Biotech Values

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Has the Fed’s loose monetary policy retarded US economic growth? That’s the thesis of a piece in today’s Barron’s

Economics is commonly misunderstood by our public because every action or policy has two sides. Partisans argue one side of the effects as if there is no other side to the story.

I think it indisputable that lower rates paid to savers, lowers spending by those savers and thus GDP. The magnitude is subject to dispute and will be a function of confidence. Would savers benefiting from the higher rates that prevailed before the financial crisis have maintained their spending levels if asset prices (the most sensitive component of the economy to interest rates) had kept collapsing rather than stabilizing and recovering? Think of their propensity to spend in the context of the Jamie Dimon scenario*, another 20% off RE and equities, and a collapsing banking system (nationalization of Bank of America). What spending would we get out of those savers then?

There is a second order effect that is too often left out in these debates - intermediation of the financial system. Normally it does NOT matter to GDP whether savers spend or not. If they save (not spend), the funds should become available to those who would spend/invest via bank intermediation. But here again, just as in the first order effect, confidence will determine the willingness of borrowers to borrow and spend. We know how that is working - it is not.** The cause - whether borrower or lender (banks are under a high level of regulatory scrutiny that is impacting lending) - really makes no difference to the spending.

The grasshopper and ant fairy tale is a good one to teach children and sound advice to the individual. But the "value" accorded savings is like other pure competition commodities subject to wide variance in price - including near zero pricing at times of over supply. To substitute a fairy tale for sound economic decisioning is delusional.

Over the last 40 years we have watched a secular decline in interest rates of all types. Even when the Fed wanted to keep rates high - they could not do so without watching economic activity decline unacceptably - leading to a wide output gap - and high unemployment. In my view, the Fed has largely served us well while the Congress has spend like a drunken sailor with no though for the bill coming due.

Lastly, the article suggests abandoning what we have learned about monetary policy. That is error, IMO. Bernanke knows what he is doing.

ij


* “Here’s the drill,” he continued. “We need to prepare right now for Lehman Brothers filing [for bankruptcy protection].” Then he paused. “And for Merrill Lynch filing.” He paused again. “And for AIG filing.” Another pause, “And for Morgan Stanley filing.” And after a final, even longer pause he added: “And potentially for Goldman Sachs filing.” Jamie Dimon 9/13/2008 at pg 3 of Too Big Too Fail

** http://research.stlouisfed.org/fred2/data/TOTLL.txt