central banks

Too Close to the Sun

© Can Stock Photo / Paha_L

In Greek mythology, Daedalus constructs wings of feathers and wax so he and his son Icarus may escape from the island of Crete. Although warned against flying too close to the sun, Icarus becomes giddy with the sensation of flight. His wings melt when he gets too close to the sun, and he crashes into the sea and drowns.

This tale of hubris is perhaps mimicked in our time by central bankers around the world. Central banks including our Federal Reserve Bank are charged with conducting monetary policy to achieve stability of prices and favorable economic results. The stresses of the last global recession induced some of these authorities to adopt unprecedented policies.

Among these ideas, the most unusual might be negative interest rates. If we think of the rate of interest as a price – the price of money – then the concept of negative rates seems insane. If bananas had negative prices, producers would have to pay you to take them.

There are practical problems, too, for savers and investors. Imagine having $100,000 in the bank today. After a year of -1% interest, you would have, say, $99,000. “Money in the bank” would no longer be like money in the bank.

Why would central bankers consider such a policy? Like Icarus with his wings, they seem intoxicated by their apparent power to manipulate the economy. Negative interest rates would be a strong incentive to reduce savings and increase spending. This could theoretically boost the economy.

The unintended consequences of their actions could create real problems. Average folks trying to save for the future were severely disadvantaged by the zero interest policy of the last decade. Negative rates would make that even worse.
The Federal Reserve has not yet gone below zero. But a research paper published by a Fed official earlier this year concluded that “negative interest rates might be a useful tool…”1

Clients, our concern over this trend in Fed thinking bolsters our conviction about the investments we hold that would potentially benefit from the unintended consequences. No guarantees: we wish central bankers would simply avoid flying too close to the sun, so to speak.

Clients, if you would like to talk about this or anything else, please email us or call.

Notes & References

1. “How Much Could Negative Rates Have Helped the Recovery?”, Federal Reserve Bank of San Francisco. https://www.frbsf.org/economic-research/publications/economic-letter/2019/february/how-much-could-negative-rates-have-helped-recovery/. Accessed June 25th, 2019.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Medicine is Worse than the Disease

© Can Stock Photo Inc. / nebari

Monetary authorities took extreme measures during and after the financial crisis. These policies failed in their stated goal. More importantly, they have the potential for much mischief in the portfolios of the unwary in the months and years ahead.

Fed Chairman Ben Bernanke made it clear that the role of zero interest rates and Quantitative Easing was to push money into productive investments (or “risk assets”) that would help the economy grow. Instead, the biggest tidal wave of money ever flooded into supposedly safe assets, like Treasury bonds. Money flows into US stocks disappeared in the crisis, and basically have never come back. Zero interest worked exactly opposite the way it was supposed to. This obvious reality is totally ignored by the central bankers.

Current Federal Reserve Chair Janet Yellen continues to parrot the party line. Progress toward undoing the mistaken crisis policies has been excruciatingly slow. And the potential for damage to safety-seeking investors continues to mount. Similar policies, or worse, are in effect around the world.

Standard & Poor’s recently issued a report stating that corporate debt would grow from a little over $50 trillion now to $75 trillion by 2021, globally. Bonds are the largest single form of corporate debt, which is how investors are affected. This isn’t happening because corporations are investing so much money in new plants and equipment and research. It is merely meeting the demand of safety-seeking investors for places to put money. We think of this as “the safety bubble.” It appears to be the biggest bubble in history.

Standard & Poor’s is warning of future defaults from companies that borrowed too much money at these artificially low interest rates. Our concern is that when interest rates inevitably rise, people locked into low interest investments will see large market value losses even if their bonds are ultimately repaid.

We’ve written about the impact of higher inflation on today’s supposedly safe investments. Now the warning from S&P highlights another risk. The distortions created by counter-productive monetary policy are growing.

Of course, we believe our portfolios are constructed to defend against these risks, and to profit from the artificially low interest rates. We will continue to monitor these and other developments. If you have questions or comments, please email or call us.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.