Can anyone defend ZIRP going into 2013? | TigerDroppings.com

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Doc Fenton
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Member since Feb 2007
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Can anyone defend ZIRP going into 2013?



This is getting freaking ridiculous.

I have long defended the FOMC's actions in 2001, while saying that its members made a mistake by keeping rates so low in 2003 & 2004. (See " History of Federal Open Market Committee actions." See also, Historical CPI.)

As some may recall, I approved of the version of TARP that was passed in the fall of 2008, and also approved of Bernanke's monetary policy in 2008 & 2009. In 2010, I began to grow wary of it. Going into the winter of 2010-2011, I said that he had made a big mistake by going forward with QE2. I later backtracked on that assertion in late February 2011 ( LINK) when I saw how QE2 caused a big spike in volume to home real estate sales, helping to work off a lot of toxic inventory.

Okay, but I disapproved of ZIRP continuing through 2011, and I definitely was against it in 2012. Now look at the latest NAR figures that came out on residential real estate for November 2012, and compare those with the annual figures for 2008 through 2011:

Existing Home Sales from NAR
(S.A. annualized volume in millions, median sales price in thousands of dollars, housing inventory in months)
2008, 4.11, 198.1, 10.4
2009, 4.34, 172.5, 8.8
2010, 4.19, 172.9, 9.4
2011, 4.26, 166.1, 8.2
2012-Nov, 5.04, 180.6, 4.8

So now home prices have not only stabilized, but are rising again, and inventory has actually dropped below a 5 months supply.

Why is Bernanke still executing ZIRP, despite all its known corrosive effects on the wider economy?







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BennyAndTheInkJets
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NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


quote:

Why is Bernanke still executing ZIRP, despite all its known corrosive effects on the wider economy?

I'm very curious what you believe these known corrosive effects are. You picked out one indicator for your point, why not look at the outflows from equity mutual funds? Why not look at shaky new orders and backlog? What about the coming austerity that will hit aggregate demad? Housing is starting to finally rebound but you are ignoring the fact that other parts of the economy are still fragile.

After the QE4 announcement, nobody was surprised with the outright treasury purchase program, but most were surprised with the inflation and employment thresholds (which the Fed will take a great degree of lattitude with as Bernanke indicated in his press conferences). It was the Fed's way of adding volatility back into the market, and it worked if you look at normalized swaption volatility across tenors. This is a very new Fed with a new way of conducting policy, they can control risk in the market by controlling volatility. When you have temporal language (rates low till mid 2015), it sucks out volatility but having less "set in stone" thresholds add volatility, and from volatility comes risk then return. The 5-year yield is already up 16 basis points this month, this steep curve can allow investors some pretty good roll-down into the area the Fed is controlling.

It's all about controlling the amount of risk in the market, and the Fed is now comfortable enough that they'll start injecting risk little by little. I wouldn't pay attention just the basic ZIRP, I'd pay attention to how the Fed communicates ZIRP as what their current policy and focus is.






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Doc Fenton
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Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


One of the main problems of ZIRP is that it makes relative risk too high for people to do anything productive with capital. The Fed obviously does not want to add more risk to expansionary investment decisions for people sitting on large capital pools. To the extent that implied volatility metrics may have been caused by Fed statements about easing its inflation targets, this just means that the Fed is more comfortable with inflation. It's certainly not a metric that is signaling an increase in genuine macroeconomic risk, at least not from any common understanding of that term.

Also, I don't think going even deeper in the ZIRP direction is at all consistent with a longer term strategy of gradually introducing risk back into the market little by little. If anything, it just increases the distance the Fed will have to go whenever it finally decides to reverse direction one day in the far distant future. Is the Fed still going to be talking about the fragility of the economy when it's buying Treasury debt while the debt-to-GDP ratio climbs beyond 100%? It seems to be backing itself into just that sort of a corner here.

Thus, ZIRP has corrosive effects not only on individual firm investment decisions, but also on government fiscal decisions, to say nothing about how individual wealth investors may decide to hedge their portfolios by recklessly flooding money into commodities and other asset sectors that often exacerbate positive-feedback scenarios.

All this, however, is tangential to the main point, which is that the Fed should not be doing what it's doing, because it has no legitimate institutional justification for doing so. The economy is not fragile. It may be flat. It may be in poor shape. It may have longer term fiscal disasters already built in that cannot be avoided. It will likely enter recession next year. But none of this implies a fragility that will soon result in a deflationary spiral. Absence such a risk, the Fed should not pursue ZIRP.

