The Free Money Bill Comes Due
Movements Start Small #27
In 2010, Fed Chairman Ben Bernanke had a plan to get the economy going again. Despite stabilizing the financial system after the 2008 crisis, the Fed was frustrated by the anemic employment recovery.
The problem: long term “risk free” Treasury rates were still too high offering a tempting alternative to investing in the economy. Too many people were just saving! God forbid! If he took these rates close to zero, those dollars would be more likely spent or redirected to chase returns via investment - in companies, houses, who knows what. And, more spending and investing would mean more economic activity and hiring. The days of ZIRP (zero interest rate policy) were born.
One courageous member of the Fed, Tom Hoenig did the unthinkable, voting against the policy change. The risks were clear in his mind:
I am confident that holding rates down at artificially low levels over extended periods encourages bubbles, because it encourages debt over equity and consumption over savings. While we may not know where the bubble will emerge, these conditions left unchanged will invite a credit boom and, inevitably, a bust.
The policies would drive economic activity, yes. But, asset owners (the rich) would benefit the most, widening inequality and driving massive economic distortions by propping up bad investments. Zero cost of money also means a lot more debt (it’s almost free after all) - adding to the risk of the overall system.
While Hoenig was viewed as a hard-money chicken little, even progressives like Paul Krugman expressed ZIRP concerns, warning America was following Japan down an inevitable liquidity trap: “Seriously, we are in deep trouble. Getting out of this will require a lot of creativity, and maybe some luck too.”
Well, get your rabbit’s foot out. Deep trouble is near.
With ZIRP and fiscal spending hitting new heights during COVID, asset prices, as predicted by Hoenig, climbed to the moon. Just over a year after hitting $2 trillion in market cap, Apple hit $3 trillion. Another trillion in value on basically minor earnings growth (10%). Nothing really had changed for the company except the investing environment. With blue chips like Apple overvalued, the junk started getting bid up. AMC, Gamestop, Peloton. The same dynamic happened to real estate. And art. Then the yield chasers had to get creative. Welcome crypto!
Today, with inflation fully spread to goods and services, ZIRP cannot stand, and the “everything bubble” is getting reversed.
So what, you say? These crypto (and meme stock) bros didn’t deserve their Lambos anyway, so good on them for losing everything. SBF? To jail you go! I agree!
But, these stories are the infamous tip of a very large iceberg. Even “risk free” Treasury notes are down over 30% from their highs. The meme stocks are down 90%. Facebook over 60%. Even the mighty Apple is down 25%.
The implications of this asset deflation are unknown, but some are starting to rear their head.
One massive case in point. Two weeks ago the Teamsters Union pension fund got a massive bailout. In addition to chronic mismanagement and a history of embezzlement and fraud, the fund was going to fall massively behind in retiree payments due to declining investment returns. How far behind? 60%!
Don’t worry, the government stepped in to fill the gap. The price tag: a mere $36 billion. That is many times the highest estimated losses of real capital in FTX. And three times the net cost of bailing out the car companies in 2008. Nothing to see here. These are good union folks. And we already had the money…in our COVID relief bill.
Even if you feel the Teamster’s are deserving of a bailout…who gets to decide? And, who will get the next one? When the government is in charge of winners and losers then the key to success is your lobbyist. Cronyism and political gamesmanship will just grow. And, it will be a long line asking for help. The estimated gap in public pensions is $1.4 trillion and expected to grow massively this year with falling asset prices. $7 trillion sits in 401-Ks vulnerable to price shocks. U.S. Companies sit on $14 trillion in debt. And, don’t forget student debt of almost $2 trillion. I could go on. Many losers will emerge and they will ask the government for help. Yes, a government with $31 trillion of debt itself.
Cheap money is a hard drug to quit. It feels great at first, but an overdose drives inflation and increased income inequality. A withdrawal inflicts huge losses in wealth for those who relied upon it never ending - and eventually jobs and real hardship. Some tough choices have to be made - soon - or we will have to do it in the middle of a crisis. Given the appetite of both parties to give out goodies (and face few immediate repercussions), it's hard to see the cliff being averted.
If there is any lesson from the crypto debacle it is that some things deserve to fail. And should be allowed to. Bad investments need to blow up so investors know that undo risk will not be backstopped. Distortions in money drive distortions in the economy - and the world economy today is upside down as it reacts more to money creation and cheap credit than innovation and productivity.
As for the architects of this grand plan of ZIRP, well Bernanke might have gotten the Nobel Prize, but my hunch is Hoenig’s warnings will win the history books - and his mindset might be just what we need to navigate to the other side. If nothing else, we need to stop dismissing those asking hard questions and demanding tough trades. It’s easy giving freebies out, but leadership in the coming decade will demand some real sacrifice to get our economy back to fundamentals.
Good Links
Money and the Fed are sure to dominate the headlines in the next several years. The best book on how we got here is the Lords of Easy Money. It's an easy to understand story on a complex and essential topic.
Two years ago, I wrote about the mess of our monetary policy and why we needed some other voices, like Judy Shelton who at the time was viewed as a crank - just like Tom Hoenig.
Cheap money and high asset prices also gave our governments record tax receipts and low interest payments for a decade. Not anymore. At this rate an almost $2 trillion deficit in 2023 is possible - even without a financial crisis.
Yes, I still believe in Bitcoin. Why? At its core it is a boring savings technology in a world that only supports investing and spending. I think it will eventually act as such. Other cryptos? The vast majority (all?) are Ponzi schemes, veiled securities for risky startups or speculative financial engineering.
Congrats to Argentina and Messi! But, back home things are hard. Inflation is destroying the currency…again. “If you had $100,000 worth of pesos in 1995, they are worth $310 today.” Fascinating podcast interview on how people live and save (bricks!) in this world.
If you grew up in the 70s and 80s and liked sports at all (and some profanity), there is only one twitter account you need.
Great article Lew!
Well done Lew. Thank you for saying what needs to be said.