By maintaining artificially low interest rates, the Fed was hoping to drive investors away from bonds and into stocks and other, more risky assets. The Crash of 2008, combined with a retiring or soon to retire Baby Boomer population that is more interested in income than capital gains, resulted in a mass exodus away from stocks in the 2009-2013 period.
By keeping interest rates near zero, the Fed has been hoping to push investors into the stock market. The hope here was that as stock prices rose, investors would feel wealthier (the “wealth effect”) and would be more inclined to start spending more, thereby jump-starting the economy.
This has not been the case. Instead the entire capital market structure has become mispriced.
Individual investors have been fleeing stocks for the perceived safety (and more consistent returns) of bonds. Since 2007, investors have pulled over $405 billion out of stock based mutual funds.
The pace did not slow throughout this period either with investors pulling $90 billion out of stock based mutual funds in 2012: the largest withdrawal since 2008.
In contrast, over the same time period, investors have put over $1.14 trillion into bond funds. They brought in $317 billion in 2012, the most since 20008.
This had the effect of pushing yields even lower (precisely what the Fed wanted).
As you can see, today rates are the lowest they’ve been in over fifty years. This is not a sustainable trajectory.
Real estate and all other assets that have been financed via cheap debt have been pushed higher due to excess leverage. This includes GDP.
In the 1960s every new $1 in debt bought nearly $1 in GDP growth. In the 70s it began to fall as the debt climbed.
By the time we hit the ‘80s and ‘90s, each new $1 in debt bought only $0.30-$0.50 in GDP growth. And today, each new $1 in debt buys only $0.10 in GDP growth at best.
Put another way, the growth of the last three decades, but especially of the last 5-10 years, has been driven by a greater and greater amount of debt. This is why the Fed has been so concerned about interest rates.
You can see this in the chart on the next page (Figure 4). It shows the total credit market outstanding divided by GDP.
As you can see starting in the early ‘80s, the amount of debt (credit) in the system has soared. We’ve only experienced one brief period of deleveraging, which came during the 2007-2009 era.
As the alleged expert on the Great Depression, Bernanke couldn’t stomach this kind of deleveraging because it meant deflation which he has devoted his entire academic career to researching.
There was also career risk here. Those who have accumulated great wealth as a result of this system are highly incentivized to keep it going.
Bernanke doesn’t talk to you or me about these things. He calls Goldman Sachs or JP Morgan. And most of the Wall Street wealth of the last 30 years has been the result of leverage (credit growth). Take away credit and easy monetary policy and a lot of very “wealthy” people suddenly are not so wealthy.
Let me put this in terms of real job growth (created by startups) vs. the “job growth” of the last five years.
According to the National Bureau of Economic Research, startups account for nearly all of the US’s net job creation (total job gains minus total job losses). And smaller startups have a very different perspective of debt than larger more established firms.
The reason is quite simple. When a small business owner takes out a loan he or she is usually posting personal assets as collateral (a home, car or some other item). As a result, the debt burden comes with the very real possibility of losing something of great value. And so debt is less likely to be incurred.
This stands in sharp contrast to a larger firm, which can post collateral owned by the business itself (not the owners’ personal assets) and so feels less threatened by leveraging up.
Thus, in this manner, QE and other loose monetary policies maintained by the Fed favor those larger firms rather than the real drivers of job creation: smaller firms and startups.
For this reason, the Fed’s policies, no matter what rhetoric the Fed uses, are more in favor of the stock market than the real economy. That is to say, they are more in favor of those firms that can easily access the Fed’s near zero interest rate lending windows than those firms that are most likely to generate jobs: smaller firms and start-ups.
This is why job growth remains anemic while the stock market has rallied to new all-time highs. This is why large investors like Bill Gross have applauded the Fed’s policies at first (when the deleveraging was about to wipe him out in 2008), but then turned against them in the last few years as a political move.
This is why QE is so dangerous, because it increases concentration of wealth and eviscerates the middle class. And the coming inflation is has unleashed will only make things worse.
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