So why did I concentrate solely on housing? Because real estate was the source of what caused the financial panic, and once its threat to the system has been worked through (and bank charge-off rates and foreclosure data certainly imply that this is the case), there is no longer a justification for continued emergency measures to prevent slight drops in consumer pricing. Never forget that price stability is what the Fed is all about. So while it is perfectly reasonable to consider fiscal cliffs and equity flows and unemployment slack and all these other phenomena, this only the case so long as they are being considered solely for their potential effects on price stability. If there is no threat to price stability, then the true problem with whatever ails the wider economy lies with fiscal and regulatory policy, and not with monetary policy. To the extent that Ben Bernanke is using monetary policy to hide the non-monetary ill effects occurring in the wider economy, he is doing all of us a great disservice.

It will only increase the pain that will surely blow back in one form or another, and surely, the Fed has been adding more long-term instability to the system than it's been taking away over the past 2 years. To be blunt, bad things are coming, and right now the Fed isn't even trying to counteract them.



This post was edited on 12/21 at 10:35 am


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LSURussian
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Baton Rouge
Member since Feb 2005
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re: Can anyone defend ZIRP going into 2013?


quote:

One of the main problems of ZIRP is that it makes relative risk too high for people to do anything productive with capital.

I don't understand this statement. Can you please explain it to me? Thanks.






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Doc Fenton
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Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


Specifically for the banks and financial institutions that are required to meet certain levels of capital adequacy, in a ZIRP environment they can do so by paying virtually nothing for the regulatory required amount of borrowed capital, thus meaning that they can stay in business indefinitely (waiting things out) while at the same time drastically minimizing their investment risks with loans and such.





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LSURussian
LSU Fan
Baton Rouge
Member since Feb 2005
82864 posts

re: Can anyone defend ZIRP going into 2013?


quote:

for the regulatory required amount of borrowed capital
The is no "regulatory required amount of borrowed capital" that I know of.

In fact, there is a limit to how much debt can be counted towards Tier II capital.

Most banks have zero capital notes which they use to count towards meeting their capital requirements.

The large, money center banks have LTD as part of supplemental capital but they are certainly not required to do so.

What am I misunderstanding here?

(Edited to insert a missing word.)



This post was edited on 12/21 at 11:16 am


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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


quote:

One of the main problems of ZIRP is that it makes relative risk too high for people to do anything productive with capital. The Fed obviously does not want to add more risk to expansionary investment decisions for people sitting on large capital pools.

I fully disagree with this point. The largest capital pools are the ones sitting on corporate balance sheets and deposits from financial institutions. ZIRP gives corporations opportunities to issue cheap debt to service several areas including unfunded pension liabilities, capital expenditure, and in turn labor. Conversations from Fed governors show that they are actually very frustrated that more corporations have not taken this route, and conversations with corporate issuers show that they need clarity with taxes before they can plan. November had the highest investment grade debt issuance in history, $128.8B. This was due to corporations getting worried about the fiscal cliff and possible rate shocks so they took it while they could.
quote:

To the extent that implied volatility metrics may have been caused by Fed statements about easing its inflation targets, this just means that the Fed is more comfortable with inflation. It's certainly not a metric that is signaling an increase in genuine macroeconomic risk, at least not from any common understanding of that term.

They can't control broad macroeconomic risk, but they can control the catalyst. More volatility in rates feeds into volaitilty with spreads which feeds into more volatility with riskier asset classes.
quote:

Also, I don't think going even deeper in the ZIRP direction is at all consistent with a longer term strategy of gradually introducing risk back into the market little by little.

QE4 wasn't going deeper into ZIRP, think of the highest degree of ZIRP as saying "rates will stay low forever", and the next step is giving temporal limits to how long they stay low. The next step after that is giving data contigent thresholds which is what they did. It's moving away from static ZIRP.
quote:

If anything, it just increases the distance the Fed will have to go whenever it finally decides to reverse direction one day in the far distant future.

