Miller/Howard: Whither ZIRP And QE via Q2 letter?
“The best lack all conviction,” as Yeats said of an apocalyptic time he envisioned. We would rephrase, or paraphrase, today, and say, “The best lack all conviction about the future of interest rates, the economy, and stocks, but they seem perfectly happy to offer prognoses as if they did not lack conviction at all.” We can’t blame anyone whose expertise, drawn mainly from post-WWII situations, fails to totally comprehend and absorb the meaning of the elements in today’s environment.
As the ads say, this is definitely not your father’s Buick. So much of what investors learned in business school or CFA training about markets and cycles just doesn’t apply. A doctor is trained to recognize streptococcus virus, and he will run the test and recognize it, plus the effects on the patient and the array of cures. There’s an established protocol. He takes the same steps every time, and he will come up with the same result. But what’s an economic thinker to think about ZIRP (zero interest rate policy)?
It dominates the financial landscape today, and yet it is essentially an unknown entity with unknown side effects and an unknown “cure,” if that’s what should be needed. ZIRP evolved from the classic central banker response to a financial crisis: Save the banks! It was ever thus, and so will always be. That’s how the Fed functions; the first job—no matter what they say about balancing employment and inflation blah blah blah—is to save the banks. And it’s tough to fault that fundamental premise. We tried to imagine a world without banks and it was pretty much like imagining a world without utilities or cell phones or automobiles or roads. Impossible.
Indeed, given the severity of the crisis, the Fed did a pretty good job of saving the banks. While many closed, it was not nearly as bad as the S&L crisis of the early 1990s, when 4 times (~1,600 vs. 400) as many banks shut down. But what else did the Fed accomplish?
It’s tough to argue that Fed actions have done much more for the economy than to inflate the prices of capital assets. We deal here with the problem of “counterfactuals,” in that no one will ever really know what the world would look like today if the Fed had done more, or less, or nothing at all. But we also know what we don’t have today: strong economic growth of a type that might be seen as mean-reverting compared to the declines of 2008–09. There is growth—there is no gainsaying the healthy ISM numbers—but it is not strong growth. And it’s certainly not credible to the bond market, which has been lately hitting new interest-rate lows, much to the surprise of pundits who’ve been certain that the end is nigh for the bond market (including ourselves). ZIRP and the relatives who’ve moved in with it—known as the quantitative easing (QE) family—seems as though it may have saved the US from drowning, but there is no vigor in it. Think “stability” rather than “recovery.” There is a fragility that might not be able to tolerate extrinsic shocks, like geopolitical disruption, terrorism at home, ecological disasters, or a single party dominating the three branches of government…
One need only peer at the velocity of money to see that strange things are afoot, and have been for some time. Velocity is basically turnover—how quickly a dollar deposited in a bank becomes a loan, how quickly a dollar spent at Home Depot becomes a bit of income for a worker, who buys a car, whose seller makes a profit, that is then spent at Home Depot, who deposits its money at a bank, and on and on. But look at what’s changed!
This is pretty straightforward. The easy money produced by ZIRP does not have legs. In an attempt to combat this lethargy and spark a recovery, the Fed introduced QE in several installments. This was a yet more concerted effort to stabilize banks, buying securities they might otherwise have had to hold, and providing buying support under the market so the securities the banks do hold will be worth more. Of course this applies to everyone holding securities, not just banks, and the profits and easy leverage have found their way into the stock market. A consequent reduction in long-term rates has made stocks “worth” more under the Fed’s own model (now broken through artificial intervention—under the Fed, model stocks should now be selling at a 35–40 PE). QE and the stock market look like this: