re: Can anyone defend ZIRP going into 2013?

CAPE is 21.68 today, but you are wasting your time discussing equity valuations with a fixed income guy working for a huge firm. You got your panties in a wad when I kept pointing to CC charge offs being the driver in the reduction in outstanding revolving credit balances, not repayment from consumer card holders. Savings rates have declined again this year, people still can't control their buying impulses and continue to overspend. ZIRP sucks for retirees, especially those that can't afford taking on excess risk trying to generate 4-5% returns when they are lucky to find anything. What are they going to do, run down to the bank and replace their maturing 5-yr CD with one paying 1% or they could go buy a bond fund holding shite tons of bonds priced at a premium to face value and risk losing their asses. How much is ZIRP affecting their consumption capacity compared to where it might be if rates were within something resembling a historical range. I got an earful of that shite from multiple relatives over the holiday. Who is ZIRP really helping these days? It's a rhetorical question. Peace, brah, I am more with you than against you.

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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.

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It's also easy to make the case for the opposite too, as corporations had uncertainty about the cliff for a while which made them not invest in labor or projects, pulling economic weakness forward.

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

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I've been thinking about this one for a day now in regards to what I recently wrote about housing being a little more insulated than other asset prices. If the Fed stopped buying $85B in mortgages a month, how much would mortgage rates rise? The mortgage market is crazy stupid rich right now, especially in lower coupons. Premium coupons are so disjointed based on models its ridiculous. There is no conclusion to this but rather a stream of conciousness. I don't think even the most seasoned mortgage traders on the street could answer that question with any degree of certainty.

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

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The problem with this becomes a chicken and the egg debate. Do you think rising rates creates optimism or optimsim creates rising rates? I'm a lot more inclined to the latter. Also in regards to the "loads the spring" relative to my quote, staying with my analogy it's kind of like leaving the outpost to go find ammo. Only to come back and there is nothing to defend. I don't think having tools to use is justified if the damage caused by procuring these tools is too great. I think we've pretty much determined we disagree on the damage portion.

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we can agree that there are both (A) short term beneficial effects from ZIRP,

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Agreed.

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(B) long term detrimental results from ZIRP

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I disagree with you on this but not in the way you think. If ZIRP was just that, zero interest rates for an extended period, I would agree with you. But I believe that ZIRP is not what it appears on the surface at all, at least not anymore. ZIRP is the beginning of the Fed adding another tool to their arsenal, so now not only do they have Open Market Operations but they also have Open Mouth Operations. They can control volatility and risk in the markets simply by how they communicate to the public. Now they have extended language, threshold language, releasing the Fed Funds and inflation target votes, and Ben's press conferences. It's brilliant actually, and a lot easier than buying and selling securities from Brian Sack's 7th floor office.

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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.

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Are we less fragile than we were in 2009? Yes. However, one chart you should look at is the 5-year 5-year forward breakeven rates. If you notice, there have only been 3 times in the past 20ish years that this figure either broke or touched the 2% line. In September of '08, October of '10, and September of '11. I think you know what followed all of these, and why I say the recent easing is not defensive. The reason this figure is so important is that this can be looked at as what expectations are for future growth in the economy, and if we have mild deflation and that number drops significantly people will get very scared and more weakness will come.

Everything in economics is a self-fulfilling prophecy. If everyone expects Italy to default, their bond prices drop, yields sky-rocket, they refinance at higher coupons, they can't pay interest, then default. If everyone expects Italy to grow, their bond prices rise, yields fall, they refinance at lower coupons, and interest expenses can be taken care of so taxes don't have to be raised, and they grow. This is why I'm saying we can't handle it right now, because it would tell everyone that 2008 is coming back again, and the market still remembers that very well. The same goes for the fiscal cliff negotiations, it just creates the mindset that fiscal policy will never get things together and we'll keep having uncertainty. The key is to find where these correlations exist with psychology, and one correlation that I don't believe is really that relevant is optimism and the Fed Funds rate.

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Everything in economics is a self-fulfilling prophecy.

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From a certain perspective, yeah, but it can be dangerous to get carried away with this line of thinking.

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The problem with this becomes a chicken and the egg debate. Do you think rising rates creates optimism or optimsim creates rising rates? I'm a lot more inclined to the latter.

