Article Reviews, Macroeconomics

David Einhorn on Fed’s Zero Interest Rate Policy

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

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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%.

Einhorn’s Recommendations

  • 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.



2 thoughts on “David Einhorn on Fed’s Zero Interest Rate Policy

  1. does USD weakens during election period or strengthens?

    Posted by KL | July 25, 2012, 9:49 am

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