This is true, but the Fed has a lot more tools to wind down their balance sheet than just selling securities on the open market. They can start repo-ing securities back banks to avoid recognizing losses if rates were to blow out to the upside. Also, unlike the ECB the Fed can recognize losses. Even if the Fed has a negative net worth it doesn't really matter other than for political embarressment.
quote:

Is the Fed still going to be talking about the fragility of the economy when it's buying Treasury debt while the debt-to-GDP ratio climbs beyond 100%? It seems to be backing itself into a corner here.

As with the above point, they have plenty of tools rather than just selling securities. There are scenarios that the Fed would be backed in a corner but they currently are not.
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Thus, ZIRP has corrosive effects not only on individual firm investment decisions
Don't agree for the same reasons as the first point.
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but also on government fiscal decisions as well

Completely agree with this, the greatest moral hazard in the history of economics is created when the fiscal effects on the market are smoothed over by monetary policy. Think how much the VIX would spike with today's cliff negotiation news and no dovish monetary policy.
quote:

to say nothing about how individual wealth investors may decide to hedge their portfolios by recklessly flooding money into commodities and other asset sectors that often exacerbate positive-feedback scenarios.

I think you're really overestimating how much capital has flown to commodities due to monetary policy. You'll see more and more commodity investing just be sheer progression of pension plan investing but the only time I saw a substantial amount of commodity speculation was the week following the QE2 announcement, which actually ended up smoking speculators in May of that year.
quote:

the Fed should not be doing what it's doing, because it has no legitimate institutional justification for doing so

Disagree, if by institutional justification you mean the dual mandate how can you not think they are attacking price stability and employment? The dollar has actually increased in value since the beginning of QE programs and our employment issue is much more structural than cyclical.
quote:

But none of this implies a fragility that will soon result in a deflationary spiral. Absence such a risk, the Fed should not pursue ZIRP.

Agree to a point, the first two QE policies were defensive while this one is offensive. So what do you want? The economy to stay stagnant and the participation rate to keep dropping? There is a threat of deflation if we go over the cliff and still can't compromise. That is a very real threat because of the polarization right now. The Fed knows this, and this was a way of being proactive with this threat while trying to give some sort of extra spark to the economy if we avoid this threat.

I hate to break it to you but developed economies will continue to have central banks as big participants in the market for a very long time. We're not going to grow at 3+% consistently for at least the next couple decades. Some sort of hand will need to be there to make sure the deck of cards doesn't come crashing down. Don't get me wrong, I am a full believer in the beautiful equilibrium of markets and mean reversion, but we've stayed on the high end of the mean for so long that the mean reversion for the US would be almost devastating. I don't have much of a conscious, but the little sliver of one that I have knows that we have to have a monetary force to smooth the reversion.
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there is no longer a justification for continued emergency measures to prevent slight drops in consumer pricing
As with my above point, true organic growth in the US already peaked a while ago. That is your threat and justification is to add a monetary parachute for the next decades.
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Never forget that price stability is what the Fed is all about

No it's not.
quote:

To the extent that Ben Bernanke is using monetary policy to hide the non-monetary ill effects occurring in the wider economy, he is doing all of us a great disservice.

I knew before I wrote my points on the economy that you would disagree because of this point of yours. Like I said, I'm all about tough luck to gain work ethic and in turn competitiveness again, but I truly think you underestimate how hard the crash would be.
quote:

It will only increase the pain that will surely blow back in one form or another, and surely, the Fed has been adding more long-term instability to the system than it's been taking away over the past 2 years. To be blunt, bad things are coming, and right now the Fed isn't even trying to counteract them.

I think all the above points address this. I don't agree in terms of increasing the pain and long-term instability at all. I also disagree, extremely, that the Fed is not trying to counteract them. Everything they're doing is making sure the pain is decreased and that we can have some sort of long-term stability.






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Doc Fenton
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Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


Whether its borrowed or not (and in an economic sense, customer deposits count as borrowed capital), the larger principle in that there is little opportunity cost to parking capital. This is true throughout the private sector, affecting not only banks, but also the new project decisions of industrial corporations.

This is the big problem with ZIRP. Lower interest rates will tend to lower the cost of taking on more business projects, other things being equal, but when (A) you start getting close to zero, and (B) there are strong signals indicating that interest rates will remain near zero for an extended period of time, then you paradoxically get an effect whereby a low interest rate environment will actually depress economic activity. A huge portion of capital in the economy gets diverted to public activities with very low returns, and which moreover act as a net drag on the labor force. That's what we're experiencing now.

