Just read this article written by David Einhorn on the Fed’s zero interest rate policy (ZIRP), dated May 3, 2012.
Einhorn’s View on the Fed’s ZIRP
- Near zero interest rates make traditional risk-less instruments like CDs and Money Markets unattractive to savers.
- The Fed thinks that it will make people buy stocks, which pushes up the stock market, make people feel more wealthy, so that they spend more.
Einhorn’s Counter Arguments
- Bond holders will not buy into the stock market
- Existing owners of bonds will not sell, because they know the prices of bonds will not fall.
- At this point in the cycle, stocks and bonds have a strong negative correlation. The Fed should show bond owners that bond prices do fall, in order to push them into buying stocks.
- Savers still will not invest in the market
- They have seen how risky the market has been. They will continue to save more, reduce spending, and create a drag on the economy.
- Interest rates should increase so as to put more money into the hands of savers which might push them to invest.
- Incrementally lower rates now have little impact on investment decisions
- Interest rates are only one consideration among many for long-term investments. If a 10-year investment makes sense at 2% interest rate, it probably still makes sense at 4%.
- Incrementally lower rates, in an already low interest rate environment, have more impact.
- Promising zero short-term interest rates until 2014 undermines any urgency
- If people know that low-cost financing is available until 2014, it undermines any sense of urgency to make decisions to borrow money today to spend or build.
- Fed should announce a small interest rate increase and hint at more to come, in order to push people to make the decisions now or risk losing out.
- Quantitative Easing (QE) drives up prices of food and energy
- Government statisticians see lower prices due to innovation as bad deflation (e.g. iPhone with more features at same price).
- The 2010 Jackson Hole speech started QE2. People scrambled for hard assets in fear of dollar debasement, using cheap financing to fuel speculative, levered positions. Spot oil went up from $73 to $114 a barrel in 8 months. Prices of food and most other commodities went up even faster.
- Rising oil prices slows down the economy. Most recessions have been preceded by rising or even spiking oil prices.
- In the first half of 2011, when Fed signaled that there is no QE3, commodity inflation and oil prices dropped and the economy began to improve.
- ZIRP slows down recovery of housing sector
- Banks can finance underwater borrowers for free, so they have little incentive to work them out.
- This prevents the real estate market from clearing and delays economic recovery.
- ZIRP aggravates income inequality
- The rich uses cheap financing for leveraged speculation, while the poor has their income eaten up by rising food and energy prices.
- ZIRP causes the stock market to be depressed
- There are many cheap and very cheap stocks in the market currently.
- Stocks are depressed because there is an enormous tail-risk that there will be an intersection between reckless fiscal policy and the Fed’s Jelly Donut monetary policy (i.e. QE quick fix).
Current State of the Economy
- Real GDP of 2-3%.
- Inflation of 2-3%, or 3-4% if excluding the deflation from technological progress.
- Nominal growth of around 5-7%.
- Raise short-term rates to 2-3%.
- This will put more money into the hands of households, which tend to hold short-term assets and long-term liabilities (e.g. mortgages).
- Einhorn holds gold due to the Fed’s monetary policies. If the Fed changes its policy, he would sell gold, sell bonds, and buy stocks.