Zero Interest Rates Do Not Help Growth

WASHINGTON – After a mediocre 4th quarter of 2014, the US economy came to a virtual stop in the first quarter of 2015. In part this is due to the substantial slowdown within America’s oil patch, (think Texas, Oklahoma, and North Dakota).

End of the oil boom

Yes, excessive global oil supply and falling prices (minus 50%) have forced many US energy companies to scale back investments, or drastically cut down production. This has had and will continue to have a negative impact on the overall economy.  Indeed, lower oil prices mean less demand for rigs, supplies, rail cars designed to transport oil, pipes, valves, and what not. And this translates into declining business volumes for all, not to mention fewer people employed by the energy companies, their suppliers and vendors.

A mediocre economy

That said, there is no question that this worrisome first quarter of 2015 took place within a feeble recovery. Yes, the US economy keeps growing. But at a rate that is well below the post war average of 3%. Last year we did 2.4%. This year it is unlikely to get much better, given this most disappointing beginning.

It is all about ZIRP

And why is that? Why is it that we cannot shake off what some are calling our “secular stagnation”? Well, here is an explanation. What if the Fed “cure” –zero percent interest rates, or ZIRP– may be in fact the cause of the disease? In case you forgot, we are going through the longest period of Fed-mandated zero interest rates in US history.

Theoretically speaking, zero interest rates should be stimulative. Cheap money should make it easier to borrow for productive activities, this way acting as a tonic for the overall economy. Well, that did not happen. The economy grows, but very modestly. In other words, the designated stimulus does not stimulate.

A Wall Street bubble

The real beneficiary is Wall Street. With zero interest rates, for investors the only way to make money is to buy stocks. And so, largely because of ZIRP, we have a Fed-induced Wall Street boom. In fact, it is a bubble, completely out of sync with a slow growth, mediocre economy. Yes, many valuations do not even remotely match actual performance. And yet investors stay in stocks in large part “because there is nowhere else to go”.

Lunatics in charge?

If we take all this together, the only thing that we can conclude is that the Federal Reserve is run by lunatics who, whatever their intentions, have in fact created a dangerous asset bubble. Or, worse, the Fed is run by snake oil vendors who have started to believe that their junk really cures people. And so, despite ample evidence to the contrary, they keep ladling it out.

Slow economy good for stocks

And the perversion of this addiction to zero percent interest is that when the economy slows down, as it happened in the first quarter, Wall Street actually feels better, because this means that the Fed will not raise interest rates any time soon.

You see, the Fed people have said time and again that they cannot raise interest rates (remember that zero rates are the main cause of high stock valuations) until they are satisfied that the economy is chugging along nicely. With zero growth in the first quarter, no chance that the FOMC will raise interest rates any time soon.

A crazy world

So, think of this craziness. Stocks stay high because the economy is actually in bad shape. Stock would instead take a dive if the economy went into high gear, because with a healthy economy the Fed would feel compelled to raise interest rates, this way ending the Wall Street bubble.

In the old world now gone people would buy stocks in a growing economy. Now they would rush to sell them, knowing that their stock portfolios over valuation would be exposed by interest rates going back to “normal”, on account of…a growing economy.

The sad thing is that we have tacitly accepted this perversion as the “new normal”.