We're not anything as extreme as Japan yet, but we seem to be moving closer to that kind of a situation. Indeed, there has been a disturbingly fashionable trend over the past year for pundits to defend how well Japan has managed its last two decades.

I say that a little short term recessionary deflation over the next few months could be just the longer term inflationary stimulus that we need. At some point, a deliberate transition must be made to an environment of rising interest rates. This hasn't occurred since the days of William McChesney Martin.






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LSURussian
LSU Fan
Baton Rouge
Member since Feb 2005
82864 posts

re: Can anyone defend ZIRP going into 2013?


quote:

and in an economic sense, customer deposits count as borrowed capital
No, they don't. You're not using the word "capital" in its proper sense in banking terms. Deposits are a source of funds, not capital.

quote:

Lower interest rates will tend to lower the cost of taking on more business projects
That's the entire point of the Fed. To encourage borrowing for expansion and economic risk taking.

quote:

then you paradoxically get an effect whereby a low interest rate environment will actually depress economic activity.
Is this just your opinion or do you have some analysis that supports your statement? I've never seen any analysis predict lower economic activity when borrowing costs are lower.






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Doc Fenton
LSU Fan
Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


quote:

Conversations from Fed governors show that they are actually very frustrated that more corporations have not taken this route


Do you see the problem with pointing this out?

The Fed has models that say ZIRP should do something beside what it's doing, and you agree with the models, and not with what's actually occurring 5 years after the financial distress began in earnest.

quote:

They can't control broad macroeconomic risk, but they can control the catalyst.


I just don't think this is significant at all.

quote:

There are scenarios that the Fed would be backed in a corner but they currently are not.


When I say that they would be backed into a corner, I don't mean to imply that they would have limited options on how to unwind, or that I'm necessarily concerned with official Fed book losses. I mean that they will have backed themselves into a corner by trying to protect the Treasury Department, and that once they give this game up, then the Treasury Department will be absolutely fricked.

I'm sure they will try to devise some plan that unwinds while keeping Treasury debt rates low, but at some point there is a limit to what being clever can accomplish.

quote:

I think you're really overestimating how much capital has flown to commodities due to monetary policy.


This is not a big concern for me at the moment.

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Disagree, if by institutional justification you mean the dual mandate how can you not think they are attacking price stability and employment? The dollar has actually increased in value since the beginning of QE programs and our employment issue is much more structural than cyclical.


They are attacking the problem of price stability in their own minds, but they're doing it under flawed assumptions. The whole reason for having a lender of last resort is to avoid a deflationary price spiral. Absent such a spiral, there is no reason to protect the banking system with a central bank.

In normal times, with normal interest rates, I'd be perfectly fine with the Fed fighting off the mild deflation that might come with an imminent recession. The problem is that when you get interest rates that are too low and too close to zero, you start getting the opposite effect whereby you're really just continuing to depress potential future inflation.

The Fed can play all the games it wants with QE and talking about inflation targets, but these are all just clever plans that aren't working. Increasing public indebtedness is itself a cause of higher unemployment. Lower interest rates is itself a cause for lower investment. We're officially in bizarro world here.

Robert Shiller's data series on equities going back to 1871 shows that one-year interest rates have rarely ever dropped below 2%. They did from 1933 to 1950, when the government was effectively directing industrial policy in a very centralized and authoritarian fashion, and it did again in 2002-2004 with adverse effects. The previous record low was 0.53% in 1941, but we're about to record our third year in a row below that ... and without any lend-lease / arsenal of democracy type of centralized industrial plans.

No matter how much people want to wax nostalgic about the post-war economy, from 1946 to 1960 things were very, very difficult. And that was when the rest of the world was in ruins and forced to buy our stuff, and when Medicare didn't even exist. There is nothing to indicate that the Fed will be capable of engineering anything so smooth this time around.

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There is a threat of deflation if we go over the cliff and still can't compromise. That is a very real threat because of the polarization right now.


It's a short term threat to prices in 2013. It's not a systemic threat.

quote:

We're not going to grow at 3+% consistently for at least the next couple decades. Some sort of hand will need to be there to make sure the deck of cards doesn't come crashing down. Don't get me wrong, I am a full believer in the beautiful equilibrium of markets and mean reversion, but we've stayed on the high end of the mean for so long that the mean reversion for the US would be almost devastating. I don't have much of a conscious, but the little sliver of one that I have knows that we have to have a monetary force to smooth the reversion.


