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A saver's nightmare?

Bill Gross  |  29 Sep 2015Text size  Decrease  Increase  |  

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Bill Gross is the lead portfolio manager of the Janus Global Unconstrained Bond Fund. This article was originally published on the Morningstar US website. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.


So the Federal Reserve (the Fed) has chosen to hold off on their goal of normalising interest rates and the European Central Bank (ECB) has countered with the threat of extending their scheduled quantitative easing (QE) with more checks and more negative interest rates, and the investment community wonders how long can this keep goin' on.

For a long time I suppose, as evidenced by history at least. Ken Rogoff and Carmen Reinhart have meticulously documented periods of "financial repression," long stretches of years and in some cases decades where short-term and even long-term yields were capped and suppressed below the level of inflation.

In the US the most recent repressive cycle extended from 1930 to 1979, nearly half a century during which investors on average earned 1.5 per cent less than the rate their principal was eroding due to inflation. It was a saver's nightmare.

But then Paul Volcker turned the bond market upside down and ever since (until 2009), financial markets enjoyed positive real yields and a kick in the pants boost to other asset prices, as those yields gradually came down and increased the present value of bonds, stocks and real estate.

Low or zero interest rates it seems do wonders for asset prices, and for a time even stabilise real economies, but they come with baggage, and as zero or near zero becomes the expected norm, the luggage increasingly grows heavier. Model-driven central banks seem not to notice.

Accustomed to Taylor Rules and Phillips Curves, their commentary is almost obsessively focused on employment statistics and their ultimate impact on inflation. Lost in translation, however, or perhaps lost in transition to a "New Normal" financial economy, is the fact that while 0 per cent or 0.25 per cent or other countries' financially suppressed yields might be appropriate for keeping their economy's head above water, they act as a weight or an economic "sinker" that ultimately lowers economic growth as well.

"No Model" will lead to this conclusion. Only the Japanese experience of the last several decades seems to give a hint, but the ageing demographics of their society is offered as a convenient excuse for their experience. Zero is never mentioned as a complicit accomplice, especially since inflation itself has averaged much the same.

But models aside, there should be space in an economic textbook or the minutes of a central bank meeting to acknowledge the destructive influence of 0 per cent interest rates over the intermediate and longer term.

How so? Because zero-bound interest rates destroy the savings function of capitalism, which is a necessary and in fact synchronous component of investment. Why that is true is not immediately apparent. If companies can borrow close to zero, why wouldn't they invest the proceeds in the real economy? The evidence of recent years is that they have not.

Instead, they have ploughed trillions into the financial economy as they buy back their own stock with a seemingly safe tax-advantaged arbitrage.

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