Desperation rarely breeds genius. Survival biased thinking is gut based, and never stood a chance of succeeding, at least in economics. Nothing works better than keeping your feet warm, and a cool head, and not the other way around. Just what our beloved CB’s have not done as of late -in their desperate quest for a financial fix to the GFC.
Zirping lately turned to “Nirping”, of our money, will stabilize things short term. But if you are not one of the ultra-rich 0.1% of the population, it will not engender value for you, or your close friends and family. Interest rates have to go up big. But relax, maybe paying more for your mortgage isn’t going to be that bad if you add it all in. Direct, and indirect (Bastiat) effects. It is not easy to explain why, because it is counterintuitive. I will try to do it here, but let me previously decline the chance to explain this, or the need for debt and expenditure constraint, to a local crowd of “Podemos”, “Syriza”, Le Pen, or Trump supporters. Bloody solutions, and particularly beheadings, are hardly tasteful and always messy, particularly if it is your head that gets chopped off. Some in our brainless crowds are not more subtle than their mob colleagues back in 1789. Things would get nasty very fast if the mob perceives you are actually suggesting to reduce some of the entitlements and goodies (like low rates) they have become acquainted with (in fact they feel entitled to). We live incrementally dangerous times.
And we just cannot solve our problems with the same thinking we used when we created them. That is an axiom -we didn’t really need Einstein to remind us (he did). Keynesian economics is a backpack laden with theories that are “completely finished” (see definition of completely finished in postscript). We have to think different, and get rid of residual Keynesian thinking asap. Manipulating fiscal or monetary parameters is not the way to achieve sustainable prosperity. Fiscal and monetary policies “ad nauseam”, for the last quarter of a century, took us here. This last NIRP move is more of the same, and will not solve the problem, but likely finally tilt the cart.
Of course, the root of the problem is always the same story. An alcoholic needs more alcohol to keep the shakes away and preclude a “delirium tremens” crescendo. But in the long run, the one thing he doesn’t need is alcohol. We need low rates to “extend and pretend”, but we need high rates to reallocate capital correctly, revamp our supply side, get productivity growing forcefully again, and set up a deleveraging process. Eight years later, our patient is as dependent on alcohol as he ever was. Well done Ben!
One way or another, interest rates will be much higher -well before the end of this decade. And that will be good (if we can hold on to our financial wealth on the wild ride to that nirvana). The beauty of the concept is also that, as was and will always be the case, nobody expects that to happen. Analysts are expecting indefinite deflation. I am not. Markets always move in the direction that generates most pain, to the maximum number of players. Frightening, but equally thrilling. I adore (free) markets every bit as much as I hate Keynesian priests. They sure keep you alive every minute.
I won’t buy the deflationary, Japanese style, long-term ZIRP or NIRP, as a stable outcome. Slow-demand-led deflation is alive and well (aggregate demand is moribund), and will be with us for as long as the debt overhang subsists. But cost-push inflation is already on the way. Shelter, education and regulatory costs mount, and wages are pressured up. In a NIRP context, it is likely that shelter costs will continue their crazy rise.
I feel certain that if low productivity growth persists, the system becomes so unstable that a total failure is “fait accompli”, probably sooner rather than later. A Japanese future is far from pretty, but we don’t need to worry about that because, at this point in time, we will not last that long with this atrocious business model. At present, three prospective, global scenarios, are conceivable:
- Productivity growth increases markedly and allows corporates to assume higher wage and regulatory costs. We need the right investment policy for that. In view of what we have seen lately, we need a miracle!
- Corporates lift prices to recover their gross margins. Some inflation is bound to appear in this process. If it spirals out of control it could well steepen the curves everywhere. It would do so in a free market. I feel uncertain about it, in a Central Bank driven pricing of sovereigns, that is no longer a market.
- Corporates are unable to lift prices in a context of a chronic weakness of aggregate demand. Profits continue to fall, and valuation tensions increase. Nevertheless, some smart manipulation in the E-minis might make market players forget valuation conundrums -or outright prudence. Market pricing is not a telltale for anything anymore. If it ever was.