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So am I actually (see my "dangerous line of thinking" argument above), but there is a case to be made for the former. Additionally, however, there are also certain game theory type dynamics at work here, such that my argument is not really just about optimism (which can itself be important in certain situations), but is more about gaming the system such that a lot of things get put off when rising interest rates are not perceived to be a threat to eating away at future returns on projects that get delayed. In other words, why not delay if your window of safety is for sure going to be extended for at least another 4 or 5 years? Thus, I would say that the Fed-as-signaling-indicator optimism argument is distinct from the more game theoretical rational expectations argument.

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They can control volatility and risk in the markets simply by how they communicate to the public.

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I'm not entirely comfortable with the Fed chairman as magician model, but this is sort of tangential to the main point, so I'll just leave it be.

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Aside from the obvious accounting tricks used for P/E ratios, I'm not sure what all you gain from looking at those statistics.

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There were actually two different things I was thinking of, and the two points were actually somewhat in opposition to each other, so I just dumped the data there in order to get it out in the open, because I do think it's relevant.

On the one hand, I was trying to say, "look, we're not at an especially noteworthy overleveraged bubble point right now, so we can be much more confident in macroeconomic resilience to deflation."

On the other hand, my main thesis here is that the Fed erred in 2011 & 2012 by pursuing ZIRP. How could we tell if the Fed had gone too far? Well, asset prices might have started rising a little bit too steeply, which is exactly what seems to have occurred.

I mean, just look at this recent Bloomberg article from December 24: " Fed Flummoxed by Mortgage Yield Gap Refusing to Shrink: Economy."

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Record-low mortgage rates aren’t cheap enough for Federal Reserve Chairman Ben S. Bernanke as he tries to spur economic growth and create jobs.

Policy makers are disappointed that lower yields on mortgage-backed securities haven’t led to more savings on home loans after the Fed expanded its balance sheet to an all-time high of almost $3 trillion through bond purchases. Bernanke this month called the trend "unfortunate," and the Federal Reserve Bank of New York held a workshop to examine the issue.

The gap between the bond yields and home-loan rates is blunting the economic benefits of the Fed’s record accommodation, New York Fed President William C. Dudley said in a speech in New York this month. ...

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Hopefully this is just another example of the media missing context, but, Geeeez Louise! Talk about barking up the wrong tree...

In sum, I would rather have an L-shaped asset price recovery where the Fed had already done significant work "raising the shields" with increased interest rates, rather than a V-shaped asset price recovery where we're still operating under ZIRP for the indefinite future. I guess that's the main point of this whole thread, and with that, I think I can let things rest.



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Looking toward the future, I might start another thread on some of theory behind why ZIRP might be more harmful than many may think. I've still got a lot of loosely connected ideas rambling around my head from articles I've read over the past few years (many of which I will probably never be able to locate), but for the time being, I'll just create a list of articles from the year 2012 compiled from some quick Googling skills:

" The Fed is Starving Economy of Interest Income" (Warren Mosler, 1/24)
" Has ZIRP Held Back Economic Recovery?" (Asha G. Bangalore, 2/7)
" The High Cost of the Fed's Cheap Money" (Andy Laperriere, 3/5)
" The Fed's Jelly Donut Policy" (David Einhorn, 5/3)
" How ZIRP Destroys the Economy" (Mark Snyder, 9/24)
" Research and Commentary: Zero Interest Rate Policy" (Matthew Glans, 10/11)

And just for LSURussian, from the infamous financial blog sites...

" Is QE/ZIRP Killing Demand?" (Philip K. Pilkington, Naked Capitalism, 1/26)
" Bill Gross Explains Why 'We Are Witnessing The Death Of Abundance' And Why Gold Is Becoming The Default 'Store Of Value'" ("Tyler Durden", ZeroHedge Blog, 2/1)
" Policy Failure: ZIRP, Bubbles, And How The Fed Has Cost Savers 9 Trillion In 11 Years" (Colin Lokey, SeekingAlpha, 10/11)
(Unfortunately, nothing from CalculatedRisk, which is actually the only blog I give much credence to besides the occasional good SeekingAlpha article.)

Keep in mind that I haven't even read all of these yet, so I'm not saying that these are good articles. I'm just dumping some of what I am about to start reading myself, trying to mine out some gold nuggets of wisdom or insight. I'm sure a lot of it will be crap.