quote:
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.

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.

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

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.

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

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."

quote:
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. ...

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.

XXX

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.

This post was edited on 12/28/12 at 1:01 pm