NIRP is a desperate policy. CB’s are so desperate they have decided to throw in the kitchen sink as well. We are exploring the depth and extension of the expression “whatever it takes”. Yet somebody has to make everybody else aware, that ZIRP, and its turbocharged last release, NIRP, are destroying our business model -and not the other way around as conventional economists try to convey. I am not alone here but in good company. We are not that many, but we are enough. This is not a market diagnosis, and thus, subject to uncertainty. This is scientific. We are right, and time will certify that.
Six solid reasons should push us to stop this ZIRP, and NIRP, nonsense. I can think of a lot more, but these are basic stuff. Before I explain them, let us take “angst” out of the reasoning. It really does not make that much difference that we cut this short, now, or we let it crash on its own in a couple of months or years. A controlled demolition is always best, but I am not sure it is now within the realm of realistic possibilities. And by now a soft landing is, to use the Cervantes-inspired term, “quixotic”.
1.- Low or negative rates stimulate credit growth, in all areas: student debt, consumer debt, auto loans, corporate leverage, LBO’s, and social spending related deficits. Debt in all its varieties and descriptions. Low-interest rates postpone deleveraging and push credit aggregate figures up. A couple of charts from the Saint Louis Fed (FRED), via acting-man.com, show that this is a consequence that we just can’t afford nowadays. We do not want, and cannot handle, a higher debt load. We are at peak debt, or thereabouts. Consumption and debt were never valid drivers for a long lasting macroeconomic model -we should have known that when we started this model back “circa” 1987.
2.- Low interest rates create zombie economic actors and hinder Shumpeterian creative destruction. Weak industries and debtors have to default. Yes, it is a must. New ones will take their place, and produce better goods or services -in order to attract clients. If we do not improve the quality of our supply side we will not achieve a permanent improvement in aggregate demand (Say). There is no way around that fact, no matter how much we print, or how much we grow credit.
In this process both a destruction of inefficient supply and macroeconomic global deleveraging, take place together. Ideally, it ought to have been an ongoing process, one that remains subdued, and reignites itself every two or three years. Preventing it, we generated the need for a devastating simultaneous cleanup. It is like forest fires. Your options are, engaging in frequent controlled fires, or waiting for the big one -that might run out of control. And no, no fires forever is not an option. The great moderation and the taming of the business cycle were a mirage. A frequent hallucination, commonly found, mainly but not only, in Central Bank priests.
I have this much to say for him, Bernanke is apparently still unaware of what he has done. Unfortunately, I share Kafka’s view on ignorance. It is not bliss, it is oblivion. Possibly, probably, arrogance and pride will never allow him to find out. He will live in perennial denial. The rest of us will repent all that wording on the great moderation. Too late. We will all pay a hefty price for the Princetonian, absurd economic experiment.
Even if we did not have to weed out inefficiencies (more often than not, they are intertwined with corruption), we need high rates that induce a deleveraging process. It could have been a more or less orderly process, but not anymore. It will be a nasty deleveraging, and the more we wait, the worse it gets. Remember, regardless of Summers’ wishful thinking, there are no free rides in macro. And time costs money (wow, sorry, I was forgetting that that is not the case with abundant NIRP!). Anyway, a disorderly, but managed deleveraging, is the best available option today. Or else let’s kick the can forward. Yeah! Let’s do it -one more time. “Inoubliable” Cole Porter. A beautiful piece to relax our minds.
3.- Low rates do not stimulate productive investment, but rather the opposite. Rarely in economics, something on the cheap, or abundant, sees its use optimized. If something is not expensive, it is unlikely that we will make good use of it. And we have not. Had we done so, we would have one of two things: vigorous supply side growth and improvement, lowering the marginal cost of production, or surging productivity growth.
- Corporations did, in fact, lower the marginal cost of production, during the first couple of years post GFC. That made profits soar as a percentage of GDP, in a context of wage stagnation. Most of it came out of stagnant labor costs and redundancies, in a wonderful world where any aggregate demand that was being destroyed in that process, reappeared, out of the blue, via government deficits. It was good while it lasted, even if most of the investment targeted the substitution of labor with capital (hardly the best allocation to grow the economy from a macro perspective). Well, for better or worse, that’s gone. I doubt we can see substantial supply side improvement from now on because the easy part (worker substitution for technology) has been done, and CAPEX has recently not grown to expected levels. We now have empirical evidence that the IS-LM model was flawed.