Well here's the heart of our disagreement.

I do have a conscious, and my conscious tells me that it is absolutely wrong to use monetary policy as a way to smooth over the path to willed economic decline. I mean, Jesus man, just think about what you've written here. You've essentially just said that the developed world has had a good run, and should just content itself with subpar growth far out into the future.

Is such economic stagnation an inevitability of developed economies? I suppose you could say that it is, but still, it's a willed electoral choice, and one that I don't want to play any part in aiding or abetting.

If you want to get me on your side for taking on sub-optimal growth for a few years to prevent a crash, in order to grow more later, then I'm all ears. But when you start talking about managing permanent decline, I'll have none of it. If that's the case, then we'd be better off with a civilization-wide crash.

quote:

I also disagree, extremely, that the Fed is not trying to counteract them. Everything they're doing is making sure the pain is decreased and that we can have some sort of long-term stability.


But it's not. It's only trying to counteract the medium term problems by doing a bunch of clever tricks to try to engineer inflation over the next 5-10 years. But what then? When it comes to the problems that exist on a much larger scale, the Fed is playing right into sedating us all into long-term death. Until it makes a clean break from its current accommodating role, we're all just going to keep digging that demographic hole deeper and deeper. This is what happens when the interest rate mechanism becomes broken.

I'm out for today...







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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


quote:

Whether its borrowed or not (and in an economic sense, customer deposits count as borrowed capital), the larger principle in that there is little opportunity cost to parking capital. This is true throughout the private sector, affecting not only banks, but also the new project decisions of industrial corporations.

Ummm.... this is just wrong. There is a huge amount of opportunity cost to parking capital? Did you mean to say something different?
quote:

ower interest rates will tend to lower the cost of taking on more business projects, other things being equal, but when (A) you start getting close to zero, and (B) there are strong signals indicating that interest rates will remain near zero for an extended period of time, then you paradoxically get an effect whereby a low interest rate environment will actually depress economic activity. A huge portion of capital in the economy gets diverted to public activities with very low returns, and which moreover act as a net drag on the labor force. That's what we're experiencing now.

I understand what you're saying here, and even though it isn't supported by previous data I see this everyday. There's a reason you had static ZIRP then a threshold ZIRP. That's why they took away the static portion. You keep ignoring this.
quote:

We're not anything as extreme as Japan yet, but we seem to be moving closer to that kind of a situation. Indeed, there has been a disturbingly fashionable trend over the past year for pundits to defend how well Japan has managed its last two decades.

We are very different from Japan in an economic sense. We may very well have low interest rates for two decades but we will not look like Japan. Different discussion though.
quote:

I say that a little short term recessionary deflation over the next few months could be just the longer term inflationary stimulus that we need. At some point, a deliberate transition must be made to an environment of rising interest rates. This hasn't occurred since the days of William McChesney Martin.

I'm going to answer more to this in the next post but you have to understand, and I hate that I'm talking my shop too much in this, but... WE ARE IN A NEW NORMAL OF LOWER GROWTH PROSPECTS. HISTORICAL PRECEDENTS CAN BE THROWN OUT THE WINDOW.






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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
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re: Can anyone defend ZIRP going into 2013?


quote:

The Fed has models that say ZIRP should do something beside what it's doing, and you agree with the models, and not with what's actually occurring 5 years after the financial distress began in earnest.

This isn't because the Fed was somehow doing the wrong thing, there are external factors that forced the needle the opposite way.
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I mean that they will have backed themselves into a corner by trying to protect the Treasury Department, and that once they give this game up, then the Treasury Department will be absolutely fricked.

I disagree with this but instead of argueing this all I want to say is, get used to it.
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I'm sure they will try to devise some plan that unwinds while keeping Treasury debt rates low, but at some point there is a limit to what being clever can accomplish.

I think you'd be surprised.
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They are attacking the problem of price stability in their own minds, but they're doing it under flawed assumptions. The whole reason for having a lender of last resort is to avoid a deflationary price spiral. Absent such a spiral, there is no reason to protect the banking system with a central bank.

