RISK

Risks, Hedges & Opportunities: ZIRP for the Greater Good

Several reputable critics of conventional monetary theory are manifesting suspicion about the supposed beneficial economic effect of the Fed’s ZERO-INTEREST-RATE POLICY (ZIRP) that was introduced in December 2008 and recently extended to late-2014 with a return to normalcy in 2018. A now ten-year project that advocates believe to be necessary and appropriate to suppress and contain the very long expected episode of the debt deflation effect on the prospective level of economic activity.

However, a body of experienced bankers and seasoned bond portfolio managers seem to think that Chairman Bernanke is not above it and media is giving them space to make their point. They are arguing in the public press that the standard Keynesian-monetary line that was the appropriate remedy to prevent an economic disaster in 2008 may not be the one to push the economy forward and upward to full employment. They are calling for the Fed to raise interest rates now.

In an oblique, perhaps weird, way it appears to have found its source out of libertarian ideology. Yet, I fail to see any of this in the Austrian school of economic thought where libertarian philosophy is at its best. I stand to be corrected, but my understanding is that the cost of money must ratchet downward to a point of inflection where risky investments can outperform bonds over a very long time. It is only at that moment that investors can be rewarded consistently and over a safe period of time for taking riskier investment decisions.

Complaints from the community of bankers and bond managers are much more about the concerning effect that a protracted period of low interest rates can have on banks’ net interest margin and bond portfolios’ profitability. They may be omitting the greater good. An appropriately obliging monetary policy should eventually spur loan and capital demand and ultimately support the economic recovery, job creation and returns for savers.

Incidentally, we may be approaching this point of inflection. During the past twenty years, the risk premium on stocks has been negative with returns on bonds and loans outdoing those on stocks. That is about as long as previous secular cycles of this type have been. It may be too early to predict a turn for the better, but excess bank reserves peaked on July 20 and have since been in a slow-but-steady downward trend; also most of the fall came from increased bank lending and corporate bond purchases. What all this means is that a slow-but-steady improvement in economic activity is becoming visible while missteps and blips could be overcome by continued monetary accommodation.