In last week’s Money and Markets column, I explained that the Federal Reserve’s policy of keeping interest rates low and purchasing trillions of dollars in securities is pushing investors further into the danger zone.
This unconventional approach is good for big banks, governments and borrowers (after all, who doesn’t like to borrow money for free?), but it is very bad for savers.
Near-zero interest rates have created incentives for the world’s biggest banks to borrow from the Fed — as well as the developed world’s other central banks — and allocate the money to their proprietary trading desks to engage in risky leveraged financial-market speculation which, in turn, artificially props up the stock market.
On the other hand, near-zero interest rates punish prudent savers who are called upon to bail out the reckless. Everyone who thought their savings might provide a comfortable retirement has to come up with another plan with interest rates near zero.
|Central bankers’ actions are destroying savers who rely on interest payments from their bonds.|
In the uniquely unusual world in which we live, the Fed and other central banks have created a scheme designed to encourage consumers to spend to help the economy while taking money away from savers who would like to earn a respectable rate of interest. But, ironically, the very same policies that are intended to induce savers to consume more actually causes them to spend less in order to make their savings last.
We live in an upside-down world where the actions of central banks are destroying savers who rely on interest payments and fixed coupons from their bonds. They also harm lenders who have lent money and will be repaid in devalued dollars, if they are repaid at all.
Today is a time of financial repression, where central banks keep interest rates below inflation. Standards of living are falling for many, economic growth is anemic, big banks are bailed out and older savers are punished.
Central banks think they can swell the size of their balance sheet, print money to finance government deficits and keep interest rates at zero with no consequences.
Why is this going on?
Federal Reserve Chairman Ben Bernanke is one of the world’s experts on the Great Depression. He has learned from history and knows that too much debt can be lethal. He also knows that the world’s financial system is loaded with debt that it can’t repay.
Debt can only be retired in three ways: 1. defaults; 2. paying down debt through economic growth; or 3. eroding the burden of debt through inflation or devaluations. During the Great Depression, we had defaults. But defaults are painful, and no one wants them. We don’t like pain.
Growing our way out of our debt problems would be ideal, but it isn’t an option. As I explained in my Money and Markets column on Aug. 14, economic growth is nowhere to be found. That means Bernanke is left with no other option but to print and devalue the dollar because he promised he would not let deflation and another Great Depression grip America.
In the movie A Few Good Men, Jack Nicholson played Colonel Nathan Jessup, who was guilty of using unconventional approaches to discipline to preserve America’s freedom.
Bernanke could not be further from Jessup, but they are both men on a mission. Jessup is obsessed with enforcing discipline on his base at Guantanamo. He has seen war and does not take it lightly.
In his own way, Bernanke sees himself as the financial market’s version of Jessup, standing on the wall fighting for us.
David Zervos, chief market strategist at investment bank Jefferies & Co., humorously observed that if Bernanke could be honest with the public, he would paraphrase Jessup’s speech as follows:
You want the truth? You can’t handle the truth! We live in a world that has unfathomably intricate economies, and those economies and the banks that are at the center of them have to be guarded by men with complex financial models and printing presses. Who’s gonna do it? You? Can you even begin to grasp the resources we have to use in order to maintain balance in a financial system that’s on the brink of collapse?
I have a greater responsibility than you can possibly fathom! You weep for savers and creditors, and you curse the central bankers and quantitative easing. You have that luxury. But you don’t know what I know: that the devaluation of currencies and low interest rates, while tragic, probably saved the world’s economy. And my policies, while unconventional, saved jobs, banks, businesses and whole economies!
You don’t want the truth, because deep down in places you don’t talk about at parties, you want me in charge of the Central Bank! Without my willingness to serve, deflation would come storming over our economic walls and wreak far worse financial havoc on our entire nation and the world. I will not let the 1930s repeat itself on my watch.
I have neither the time nor the inclination to explain myself to people who rise and sleep under the blanket of the very prosperity that I provide, and then question the manner in which I provide it! I would rather you just say “thank you,” and go on your way.
We may dislike their tactics, but central bankers must hide the truth in order to do their job.
To avoid defaults, today’s battle with deflation requires experimental economic measures. Ben Bernanke, Mario Draghi, Haruhiko Kuroda and other central bankers are manning their battle stations using unconventional policies to get the job done. Their tactics are punishing savers, encouraging people to borrow more, providing loads of liquidity to the proprietary trading desks at big banks, artificially propping up the stock market and weakening currencies.
The endgame for the central banks is not difficult to foresee; in fact, it’s already under way. The difficulty lies in trying to predict “when” these policies will unravel. It’s not a question of how this is going to play out, it’s just a matter of understanding the sequence in which it will happen.
For savvy investors who can get it right, there will be opportunities to make money in these uniquely unusual times. Guard your capital but be opportunistic.