Central banks can't do a damn thing once a deflationary spiral has taken hold. They can only act proactively as they are doing now or at the point of shock like in '08. The threat of deflation is much smaller than it was in '09, but it is still present and I think you are still underestimating it.
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The problem is that when you get interest rates that are too low and too close to zero, you start getting the opposite effect whereby you're really just continuing to depress potential future inflation.

I mean, this just isn't true. Can you have low interest rates for an extended period with little inflation? Yes, but it's not because of interest rates. Japan has been in this spot because of a lack of innovation and natural resources, it has nothing to do with their interest rates.
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The Fed can play all the games it wants with QE and talking about inflation targets, but these are all just clever plans that aren't working. Increasing public indebtedness is itself a cause of higher unemployment. Lower interest rates is itself a cause for lower investment. We're officially in bizarro world here.

They're working but the effectiveness is decreasing because of a lack of cooperation from fiscal policy. Public indebtedness is only a cause for higher employment if interest charges are higher and austerity/taxes ensue. If you can still finance at low rates it doesn't matter. Lower interest rates are only a cause for lower investment if they are lower relatively compared to equal credit. You're igoring a multitude of factors. We are in a bizarro world, though.
quote:

Robert Shiller's data series on equities going back to 1871 shows that one-year interest rates have rarely ever dropped below 2%. They did from 1933 to 1950, when the government was effectively directing industrial policy in a very centralized and authoritarian fashion, and it did again in 2002-2004 with adverse effects. The previous record low was 0.53% in 1941, but we're about to record our third year in a row below that ... and without any lend-lease / arsenal of democracy type of centralized industrial plans.

WE ARE IN A NEW NORMAL ENVIRONMENT. HISTORY IS GOOD TO USE AS A REFERENCE BUT NOT A BLUEPRINT..
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No matter how much people want to wax nostalgic about the post-war economy, from 1946 to 1960 things were very, very difficult.

This is true.
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There is nothing to indicate that the Fed will be capable of engineering anything so smooth this time around.

Nothing to indicate won't be able to either. This is completely unprecedented policy.
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It's a short term threat to prices in 2013. It's not a systemic threat.

You are very wrong here. I can't stress enough how much is riding on these negotiations and maybe even more importantly how they are handled. The way the policy calendar looks, we'll have the budget and debt ceiling coming up in early 2013. If Obama doesn't want to give in anything and force the Pubs hand, we're going to have some very contentious policy measures in the near future that will affect us for a long time.
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I mean, Jesus man, just think about what you've written here. You've essentially just said that the developed world has had a good run, and should just content itself with subpar growth far out into the future.

No, the developed world has benefited from using cheap labor and resources with strong domestic infrastructure and defense. It's not a "good run", it's just the natural convergence of the developed and developing world. It will happen, and the less time it takes you to accept it the less frustration you'll have.
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Is such economic stagnation an inevitability of developed economies?

When some economies are developed and some developing? Yes, hence the beautiful equilibrium of economics and the market.
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I suppose you could say that it is, but still, it's a willed electoral choice, and one that I don't want to play any part in aiding or abetting.

Good for you, man.
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If you want to get me on your side for taking on sub-optimal growth for a few years to prevent a crash, in order to grow more later, then I'm all ears.

Not what I'm saying.
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But when you start talking about managing permanent decline, I'll have none of it. If that's the case, then we'd be better off with a civilization-wide crash.

Not a permanent decline, but one that will last several years/decades. A civilization wide crash may make the reversion up faster, but what happens in the process is not pretty and absolutely assinine if it can be avoided, which is what the Fed is trying to do.
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But it's not. It's only trying to counteract the medium term problems by doing a bunch of clever tricks to try to engineer inflation over the next 5-10 years.

Yes it is, and they are focusing on much more than inflation over the next decade.
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But what then? When it comes to the problems that exist on a much larger scale, the Fed is playing right into sedating us all into long-term death. Until it makes a clean break from its current accommodating role, we're all just going to keep digging that demographic hole deeper and deeper.

You could possibly call it sedation, but the broad competitiveness issues will come to light regardless of Fed policies. Developed country citizens will have to accept a lower standard of living relative to our developing counterparts in the future. Will we notice? Probably not, technology helps mask this and on an absolute scale we'll still be very well off. The demographics issue is also unavoidable regardless of Fed policies, and I have no idea why you think any sort of the current monetary policy is digging us into a deeper demographic hole. It hurts the older demographics more than anything, their pensions are primarily income at very low rates and pension liabilities have skyrocketed from low rates.
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This is what happens when the interest rate mechanism becomes broken.

