The Federal Open Market Committee has kept its key federal funds rate at near zero for more than seven years. This is a mistake. The longer we stay on this path, the further we are from where we need to be.
While lowering the rate initially was intended to provide support to an economy reeling from the Great Recession, and applauded by most economists at the time, I am beginning to question its continued utility.
While a near-zero interest rate policy initially provided much-needed liquidity during the crisis and a boost to major stock market averages, any associated economic growth that Ben Bernanke and others in the Fed rate-setting leadership might have anticipated has yet to really materialize.
For the most part output has remained tepid at best, and many corporations appear reluctant to commit huge sums of capital to their core businesses, instead plowing trillions into stock buybacks, dividend hikes, and mergers and acquisitions.
Bear in mind, this Fed is composed largely of academic Keynesians, and it is their belief, or hope, that the thousands of economic models they have created with their staff of hundreds of PhD. economists, based on theory vs. real-world experience of course, will lead the world down a path toward blissful normalization. Forgive my skepticism, but I feel like we've all been down this road before. It's like boxer Mike Tyson once said: “Everybody has a plan until they get punched in the face.”
That is to say, perhaps it is naive to expect these best-laid plans to work as predicted, given that they are based on theory and as such do not reflect the complexity and depth of the billions of economic reactions and participants influencing market behavior every day. The only way the Fed can build a model to describe such complexity is to assume away the real world — to impute market motives and relationships based on an implicitly imperfect, academic understanding of how things work and interact.
To me this is not a realistic expectation. Even if we could plan our way back to sustained economic prosperity, a monetary instrument by itself already at its lower bound — the proverbial piece of string — is not enough to resolve growth problems in the developed economies; problems driven by fiscal shortcomings and a decadeslong trend toward credit accumulation.
At a minimum we need fiscal instruments — government budgets, tax policies and prudent regulatory policy — to remedy what is primarily a fiscal problem.
Mr. Bernanke, Janet Yellen's predecessor as chairman of the Federal Reserve System's board of governors, knew this fiscal concern and said so explicitly in an Oct. 1, 2012, speech: “(M)onetary policy is no panacea. It can be used to support stronger economic growth in situations in which, as today, the economy is not making full use of its resources, and it can foster a healthier economy in the longer term by maintaining low and stable inflation. However, many other steps could be taken to strengthen our economy over time, such as putting the federal budget on a sustainable path, reforming the tax code, improving our educational system, supporting technological innovation and expanding international trade.”
Indeed, from an Austrian school of economics view, the primary reason we are in this position of yet again wondering why massive liquidity has not stimulated growth is because of, well, massive liquidity! That is to say, the policy measures implemented are the same policies that put us here in the first place. In the simplest of terms it is like robbing Peter to pay Paul. The Austrian school would say that by using artificial stimulus to smooth the economy when things are a little rough simply postpones the necessary corrections, therefore making the pain that much more severe when the bill finally comes due. Essentially, they would suggest that ultra-easy monetary policy discourages the structural adjustments that are necessary at all levels, whether governments, banking, corporate or households. In effect, zombie companies and governments are kept alive, and the financial sector is encouraged to misallocate resources to speculative plays. Sounds somewhat familiar, no?
So the question remains, without any obvious economic benefit, is maintaining a zero interest rate policy today a good idea, or is not raising rates doing more harm than its intended good? Certainly from the perspective of the many retirees who have not earned much on a lifetime of bank savings over the past decade or so, the answer is an emphatic yes to the latter question. Many institutions are feeling the interest rate pain. It is the pension funds that are having difficulty growing assets quickly enough to meet exponentially growing liabilities, the markets that have been hamstrung in terms of the ability to naturally and efficiently allocate capital, and the strong companies forced to compete against businesses kept alive artificially by cheap credit. In other words, what was once a medicine for stimulating growth might in fact today be acting as a poison.
There are many that argue the quantitative easing program served to only delay the inevitable, that the fundamental issues that caused the recession have not been addressed, and that eventually the U.S. and other indebted nations around the world will be faced with the prospect of defaulting on obligations in some form or other. Only time will tell what the lasting impact of QE will be.
The only thing almost everyone agrees on is that the future will bring more volatility. And, from an investment management perspective, we believe portfolios should be positioned accordingly with an emphasis on risk mitigation. A good dose of hope won't hurt either. n
Brooks Ritchey is senior managing director, K2 Advisors LLC, Stamford, Conn.