- Regarding productivity increases, not even the first few years after 2008 were good at that. See data for the US and the UK. They are a valid proxy for most of the rest of the OECD countries. This post-GFC economic cycle has been a productivity unmitigated disaster. Think about what’s different in this cycle. Maybe QE and ZIRP?
4.- Low rates are bankrupting our supply side. There is a very interesting piece on this issue by Andrew Lapthorne at Societé Generale. If QE and credit money is not enhancing productivity or expanding and improving the efficiency of our supply side, it must be going somewhere else. Consumption for a fact. But another of the main uses of freshly minted credit (oh yes, I think credit is so relevant it ought to be minted from now on!), is share buybacks. We were all aware of that. We were also aware of the fact that an incremental percentage of free cash flow was being used to finance buybacks that reflate eps. But, but … NFC’s are outspending cash flow by the greatest margin in twenty years! Bravo FOMC!
Forget that, after all, we are only talking rates of change. The charts below are truly staggering (soc gen and daily shot). Changing the mix of equity and debt finance on the liability side of their balance sheets, corporate executives have finally really endangered the survival of many viable companies. Low rates have not only not improved the supply side, they have been used to lever it up, in a psycho maniac race to increase “eps” above the natural profit growth. Not to mention the side issue of the gargantuan gap that has grown between reported profits, and GAAP figures. We are also at peak NFC balance sheet instability … and P&L liestatistics!
Low rates have enabled conducts that put the stability of our safe supply side infrastructure at risk! Want more of the same? If not, we have to lift rates meaningfully. Sweden’s NIRP is a case in point. Think for yourselves.
5.- Low rates have generated asset bubbles almost everywhere. No, I won’t comment on that. Stating the obvious is boring to write … and boring to read. We all know asset bubbles were the price to pay, according to Princetonian priests.
People are lending the French Government their money, at negative rates up to five years down the curve! And even the Japanese 10Y bond is “nirping” the holder’s nominal value (with a total sovereign debt overhang near 300% of GDP). Daunting. Free markets are gone. Needless to say, the harm induced by incorrect pricing, to an optimal allocation of savings, is behind the productivity disaster. Most likely, together with other factors outlined in this post.
6.- Low rates are unfair and ethically repugnant. Don’t worry. I will not give you a sermon on the morality of depriving the real savers out there, of their hard earned retirement income, just because others played it easy with debt. I know. Who cares nowadays!
But some economic aspects should worry us.
- The population is growing older, and the population pyramid inverting. If our grandpas (mind you, I am nearly in that league now that I think of it) are deprived of income, they will not spend. And they are on their way to becoming our largest population class.
- Second. When deprived of income from their savings, they will not abandon the workforce, and will not leave some jobs available for the younger generations. Retirement is necessary if we are to keep the prime segments of our population employed. But we cannot fund retirement with entitlements that have been massively underfunded (at best, in private retirement schemes and endowments), or even ignored (at worst, in public balance sheets).
- Insurance companies will all be bankrupt if this NIRP deflationary biased environment persists. Banks already are, but we will make it worse. Active fund management is being destroyed by manipulated and bubbly asset prices. Hedge funds are disappearing. The herd is massively placing itself in hands of the ETF’s. And ETF’s rely on indexes and benchmarks, that are Central Bank manipulated. The entire financial sector will be gone after a couple of NIRP years. CB’s, and manipulated markets will play the role -using ETF’s.
To conclude: We need high-interest rates in a healthy, long-term oriented, macroeconomic model for our world, but we cannot get them because we need negative rates to further extend and pretend. Nobody wants to do the right things, and assume the default debacle, on his watch. We have to wait, and constantly scrutinize the cracks in the system, trying to anticipate the breaking point and time. A tough call.
Best of luck to us all. Low-interest rates will not be here forever. Long Bonds are maybe even more dangerous than stocks. We have to play the last stages of the bond rally with care because we don’t know the event that will morph into the proverbial straw that breaks the camel’s back.
PS. In a recent linguistic conference held in London, England, and attended by some of the best linguists in the world, Samsunder Balgogin, a Guyanese, was the clear winner.
His final challenge was this: “Some say there is no difference between complete and finished. Please explain the difference between complete and finished in a way that is easy to understand.”
His astute answer: “When you marry the right woman, you are complete. When you marry the wrong woman, you are finished. If the right one catches you with the wrong one, you are completely finished.“
His answer was received with a standing ovation. Keynesianism is completely finished.