Where in the wide world of frick did you come up with that conclusion?
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I'm out for today...

I'll chill in this thread till then. See you tomorrow you bastard.



This post was edited on 12/21 at 2:28 pm


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Doc Fenton
LSU Fan
Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


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.






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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


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.
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 at 9:52 am


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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


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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foshizzle
LSU Fan
Washington DC metro
Member since Mar 2008
30160 posts

re: Can anyone defend ZIRP going into 2013?


Fenton, Russian and Benny in a policy debate.

Bookmarked for later. For now I'm just







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BennyAndTheInkJets
Arkansas Fan
NYC / Orange County
Member since Nov 2010
3994 posts

re: Can anyone defend ZIRP going into 2013?


Bumping for Fenton's return.





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Doc Fenton
LSU Fan
Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


quote:

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.


I wouldn't be so sure of this.

quote:

98% of net job creation comes from small business, and almost all innovation.


I'm wary of statistics, but yeah, in general net job growth and technological progress comes from relatively new small businesses that are in the process of becoming larger. (I prefer phrasing it this way just to avoid the political trap of having people somehow think that mom & pop small businesses are the true engines of economic growth.)

quote:

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.


Interesting. A guy I know who teaches an equity derivatives trading class, and who used to work at Credit Suisse, echoed these same thoughts for traders in the post-2008 world. Risk and legal compliance is about half of what they do now, apparently.

quote:

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.


I agree, but in some sense, I think this is already baked in. No amount of successful negotiations in Washington in coming weeks can offset the fiscal cliff effect that is already set in stone to occur in 2013. In some sense, that makes the timing of this thread unfortunate, but it is what it is. I have no doubt that a lot of economic growth from the last 2 quarters has been artificially "pulled forward" by corporations in order to avoid higher tax rates in 2013. Whether or not taxes are higher in 2013 or not is immaterial, at least as it relates to the question of whether the effect will occur or not. It will. The regulatory uncertainty/madness is another issue that still lingers and poisons everything. I admit this.

quote:

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...


Now we're getting somewhere. I'm going to try to respond to this in another post below.

quote:

So you're telling me as a Fed chairman, Bernanke should speed up a serious funding crisis?


No, I wouldn't put it that way, as popular as that kind of crazy argument has been around here in years past. What I'm saying is that he should not go so far to mask the existence of a crisis that already exists, because doing so is helping it become even worse.

quote:

However, I fully disagree that private sector growth is also delayed from ZIRP for reasons I have outlined so far.


This is why I think that perhaps a new thread might be warranted.

quote:

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.


But home prices dominate nominal wealth in the U.S., and I think looking toward Flow of Funds statistics might be helpful here.

quote:

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.


But didn't you just write the following?

"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."

Raising rates not only improves business optimism and allocative efficiency, but it also "loads the spring" of the Fed's arsenal, so to speak.

quote:

After all this, you want to point at ZIRP as the reason we are experiencing slower growth?


No. I am in no way saying that Fed policy--even going back 20 or 30 years--is at the root of what ails us. I'm just saying that all the signs are pointing to the conclusion that we would be better off with the Fed at least beginning to implement an exit from ZIRP, rather than trying to stay burrowed within its false cove of safety for years upon end. The longer this goes on, the more I think the Fed might be fanning the flames of a huge, upcoming long term crisis.



This post was edited on 12/27 at 8:46 am


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Doc Fenton
LSU Fan
Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


So I'm just getting back to this thread after Christmas Day and Boxing Day, and screwing around on the OT, and all that.

To answer my original subject line question, the answer would appear to be a resounding yes. That being the case, I think I'm going to create a new thread (maybe not for another few weeks, but at some point) collecting and discussing all the different viewpoints out there about how ZIRP might actually be having a depressing effect on private sector economic expansion.

Like I said above, the timing of this thread with respect to the current fiscal cliff negotiations is somewhat unfortunate, because I don't want to focus on that too much. And really, if the Fed maintained ZIRP through 2011 & 2012 up until this point, how could you expect it to begin an exit right when all this is going on? Fair enough, but there are still larger arguments to be put forth.

