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posted on 27 April 2016

Central Bankers To The Masses: Let Them Eat Rate!

by Danielle DiMartino Booth, Money Strong

Money Strong Article of the Week

There never was any cake, just crust.

And the French Marie had nothing to do with it. Rather, a Spanish-born queen married to France's King Louis XIV a century earlier was the ill-mannered Marie who may have dared to taunt the peasantry. So how then exactly did, "Let them eat cake!" become so universally associated with Marie-Antoinette? In a nutshell: Blackmail.

Historians have uncovered the nasty truth, and it can be laid squarely at the feet some far from scrupulous London-based thugs, intent on shaking down King Louis XVI with threats to besmirch his young bride's reputation. According to Simon Burrows of Leeds University, a criminal network, drawn to the French monarchy's vast wealth, plotted to profit by producing a series of pamphlets filled with lies about the ill-fated queen. Those lies included a charge that she had callously suggested her subjects eat cake in response to news of a bread shortage plaguing the masses. Though the king paid a dear price for the pamphlets' destruction, some 30 copies were not burned as promised and found their way into the public's hands sealing the queen's fate kneeling before the guillotine.

Today, the shortage plaguing angry masses of savers worldwide is not one of bread or cake, but rather one of positive rates of return on their cash holdings. The central bankers know best as they command us to eat one rate cut after another. And like it.

For nearly 30 years, central bankers have based their haughty reasoning on the idea that the lower the interest rate, the greater the generation of economic growth. As then Fed Chairman Ben Bernanke explained in 2012,

"My colleagues and I are very much aware that holders of interest-bearing assets, such as certificates of deposit (CDs), are receiving very low returns. But low interest rates also support the value of many other assets that Americans hold, such as homes and businesses large and small."

It's certainly been the case that the prices of homes and businesses have been upheld. Though their appetite may have waned a bit, investors have richly rewarded companies who use low interest rates to finance share buybacks with debt. And there's no doubt investors of a different ilk did more than their fair share to prop up home prices at the lower end while wealthy individuals have bid up the prices of luxury homes to record highs.

The question is, is that what Bernanke intended? It would appear not as one of the stated objectives of the punishing policy of ultra-low rates was to spur income-generating job creation:

"Healthy investment returns cannot be sustained in a weak economy, and of course it is difficult to save for retirement or other goals without the income from a job. Thus, while low interest rates do impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates help promote."

Or at least that's what Bernanke led us to believe.

While it is true that returns on risky investments have been stellar, fewer and fewer Americans are comfortable with the risks associated with owning the most common of the pack - stocks. According to an April Gallup poll, the percentage of U.S. adults invested in the stock market has fallen to 52 percent from 65 percent in 2007, a 20-year low. So while there are definitely benefits to some, Bernanke's "ultimately benefitting most" part has fallen far short, and to an increasing extent.

Digging into the data, at -14 percentage points, those aged 18 to 34 were the most aggressive lot to abandon stocks. Meanwhile, at -9 percentage points, those aged 55 and above were the least. There seems to be an intuitive disconnect somewhere in that divide, one that should keep policymakers up at night.

There is a very real refute that we'd have to return to the bad old days of rampant inflation, when the degradation of the purchasing power of the dollar more than offsets the plump interest rates on offer at our local bank branch.

While we collectively rue that era, it's fair to say most seniors would gladly settle for a happy medium, a return to the turn of this young century when you could get a five-year jumbo CD sporting a five-percent APR, which was offset by inflation somewhere in the two percent vicinity. Traditionally, two to three percentage points above inflation is where that old relic, the fed funds rate, traded. So the math worked.

Of course, it could be worse. At least U.S. yields on savings are positive. That's more that can be said of the $7 trillion of foreign sovereign bonds trading at negative yields. This dynamic spells disaster for life insurers to say nothing of pensions. Increasingly, foreign pensions are raising retirement ages as well as requiring higher employer and employee contributions, all the while lowering the salaries against which benefits are calculated, even as they segue benefits onto 401k-style platforms.

