You don’t need to just take my word for how bad persistent low interest rates will be for the economy. “Bond King” in exile Bill Gross makes arguments very similar to those I’ve made:
But models aside, there should be space in an economic textbook or the minutes of a central bank meeting to acknowledge the destructive influence of 0% interest rates over the intermediate and longer term.
How so? Because zero bound interest rates destroy the savings function of capitalism, which is a necessary and in fact synchronous component of investment. Why that is true is not immediately apparent. If companies can borrow close to zero, why wouldn’t they invest the proceeds in the real economy? The evidence of recent years is that they have not. Instead they have plowed trillions into the financial economy as they buy back their own stock with a seemingly safe tax advantaged arbitrage. But more importantly, zero destroys existing business models such as life insurance company balance sheets and pension funds, which in turn are expected to use the proceeds to pay benefits for an aging boomer society. These assumed liabilities were based on the assumption that a balanced portfolio of stocks and bonds would return 7-8% over the long term. Now with corporate bonds at 2-3%, it is obvious that to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10% a year to meet the targeted assumption. That, of course, is a stretch of some accountant’s or actuary’s imagination.
It’s his continuation that I find interesting:
Do central bankers not observe that Detroit, Puerto Rico, and soon Chicago, Illinois cannot meet their promised liabilities? Do they simply chalk it up to bad management and inept governance and then return to their Phillips Curves for policy guidance? Do they not know that if zero were to become the long-term norm, that any economic participant that couldn’t print its own money (like they can), would soon “run on empty†as Blackstone’s Pete Peterson once expressed it in describing our likely future scenario? The developed world is beginning to run on empty because investments discounted at near zero over the intermediate future cannot provide cash flow or necessary capital gains to pay for past promises in an aging society. And don’t think that those poor insurance companies and gargantuan pension funds in the hundreds of billions are the only losers. Mainstream America with their 401Ks are in a similar pickle. Expecting 8-10% to pay for education, healthcare, retirement or simply taking an accustomed vacation, they won’t be doing much of it as long as short term yields are at zero. They are not so much in a pickle barrel as they are on a revolving spit, being slowly cooked alive while central bankers focus on their Taylor models and fight non-existent inflation.
There’s actually quite a bit of subtext in his remarks. Some of it is the complaint of the applied practitioner about theoreticians. It wasn’t always that way. Once upon a time Fed governors were actual bankers and investors.
401ks, life insurance, retirement, pensions…. Yup, even Bill Gross thinks it is all about a special interest group. Given my white hair, maybe I should appreciate this more. Meh. Anyway, Gross dislikes our economy up until 1980, and thinks everything was peachy up until rates were at zero. Think about that. His nirvana is the 80s, 90s and early 2000s. Debt financed growth in the 80s, bubble growth in the 90s and fraud based growth in the 2000s. Growth that really benefitted a small group in our country. Growth prior to his nirvana years resulted in more income for everyone. From the 80s on it only helped a few wealthy people like, well, Bill Gross.
“Instead they have plowed trillions into the financial economy ”
Unlike in the 90s and the 2000s when no money went into the financial economy. No wonder he is in exile.
Ok, that was fun, but you would think an economic textbook would note that there are winners and losers when you raise rates (even Gross notes that if you read his entire piece) in a sluggish economy. Why do we want to make old people the winners? Because we care about them so much? Look at our government expenditures. We are basically, as has been said before, an insurance company, mostly for old people (even Medicaid has about 1/3 of its spending going to the elderly), with a big army. 3.8T budget with 1.3T in SS, 0.6T in Medicare, 0.16T in Vet benefits and (1/3)0.4T in Medicaid. Over half of our federal budget goes to old people, and now we also want to make sure the winners in our choice about rates to be old folks. I wonder what color of hair Bill Gross is sporting?
Steve
“If companies can borrow close to zero, why wouldn’t they invest the proceeds in the real economy? The evidence of recent years is that they have not. Instead they have plowed trillions into the financial economy as they buy back their own stock with a seemingly safe tax advantaged arbitrage. ”
They have cash, and limited investment opportunities. Add a low cost of capital and you get the massive balance sheet restructuring going on. Critics can criticize stock buybacks if they like, but you reap what you sew.
Interest rates shouldn’t be instruments of social policy, especially to bailout the largesse of politicians who gave out goodies to voters who would support them, and especially not some Rube Goldberg scheme of calculus to screw savers to offset their transfer payments. What could go wrong?
“Interest rates shouldn’t be instruments of social policy”
Unless it is policy that is helping old folks, and the investor class.
Steve
No, steve. They should be let find their equilibrium without manifest manipulation, for the benefit of old people, investors or anyone. But being in a subsidized industry yourself I can see how you would have a soft heart for intervention.
Why do we want to make old people the winners? Because we care about them so much? Look at our government expenditures.
…and yet when there are even any conservative considerations to reform “old peoples’ programs,” (SS, medicare), the dems scream and point fingers at such evil thoughts. However, when it comes to people “saving” for their old age, having decent interest rates providing incentives for such actions, that becomes a bad thing???
BTW, I don’t have white/gray hair yet. But, I do believe that providing a fiscal environment for savings is better than depending on a government to provide unsustainable subsidies for one’s old age.
The interbank rate is naturally zero. Gross, whether he knows it or not is calling for active government intervention to provide a higher return and provide more financial assets. Note he explicitly states that without such the private domestic sector runs out of currency.
This is the opposite position from tbe one he took which resulted in PIMCO’s biggest loss so we can’t say he doesn’t learn from his mistakes.
“They should be let find their equilibrium without manifest manipulation, for the benefit of old people, investors or anyone.”
As was pointed out, corporate bond rates are also low. Markets seem to be telling us that rates should be low, and they are low nearly everywhere in the world. So, I will just quote left wing commie Kling.
“The fact that interest rates generally move together can be consistent with a number of hypotheses. One hypothesis is that the Fed influences all of these interest rates. Another hypothesis is that the views of the Fed are usually not much different from the views of markets. The question to ask is what happens when the long-term interest rate is X and the Fed thinks that it ought to be Y. Can the Fed move the long-term rate from X to Y? My impression is that the answer is in the negative.”
Rates are probably about where they should be, unless you want to interfere for the sake of social policy.
Steve