will stay low until unemployment is below 6.5% or inflation is above 2.5%". These are data thresholds that zero interes rates are conditional upon. That's what I mean when I say they are moving from static to threshold ZIRP, which adds more volatility to the market.
quote:
I think you are vastly overestimating the risk to the system in 2013 that might arise from a recession, potential deflation, and the ongoing fiscal cliff negotiations. I simply don't take these things very seriously.
98% of net job creation comes from small business, and almost all innovation. Orcale and Cisco haven't innovated anything in a long time, but they buy small businesses and use their distribution networks and infrastructure to profit. The unintended consequences of policy usually always hits small business the hardest because they don't have the same compliance, legal, or accounting departments that can adjust smoothly to new policy. People ask me what the fastest growing job in finance today is and my answer is always compliance, and it's really not even close. If small businesses become strangled from tax hikes from going over the cliff, then readjusting to new deals that get done over time it really strains them and in turn the economy. Out of all of our arguments this is one I just can't see from your perspective, I don't understand why you can't take this seriously.
quote:
If prices drop 2% in 2013, we can handle that. I even think that the Fed can in fact halt a deflationary spiral once it has taken hold, but in any case, that won't even be necessary, because a deflationary spiral cannot take hold within a period of less than 6 months. That's just not enough time, and if the the government could successfully halt the cliff that occurred from September 2008 to January 2009, then it sure as shite can do the same for anything that might happen in 2013.
You have to understand we're growing at 1-2% real growth in a leveraged economy, the leverage portion is what makes this idea of "stall speed" for an economy very important. Nobody really knows what stall speed is, but if prices drop 2% in 2013 I can almost guarantee you we will be under stall speed and the Fed will come with any other form of easing that it can, and I can almost promise you that. The difference in '08 and now is that in '08 we actually had policy tools that had not been exhausted, which is not the case now. Think of it as trying to defend an outpost, right now the threat of an attack isn't as strong as it was four years ago but our ammo is much more drained now.
quote:
There are two things necessary to avoid this crisis: (1) political will to privatize entitlements, and (2) strong economic growth from the private sector. Now I've pretty much conceded defeat on (1), and it's not worth talking about on this board anyway. But however you feel about (1), it's undeniable that ZIRP is helping to kick the inevitable reforms further down the road. As for (2), it's become cliche for everyone to say that we can only grow our way out of the federal government's long term debt crisis, and that's certainly true. But the longer we stay in ZIRP, the more private sector growth gets kicked down the road as well.
We agree on one thing, we have to have entitlement reform. There is just no way around it. However, we disagree that ZIRP is continuing to kick the can down the road with it. Politicians wouldn't have the political will to reform entitlements whether interest rates are 0% or 100%. It's going to take a SERIOUS funding crisis for politicians to even look at real reform to entitlements. So you're telling me as a Fed chairman, Bernanke should speed up a serious funding crisis? That's absolutely assinine. He's supposed to make his decisions independent of politics, but unfortunately he's been having to make decisions in spite of fiscal policy. Also, we can't grow out of our current debt. It just can't happen either when you add all unfunded liabilities into the equation. However, I fully disagree that private sector growth is also delayed from ZIRP for reasons I have outlined so far. Growth is currently being delayed because of fiscal policy, monetary policy is currently set up to enable growth.
quote:
ZIRP is like an ICU ward for systemically important sectors of the economy that need emergency life support. While it allows repairs to occur to the gaping holes that have been blown into balance sheets, it does so at the expense of allocative efficiency and economic growth everywhere else. This is simply a reflection of the "no free lunch" rule. So while I supported Bernanke for conducting ZIRP when it was necessary to save the financial system and prevent the collapse of asset prices, I just don't see that as a danger anymore (since these asset prices have already bottomed), and I don't see how a mild recession or mild deflation could possible trigger a panicked deflationary spiral that would make the public think a bubble was collapsing.
Asset prices have hit a bottom because the foundation is monetary policy (less so for housing). If you take away current easing policies then we are nowhere near where risk assets should be priced. There is a chance a mild recession (not deflation) is going to take hold in 2013 regardless of ZIRP, but if you took away the easing programs I doubt there would be anything mild about it. Then businesses would have demand uncertainty with no incentive to borrow and invest in projects cause of higher rates.
This post was edited on 12/24/12 at 9:52 am
Posted on 12/24/12 at 9:39 am to Doc Fenton
quote:
The bubbles that are being built today are being built elsewhere, and they are being built with the help of ZIRP.
Bubbles have existed throughout time with and without low rates.
quote:
In my view, the totality of the evidence suggests that we would be in a much better condition now if the fed funds rate had been raised by about 1.00-1.50% over the last year or two.
I can't even come close to agreeing with this. What evidence are you referring to because I don't see anything anywhere that would suggest this.
quote:
I genuinely believe that doing so would have spurred greater business investment and would not have had any significant disinflationary effect on consumer prices.
I do not at all. Businesses are the ones that are being aided by ZIRP, but monetary policy is being completely undermined by fiscal policy. Remember when I noted the two largest pools of capital (corporate balance sheets and bank reserves)? Commercial bank investments are getting hurt really bad by ZIRP, I will say that. Deposits are earning 25 basis points and the 5-year treasury rate (the sweet spot for commercial banks) is only at 77 basis points (spread of 52 basis points). This is why banks are trying to lend, and the good news is lending is picking up. The bad news is there are not qualified businesses and people looking to borrow, because new regulation changed the definition of who and what is qualified. Different discussion for another day before we go down that rabbit hole.
quote:
But that's not what happened, so here we are, heading into 2013, with people starting to believe that the ZIRP implemented in 2008 could end up lasting for a decade or more. Any way you slice it, that just seems like insanity to me.
And I don't understand why you are attributing this to ZIRP when in this time period we've also had a European debt crisis, an emerging market growth slowdown, shortcomings in US education coming into focus, a debt ceiling negotiation nightmare, and now a fiscal cliff negotiation nightmare. After all this, you want to point at ZIRP as the reason we are experiencing slower growth? Any way you slice that, it seems like insanity to me.
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