For now, the judiciary in the U.S. is holding the legal line. As long as that's the case, actions to shore up pension underfunding will be avoided. Of course, at some point drastic measures will be required as the tax bases supporting future benefits shrink in proportion to the highest tax payers fleeing the fleecing.

Public pensioners with no back-up savings are sure to be enraged when their day of reckoning arrives. Then, today's non-pension-backed retirees making crumbs on their cash holdings will be flush in comparison.

And yet Bernanke deigns to wonder. Last fall after leaving the Fed, he had this to say to Martin Wolf of the Financial Times:

"It's ironic that the same people who criticize the Fed for helping the rich also criticize it for hurting savers. What's the alternative? Should the Fed not try to support the recovery?"

This coming from the same man who once said,

"No one will lend at a negative interest rate; potential creditors will simply choose to hold cash, which pays a zero nominal interest rate."

According to one recent Wall Street Journal story, that last observation certainly does hold true. Negative interest rates do benefit at least one of our contingencies: U.S. companies with European subsidiaries. Now that the European Central Bank (ECB) is in the business of buying corporate bonds, demand for issuance is all but a lock given the ECB can buy up to 70 percent of an issue, at issuance, to boot. Bully for that?

Not so fast says Standard & Poor's (S&P), which just stripped the energy giant ExxonMobil of its 'AAA' credit rating, coveted since 1949. Why? Share repurchases and dividend payments have "substantially exceeded" internally generated cash flows in recent years even as its debt load has doubled. That leaves two solitary AAA-rated U.S. credits, Johnson & Johnson and Microsoft. It's getting mighty lonely at the top.

But of course, there's nothing of the wildcatter in ExxonMobil's overindulging its shareholders. For seven straight quarters, over 20 percent of the companies in the S&P 500 have reduced their year-over-year share count by at least four percent, which conveniently translates into at least a four percent pop in their PER share earnings. Ain't math grand?

Based on the data thus far, the trend is becoming increasingly entrenched. S&P's Howard Silverblatt anticipates that public filings will reveal that over one-in-four deep-pocketed (debt-pocketed?) issues were in the aggressively juicing earnings cohort in the first quarter.

The end result of all of these financial shenanigans? For starters and enders, a whole lot of nothing productive. According to Bookmark Advisors' Peter Boockvar, the absolute level of core capital spending (nets out transportation) was $66.9 billion vs. $69 billion in 2011. As for the percentage of capacity that's being utilized, it remains well below its long-term average seven years into this economic expansion. Boockvar noted:

"Cheap money has created too much excess. On top of that, some CEOs are more interested in the short term focus on other capital uses such as buying back their own stock in the now second-longest bull market of all time."

Is it any wonder small investors continue to lose faith in the stock market? Should they be chastised for wanting a teensy weensy return on their cash? Dare we brand these conservative souls greedy, wanting to have their cake and eat it too?

Perhaps. But maybe the real solution to placate the angry masses is an admission that the original intent of zero-to-negative interest rates has utterly failed. Sufficient economic growth to offset the forced risk taking simply has not materialized leaving Grandma and Grandpa with their life savings hanging in the balance.

Perhaps the current conundrum will present an opportunity when the next recession arrives, a chance to recognize the failure of the low interest rate era. As counterintuitive as it would seem, why not use the next period of economic weakness to set a permanently higher floor on interest rates. Will the weakest operators meet their makers at the corporate guillotine? Naturally that will be the case. But isn't that the American way?

A new generation of revolutionary central bankers must be called to arms for all of our sake. Their battle cry: We commit to never returning rates to zero or below again, to never let be money be free and forever ensure there is a true cost associated with borrowing. Release the markets to set interest rates now and forever!

Will it work? Stranger things have been known to succeed in capitalistic economies with competitive and freely functioning markets.

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