Nobody has any idea how well the feds are going to go about implementing ObamaCare & Dodd-Frank, or how big of a disaster it might be. (It depends a lot on how flexible or obstinate certain groups of people decide they really want to be.)

Ten years later, we are still suffering mightily from Sarbanes-Oxley. ICE is buying the NYSE, venture capital investment has been almost terminally flatlined for years, other countries are becoming more competitive for startup firms relative to the U.S. Things look bad in a lot of ways.

Putting all that aside for a moment, however, we can agree that there are both (A) short term beneficial effects from ZIRP, and (B) long term detrimental results from ZIRP. Moreover, there are no reliable methods available to accurately quantify the magnitude of these effects pulling in each direction. In fact, there are countervailing effects going in both directions just in the short term now, and it’s no longer certain that even the short term effects of ZIRP are stimulative.

So then it seems as though we have three separate topics up for debate:

#1. Just how meager are the short term benefits from ZIRP, and just how corrosive and damaging are the long term detriments of ZIRP? This question would mostly hinge on just how much long run damage is being done.

#2. Focusing just on the short term part, there appear to be net benefits and drawbacks here as well, not even looking at the longer term detriments. I'm not going so far as to say definitively that ZIRP is dampening even short term growth, but at this point, it certainly wouldn't surprise me if this were true.

#3. How resilient is the current macroeconomy to a mild drop in consumer prices? This is where nominal net wealth figures and charge-off rates and outstanding loan figures and Shiller 10-year P/E ratios and stuff would be highly informative. Unlike many around here in 2008, I was adamant about the overriding need to maintain price stability in the midst of an asset bubble collapse. But looking at a lot of Federal Reserve historical data, I think I can lay out a very good case for why we're no longer in that type of situation, and why the economy--miserable as it may be--is not as fragile with respect to mild deflation as you seem to believe. This is in no way meant to discount the severity of the actuarial entitlement problems that will arrive in coming decades, which is one of the main reasons to oppose ZIRP now.



This post was edited on 12/27 at 9:00 am


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Doc Fenton
LSU Fan
Member since Feb 2007
51086 posts

re: Can anyone defend ZIRP going into 2013?


Here's some data I posted in a thread ( LINK) from about 6 months ago...

quote:

Net Wealth in the U.S.
(Year, Net Wealth at end of year, Nominal GDP, Wealth-to-GDP Ratio)
(GDP & wealth figures given in trillions of USD)
1994, 25.54, 7.09, 3.60
1995, 28.21, 7.41, 3.80
1996, 30.10, 7.84, 3.84
1997, 33.96, 8.33, 4.08
1998, 37.91, 8.79, 4.31
1999, 43.02, 9.35, 4.60
2000, 43.28, 9.95, 4.35
2001, 43.13, 10.29, 4.19
2002, 42.10, 10.64, 3.96
2003, 48.02, 11.14, 4.31
2004, 54.96, 11.85, 4.64
2005, 61.22, 12.62, 4.85
2006, 65.65, 13.38, 4.91
2007, 66.17, 14.03, 4.72
2008, 53.55, 14.29, 3.75
2009, 55.59, 13.94, 3.99
2010, 59.16, 14.53, 4.07
2011, 60.04, 15.09, 3.98


The latest report for the 3Q of 2012 reveals (on table B.100 LINK) that private net worth is at about $64.77 trillion.

Could we fall back from $66.2 trillion to $53.6 trillion like what happened from 2007 to 2008? I don't think so. Housing is just much more stable, and so are corporate balance sheets.

Employment ratios? They're already extraordinarily low. Outstanding loans? Go to the Fed's data releases and look at seasonally-adjusted historical consumer debt levels. From the July 2008 peak to October 2012, it's only gone from $2.58 trillion to $2.78 trillion. Given how much it usually increases in 4 years time in nominal terms, that's anemic.

P.S. -- And I think I got into a big argument with another poster a couple of years back on just how much new regulation was harming credit card debt. Well 4 years later, revolving debt is still about 15% below what it used to be in nominal terms.

P.P.S. -- I think Shiller's cyclically-adjusted 10-year price earnings ratio (CAPE) stood at 21.45 for October 2012, down from the 27.31 level he records for October 2007, but up from the 13.32 level he records for March 2009.



This post was edited on 12/27 at 7:12 am


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