Crushing the Middle Class
The Trouble with ZIRP
by Mike Whitney
CounterPunch (September 25 2013)
The Federal Reserve (“FED”) presently lends money at a lower rate than anytime in history. In fact, the rate at which the Fed lends money is more than a full percentage point below the current rate of inflation. That means the Fed is subsidizing borrowing. Naturally, zero rates create price distortions which are greatly amplified by the Fed’s asset purchase program called Quantitative Easing (“QE”). During its three rounds of QE, the Fed has ballooned its balance sheet by more than $2.8 trillion inflating the prices of financial assets across-the-board while establishing itself as the world’s biggest buyer of US Treasuries, the benchmark asset class upon which every financial asset in the world is priced. Those prices are now grossly distorted due to the Fed’s presence in the market. (Note: Fed chairman Ben Bernanke set the Federal funds rate in the range of zero to 0.25% in December, 2008 and has kept it there ever since. The policy is called zero-interest-rate-policy or ZIRP.)
When rates are cut to zero, it means that the demand for credit is weak. If the economy was growing at a faster clip, then the demand for funds would increase and the Fed would raise rates so they were closer to their normal range. But the Crash of 2008 triggered deflationary pressures (particularly massive deleveraging by homeowners who saw their home equity go up in smoke during the downturn) unlike anything experienced since the Great Depression. For the Fed to adequately address the sharp drop in demand, it would have had to set its target Fed funds rate at minus six percent which is impossible since the Fed cannot set rates below zero. (This is called ZLB or zero lower bound problem.) Thus, the Fed has implemented other strategies which are supposed to achieve the same thing.
Bernanke’s asset purchase program, QE, is an attempt to push rates below zero by reducing the supply of risk-free assets. By loading up on US Treasuries (“UST”) and agency mortgage-backed securities (“MBS”), the Fed tries to lure investors into stocks and bonds hoping to push prices higher. Higher prices create the so called “wealth effect” which paves the way for more consumption and investment. Hence, soaring stock prices create a virtuous circle which boosts demand and jump-starts the flagging economy. That’s the theory, at least. In practice, it doesn’t work so well. Five years after the policies were first implemented, the economy is still sluggish and underperforming (GDP growth is below two percent for the last twelve months), the output gap is still roughly $1 trillion per year, and unemployment is still sky-high. (Unemployment would be fourteen percent if the people who have dropped off the unemployment rolls and who are no longer actively looking for work were counted.) For all practical purposes, ZIRP and QE have been a bust.
The traditional antidote for a “liquidity trap” (that is, when normal monetary policy doesn’t work because rates are already at zero) is fiscal stimulus. In other words, when monetary policy can’t gain traction because consumers and businesses refuse to borrow, then the government must use its balance sheet to keep the economy growing. That means widening the budget deficits and spending like crazy to increase demand until consumers and businesses are in a position to resume their spending. Bernanke’s monetary policy is the polar opposite of this time-tested remedy. The Fed’s policy provides zero-cost reserves to poorly run zombie banks who refuse to pass on the savings to their customers via credit cards or mortgage rates. If the Fed was serious about expanding credit and strengthening growth, it would require the banks to cut their credit card rates and mortgage rates so that consumers benefit equally from the Fed’s cheap money. (In other words, if the Feds funds rate dropped from six percent to zero percent then credit card rates should be slashed from eighteen percent to twelve percent. That would stimulate more consumer spending.) But the Fed has made no demands on the banks. Instead, all of the gains from the wider spreads have gone to the banks, which is why ZIRP and QE have had virtually no impact on lending at all.
The main beneficiary of the Fed’s policies has been the investor class. While low rates have helped households reduce their debtload more easily, low interest lending coupled with the ocean of liquidity provided via QE has triggered a long-term stock market rally that has increased equities funds inflows to new records, boosted margin debt to precrisis levels, quadrupled stock buybacks from their 2008 lows, buoyed covenant-lite loan sales to $188.7 billion (“far surpassing the record of 2007”), and sent all three major indices to new highs. Unable to find profitable outlets for investment in the real economy, investors have taken their lead from hedge fund manager Ben Bernanke, snatching up stocks and bonds in a ravenous, yield-crazed flurry of speculation. Indeed, they have done quite well too, raking in sizable profits even while the real economy is still flat on its back. The bottom line: All the gains from ZIRP and QE have gone to Wall Street with precious little trickling down to the workerbees.
After five years of monetary policy that has failed to produce a strong, sustainable recovery, reasonable people have begun to wonder if Bernanke’s real objectives are different than those in his official pronouncements. After all, the Dow Jones and S&P 500 have more than doubled in the last four years, corporate earnings just hit an all-time high of $2.1 trillion, the banks announced record profits of $42 billion in the second quarter of this year, and – according to a new study by Emmanuel Saez, an economics professor at University of California at Berkeley – the top ten percent of earners in the US captured 50.4% of total income in 2012, a level higher than any other year since 1917 (Los Angeles Times). Meanwhile, 47 million people are scraping by on food stamps, labor’s share of productivity gains have never been smaller, median household income has plummeted by 7.3 percent since the end of the recession (Sentier Research), and 46.5 million Americans now live in poverty (US Census Bureau). Inequality – which is already at levels not seen since the Gilded Age – continues to widen at an accelerating pace while the battered and rudderless economy drifts from one crisis to another.
To pretend that the objectives of ZIRP and QE are different than the results they’ve produced (that is, greater concentration of wealth and political power, and the crushing of the middle class) is laughable given the fact that they’ve been in place for more than five years without any significant change. This suggests that the Fed’s policies are doing what they were designed to do, shift more wealth upwards to the uber-rich while political leaders dismantle vital saftey net programs which protect ordinary working people from the ravages of unregulated capitalism. The Central Bank and the political establishment in Washington are working hand-in-hand to restructure the economy along the same lines as they would any third world banana republic.
And that’s the real goal of the current policy.
Mike Whitney lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (2012). Hopeless is also available in a Kindle edition. Whitney’s story on declining wages for working class Americans appears in the June issue of CounterPunch magazine. He can be reached at email@example.com.