OCTOBER 2016 – Advisor Commentary
Vice Chairman of the Federal Reserve, Stanley Fisher, is making rounds advocating the need to for Fiscal (Tax) policy initiatives. His argument is that we appear to be in a period of low inflation and low natural interest rates—an equilibrium point so low that our zero interest policy cannot stimulate greater economic growth. Fisher says that such an environment can foster a “Liquidity Trap,” where the economy is vulnerable to adverse shocks that may render conventional monetary policy ineffective. Further he argues that Central Bankers’ non-conventional monetary policy tools taken thus far, such as Quantitative Easing (“QE”) where large scale bond purchases have been made, have lessened concerns about a ‘Liquidity Trap’ but ultralow interest rates are nevertheless worrisome because they may reflect deep-seated economic problems. Fisher gives mention of Larry Summers argument that we may be in a period of “Stagnation” citing how low interest rates and the lack of economic growth may be reflecting how households and businesses feel about the economy influencing their savings and investment decisions. He then makes the circular argument that persistent low savings and investment in-turn impact the natural interest rate in the economy fueling uncertainty and reduced demand—in sum, not spending results in greater savings, lower productivity, and an extended cycle of slow growth.
Vice-Chair Fisher advocates continued monetary stimulus, but is urging Congress for fiscal policy help to reduce excessive precautionary saving and weak demand. Like both Presidential candidates, Fischer thinks some combination of improved public infrastructure, better education, and encouragement for private investment with effective regulatory policy could increase the ‘natural interest rate’ and reduce the potential of a ‘Liquidity Trap’— the real mission being to increase growth and productivity.
Telling in Fisher’s remarks are his near admittance that we remain in a stagnant economy with lackluster demand and perhaps are at the end of what Monetary policy can do as interest rates are still at the near “Zero bound” level. It is also important to note that fiscal policies to fund infrastructure investments is spending too. As reported in our previous commentary, the world has accumulated $152 Trillion in additional debt since 2008. Reportedly, only 25-30% of it is government debt, with households and businesses making up the other 70-75%. Housing and Energy account for most of this new debt, but student loan and auto debt thats continued to be securitized are at too high levels. One must remember the multiplier effect: Banks keep about a nickel for every dollar on deposit loaning multiples of their deposit dollars. When losses mount as they did in the Great Recession, the multiplier works in reverse so that a $100,000 loss means the bank must replace $2.0 million (20 x $100,000) in depositor money (Banks were using 40 multiples then!). Needless to say banks are not only tax free entities, but are still rebuilding deposit capital and there are signs they may yet suffer additional losses if we don’t pull out of this stagnate economy soon. Spending on highways, roads, bridges, and education is needed and desirable, but unless ‘natural’ consumer demand is increased in small business goods and services it is unlikely we will stimulate real demand and create greater productivity for the long term. Businesses cannot be induced into making capital investments unless there is an expectation of greater long term demand. Thus far, most all Fed Monetary policy has been targeted to helping banks shore up their financial condition and too little has been done to help consumer demand. Initial TARP money targeting home lending was used by banks to fund their own loans. HARP1 and HARP2 programs targeting upside down homeowners were fraught with so much bank fraud they had poor outcomes and the few hundred dollars Congress did pass on to taxpayers were too little to have any material impact. Indeed the Fed continues its Supply Side, trickle-down policies of the industrial age expecting that helping industry will help consumers. The needed solution must address the demand side which can be accomplished with fiscal policy, less government spending and incentives to work and earn a living wage.
This industrial-age bent on Keynesian economic policy purports more of the same for the US economy, and indeed the global economy. Deflation can be put off for longer but policy makers must recognize that real demand comes from pro-business policies and new found confidence in the game plan citizens and businesses alike. Because government has needed to stimulate to the degree we have done so amassing $20 Trillion in debt, (independent estimates of US debt obligations are $80 to $95 Trillion) higher interest rates and taxes will become counter-forces to future growth. More likely outcomes could be undesirable. We are therefore cautious regardless of who is elected. The next President will have a honeymoon period and any initial turbulence will be addressed by monetary intervention. Though we still see value in select opportunities and are positioned to be pro-active in our strategy, our goal for year-end is to harvest select gains and be positioned for the New Year and whatever it brings.