Guest Article: St. Louis Fed and the circular unconstructivity of sustained Federal Reserve zero interest policies

By David Schane – USA, 20 Aug 2015.

While the recent and transparent analysis of the St. Louis Fed regarding the ineffectiveness of various QE programs is both notable and commendable. I would go further and personally cite the following reasons why Fed policies are circularly unconstructive.  Note, the order of the points below is just by

stream of consciousness and not by importance:

1. Some creative destruction is necessary and seemingly endless ZIRP (zero interest rate policies) for all these years past the nadir of the real banking crisis sustained zombie like companies with a misallocation of resources that would not have happened had markets been allowed to allocate capital according to more traditional risk/reward metrics.  In fact, ZIRP is deflationary in this way as marginal producers (that would have disappeared from the marketplace with normalized interest rates) can survive and compete on price thus robbing healthier companies of the pricing power they could have otherwise achieved.
2. There are tens of millions of retirees and other savers who have been deprived of earning any money in normal bank accounts and high quality short term instruments.  When I was a boy in the 1970’s, essentially all bank savings accounts (that were fully federally insured by the FDIC and other equivalent agencies of the day) earned 5.25% interest by law (before various deregulations) in the USA.  Now, retirees and other savers earn a few basis points or something similar on their bank accounts – and most or all of this meager income is drowned out by small fees (like making an out of network ATM withdrawal).  Imagine all the spending which has been taken out of the economy when retirees earn no return on their money (and accordingly consume less).
3. Risk taking on the part of business is not stimulated when there is no incentive for Main Street business to invest and expand (as there’s no incentive to rush out and grab a good interest rate when interest rates remain low ad infinitum).  Furthermore, most Main Street executives did not have easy access to credit anyway – and QE largesse never reached them.
4. Parliaments all over the world were given a free check to do nothing as central banks ruled the day with their various QE interventions.  The problem though is that central banks don’t have the tools or remedies for the economy’s maladies.  While central bankers would defend their actions by saying they wanted to be a bridge towards more normal times, there will be no transfer of the baton back to parliaments as long as central banks stay so activist (as most politicians and parliamentarians globally are more than happy to play politics and avoid true governance year after year and let central banks do the heavy lifting, even though they cannot possible succeed).  And what we need are measures like tax reform, entitlement reform, education reform and more – to expand productivity which only parliaments can deliver.  Furthermore, we have lost precious time in even beginning to have a public policy debate on these types of potential measures.  As such, we have largely squandered one of the potential “benefits” of a crisis, namely the mobilization of the body politic to engage in a robust national debate and build a stronger economy and society post crisis.
5. Sustained ZIRP was a major factor contributing to growing income inequality.  While all kinds of policy leaders (and even central banks themselves) pontificate on the negative consequences of widening economic inequality, ZIRP as mentioned above has hurt retireees and savers (who did nothing wrong during their working careers but have now been denied any returns on their hard earned savings year after year) nor helped Main Street businesses either.  Meanwhile, sustained ZIRP has been a boon to the very few who have major wealth in financial assets.
6. Some Federal Reserve officials (particularly ex-governor Jeremy Stein) worried that sustained ZIRP would create the next financial crisis by fomenting asset bubbles and encouraging speculation, particularly since so many on Wall Street feel the Fed perenially “has their back”.
7. Mainstream publications like “The Economist” have worried central banks are woefully unprepared when the next crisis hits, as central banks have not raised rates and thereby reloaded their “policy gun” to more effectively battle the next recession or crisis.  So sustained ZIRP and the lack of normalization of rates makes us less secure in the future.
8. While various regulatory reforms have removed liquidity from the markets, I believe it can be argued that sustained ZIRP has contributed to lower liquidity conditions itself.  QE has notably removed a great deal of liquidity from the Treasury market because the Fed purchased a great deal of issuance.  Even in markets where the Fed was not a direct buyer, the aforementioned Fed “put” has put a “spell” on the market, removed normal price discovery and made investors less vigilant.  It seems to me personally that these kinds of “somnabulant” conditions not only remove volatility – but remove liquidity as a secondary effect too.  Moreover, these complacencies (and “thinness” of markets) will probably exacerbate the next financial crisis when it hits.
9. While I do not doubt the sincerity of Fed officials to try and do their best (and learn from the mistakes of history regarding the most appropriate time for policy “liftoff” and “normalization”), they remind me of a young couple engaging in family planning.  As one close (and older) friend told me many years ago when I confided that I felt insecure in beginning a family (due to company restructurings and cutbacks), he counseled that there would never be an “all clear signal” – as company restructurings and the associated financial insecurities I felt were sadly a recurring fact of corporate and business life.  So if the Fed is similarly “data dependent” and sensitive to domestic economic developments (much less international phenomenon like the recent Chinese currency devaluation), they will never have the “all clear signal” they are seeking.  Nonetheless, sustained ZIRP is not healthy in all the ways detailed above and some type of policy normalization, even gradual, must occur so that economies, parliaments and capital allocators can move forward as central banks do not have the tools to build economic wealth and health long term.

Kind regards,

David Schane, MA in International Relations – USA – 20 Aug 2015

( from the editor: we thank Mr. David Schane for sharing with us his thoughts on the FED policies. The opinions here are his own. Having traveled the world and lived in Europe as well, we believe Mr. Schane’s thoughts are valuable. They convey both a holistic view and a differentiated perspective )

No comments here should be seen or construed  as investment advice