“We’re right back
at it: trying to stimulate growth through easy money. It hasn’t worked but it’s
the only tool the Fed’s got.”
Michael Burry, CEO Scion
Asset Management[1]
Interest rates are more than an instrument of the central
bank in each country; they also represent a social contract: the savers are
rewarded and the risk takers pay a price for the risk. Or at least, this is the
way it used to be. No longer: a situation now prevails where you’re hardly
rewarded for saving and you barely pay for risk.
In theory, as Michael Burry points out, this is to
stimulate growth. The flaw with this theory is that growth is sluggish, even by
historical standards. Real GDP growth in 2015 in the United States was 2.4%,[2]
and about 1.3% for the Euro Area[3].
On their own, these figures are sluggish; in the context of near-zero interest
rate environments, they’re dire.
The road to
zero-interest rates is paved with good intentions
It’s easy to forget how we all got here. The global economy
was so short of cash that central banks began using every tool at their disposal.
Admittedly, there weren’t so many tools but before then, they were generally
considered good ones. These tools, one of which was to lower interest rates,
were broadly referred to as a ‘stimulus’ or a ‘stimulus package.’
The stimulus shows how warped modern finance in a
microcosm: in order to fix an economy which had become broken through (amongst
other things, but mainly) money which was too freely available, the solution in
most countries became to make money even more freely available. What’s even
more warped? On some level, this decision can be justified.
The justification comes in providing money to a system
which was afraid to spend what it had, encouraging the flow of money throughout
the economy and hopefully, funnelling money through to the most effective parts
of the economy again. All noble endeavours and indeed, all have been achieved
to at least some extent.
It does look distinctly like at least three things have happened
to the interest rate dynamic: (i)
people have lost faith in the judgement of the financial system, (ii) that we
have entered a truly unprecedented time, and (iii), that monetary policy will
never be quite as relevant as it once was, due to the interconnectedness of the
global economy.
(i) People have
lost faith in the Federal Reserve
Nobody needs a lecture on how the general public has lost
faith in the leaders of the financial system. Maybe what’s most telling about
it all is that one of the poster boys of the financial meltdown of 2008-2011
was Alan Greenspan, Chairman of the Federal Reserve from 1987-2006. Subprime
mortgages held a remarkably close correlation to Greenspan’s credibility.
In 2008 Greenspan told a House oversight committee: “I
discovered a flaw in the model that I perceived is the critical functioning
structure that defines how the world works.”[4]
Alan Greenspan was considered “the second most powerful person”[5]
in America. In March 2015, an NBC/Wall Street Journal poll showed 70% of
pollsters didn’t know who Janet Yellen is.[6]
 |
| Guess who? |
(ii) A truly
unprecedented time
It’s a circular argument but it’s true: the world economy
is in an unprecedented time, because it’s in an unprecedented time. Money is
virtually being given away by central banks and inflation is still below
targets, oil is at historically low prices, and banks have begun to look over their shoulders
at new innovations in finance.
Technically, none of this should affect the impact of
interest rates. But it does go to show that for the short-term at least, the
old rules don’t seem to apply. As humans, we’re inclined to look at the
short-term and mistake it for a longer-term perspective of course. But it’s
worth nothing that in the US and the EU, we’ve been living with near zero interest
for over half a decade now
(iii) The
interconnectedness of the global economy
It is now five years since Europe’s periphery was in the
midst of a debt crisis that threatened to rip the Eurozone apart. At the time,
one of the common refrains was that it was inevitable because none of the
countries which were worst affected could use fiscal but monetary policy – the
single currency, for all its benefits, effectively forced a strange type of
limbo on central banks.
It may be that something similar is happening over a
longer period of time with the US. A low interest rate in the US doesn’t mean
as much, when the same people whom it’s supposed to convince can invest their
money anywhere. And at the same time, fiscal policy is no longer a tool when
large companies are resorting to tax-inversion deals[7].
As in Europe – a strange type of Limbo for Janet Yellen.
Conclusion
In March 2016, Janet Yellen’s address to the financial
markets used the word “global” 11 times and the word “uncertainty” 10 times[8].
It doesn’t seem unfair to suggest that at least part of that uncertainty is on
Yellen’s own side. Indeed, CNBC referred to the talk as a “bunch of nonsense.”[9]
The four most dangerous words in finance are “this time
it’s different” but perhaps this time it
is – at least for a very short window in history. It can sometimes feel
like the moment in the horror film when you’re waiting for someone to jump out
from behind. For all our sakes, let’s hope it’s not too big of a shock when
that does happen.
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