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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.