Friday, October 26, 2012

David Einhorn: Headwinds from quantitative easing and zero interest rate policies overwhelm benefits

David Einhorn weighed in on QE and zero interest rate policies and made a very strong case for why the headwinds created in the real world by these monetary policies overwhelm any benefits shown in the Fed's economic model.

Regular readers know that your humble blogger has been making this point since these policies were announced.  I pointed out Walter Bagehot's, the father of modern central banking, rule not to reduce interest rates below 2% and Mark Twain's statement that he was more concerned about the return of his money than the return on his money.

In case anyone listening to or reading Mr. Einhorn's speech missed this point, Tyler Durden at Zero Hedge hammers it home while discussing this speech in his usual understated style.

David Einhorn knocks it out of the park with his very first statement during today's Buttonwood Gathering, in a segment dedicated to one thing only: explaining how the Fed's policies are not only not helping the economy, they are now actively destroying this country
"Sometimes you have to look at what is the base assumption. because sometimes you have a groupthink around the base assumption and everybody agrees to the same thing and acts reflexively and doesn't really challenge what is going on. I think we have reached that point with the monetary policy. 
The assumption is that if you want the economy to improve, if you want more jobs, if you want more consumption, what we need is ever-easing monetary policy. My point is that if one jelly donut is a fine thing to have, 35 jelly donuts is not a fine thing to have, and it gets to a point where it's not a question of diminishing returns but it actually turns out to be a drag. 
I think we have passed the point where incremental easing of Federal policy actually acts as a headwind to the economy and is actually slowing down our recovery, and I am alarmed by the reflexive groupthink of the leaders which is if we want a stronger economy, we need lower rates, we need more QE and other such measures."... 
At one point in the interview, Einhorn observes that traders and economists now have diametrically opposing views on the effectiveness of QE (no need to explain whose view is what). 
The reason for this dichotomy is simple, if crucial: we are now at a point where the entire practice of new-classical economics - the bedrock thinking of all modern soecity - is at risk of being exposed for a sham "science" which is and has always been absolutely flawed.... 
But back to Einhorn, who presents one of the most coherent explanations why QE, contrary to the Chairman's "best intentions" does nothing to stimulate the economy at the consumer level, and why it effectively serves as a hindrance to future growth: 
"Lower rates drive up the cost of commodities: oil and food. And money that is spent on oil is sent out of the country to the Mideast and it doesn't help, and takes out income from people's pockets that could otherwise be spent on other goods. 
The second [ZH: and this is by far the biggest thing that the Fed refuses to acknowledge] is that not being able to earn a safe return on savings, is causing people to hoard savings rather than consume. 
In other words if I know I am going to earn 3% in the bank I can spend that income and I can have visibility towards that, but if I know I'm going to earn zero in the bank, in order to figure out how much I need to save for retirement I need to save a much bigger number. Which means I can't spend much now, I need to save more now, to build up those savings for retirement. If I am already retired and I am on fixed income, my income has now really gone down and I have to hoard money so I can spread it out thinner over a longer part of my life. 
So by denying individuals savings or interest on income on their savings, it is causing hoarding which is driving down consumption which is hurting the economy."
Mr. Einhorn has just described what I refer to as the Retirement Plan Death Spiral.  To make up for the lack of earnings on savings on the personal or pension level, individuals and companies need to put more money into savings and less into consumption.  This effectively deprives the real economy of the capital it needs for growth and puts it into a downward spiral.
As a reminder, in America consumption, not the government... is responsible for 70% of annual GDP. Is it any wonder that the Fed's own policies, done solely to protect the financial system, and to enrich those whose wealth is already primarily in the stock market (the infamous "1%"), are the cause of the ongoing catastrophe that is the destruction of America's middle class, which day after day sinks lower and lower?
Mr. Durden's comment describes the Fed's role in pursuing the Japanese Model and protecting bank book capital and banker bonuses.
Also, in direct debunking of all those Magic Money Tree (aka MMT) "economists" who say that government deficits are a great thing because the lead to higher savings, while maybe true on paper, Einhorn shows that the "expectations" component of behavior here is far more critical than what simplistic Econ 101 textbooks claim, especially the ones that were written long before anyone thought that the US would have a Zero Interest Rate Policy for at least 7 years (and likely more until the runaway inflation finally hits): 
In terms of the savings, I don't think it's a zero sum, because it's a multiplier on the behavior. It's not just the income I am not receiving now. It is the income I don't expect to receive in the future as well. Now we are four years into [ZIRP] with a promise of at least three more, so that's seven years, and you are getting a change in behavior on a multiplied basis.
Mr. Einhorn's describes a self-reinforcing negative dynamic.  The less money people expect to earn on their savings, the more they cut back on consumption and save.

Remember, one form of savings is paying down consumer credit.  This is effectively the risk-free rate of return for individuals.

Yes, some people are borrowing more.  Just look at student loans.  However, for people with the choice to consume or save (and these are the ones who drive the economy at the margin), Fed monetary policies are putting enormous pressure on them to save/pay off their debts.
Finally, and touching on the previous point of why theoretical economists' views differ so much from those who practically make a living by being right for a change, Einhorn is laconic: 
"It's very hard for economists with models, with very limited sample sets and empirical data to understand [that we've gone beyond the point of monetary policy diminishing returns.] I think you wind up with a different view from people like me in the real world who aren't just trying to figure out what do the models say, but how do people actually behave....  
We've opened up enormous tail risks of what happens if the Fed loses control, what happens if the Treasury loses control and these scare people and drive up risk premiums, and drive down P/E multiples and make companies defer long-term investments in the country because they are worried about significant tail risks these very aggressive policies are creating."... 
None of the what Einhorn said in today's Buttonwood gathering of course is news, as he simply reiterated everything he said in his letter to investors from Tuesday, which is just as effective at explaining how the Fed's solipsistic illogical methods are bankrupting America. The key section in that letter is the following excerpt:
It seems as if nothing will stop the money printing, and Chairman Bernanke in fact assures us that it will continue even after the economic recovery strengthens. Specifically, he says, “Even after the economy starts to recover more quickly, even after the unemployment rate begins to move down more decisively, we’re not going to rush to begin to tighten policy.” Apparently, anything less than a $40 billion per month subscription order for MBS is now considered ‘tightening’. He’s letting us know that what once looked like a purchasing spree of unimaginable proportions is now just the monthly budget.
Chairman Bernanke concedes that this policy hurts savers, then offers some verbal sleight-of-hand worthy of a three-card monte hustle: He says the savers are helped by low rates because low rates support higher asset values and promote a healthy and growing economy. He then goes on to say that because savers benefit from a healthy and growing economy, we must therefore have an accommodative policy. This in turn begs the question: Does an accommodative policy promote a healthy economy?
 As monetary policies are currently implemented, Mr. Einhorn, Walter Bagehot and I would argue no.
Chairman Bernanke argues that higher asset values create a wealth effect, which he again describes, “if people feel that their financial situation is better because their 401(k) looks better or for whatever reason, their house is worth more, they are more willing to go out and spend.”

We have just spent 15 years learning that a policy of creating asset bubbles is a bad idea, so it is hard to imagine why the Fed wants to create another one
But perhaps the more basic question is: How fruitful is the wealth effect? Is the additional spending that these volatile paper profits are intended to induce overwhelmed by the lost consumption of the many savers who are deprived of steady, recurring interest income? 
We have asked several well-known economists who publicly support the Fed’s policy and found that they don’t have good answers.

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