“The Fed’s emergency policies since 2008 have in one sense been a huge success, though we will never know the counter-factual. A great depression was averted. Output is 10pc above its previous peak. Employment is up by 4.7m.
“Yet zero rates and QE set off torrid credit bubbles in the emerging world, pushing up the global debt ratio by 30pc of GDP beyond their previous record in 2008. The Bank for International Settlements calls this a “Pareto sub-optimal” for the world as a whole. The chickens have not yet come home to roost.”
– Ambrose Evans-Pritchard, The Telegraph
For seven long years, under two presidents and two chairpersons, the Federal Reserve kept its key policy rate effectively at zero. Now those years are over. We’re entering a new era – but new isn’t necessarily better.
Just for fun, I looked back to Thoughts from the Frontline for December 19, 2008 – right after the Fed first dropped rates to zero. You can read it here: “I Meant to Do That.” The theme with which I opened that issue could have worked just as well today, although we now have a different circumstance: rising rates.
The Fed has taken interest rates to zero. They have clearly started a program of quantitative easing. What exactly does that mean? Are we all now Japanese? Is the Fed pushing on a string, as Japan has done for almost two decades? The quick answer is no, but the quick answer doesn’t tell us much. We may not be in for a two-decades-long Japanese malaise, but we will experience a whole new set of circumstances.
Indeed, we now face that whole new set of circumstances. The Federal Reserve has created a series of debt and credit bubbles all over the world. The Bank for International Settlements terms this a “Pareto sub-optimal” for the global economy.
On the other hand, to say that the Fed “tightened” this week amounts to a very generous use of the word. They still own a multi-trillion-dollar Treasury and mortgage-bond portfolio in which they continue to reinvest anything that matures or pays interest. Last week’s FOMC statement pledged to “maintain accommodative financial conditions.” No one should call this crew hawkish – just marginally less dovish now.
In today’s letter we are going to examine the problematic credit markets, and I want to focus on something that is happening off the radar screen: the continuing rise of credit in private lending. I predicted the rise of private credit back in 2007 and said that it would become a major force in the world, but I got strange looks from audiences when I talked about the arcane subject of private credit. Today the shadow banking system is taking significant market share from traditional banking. Thus the market is gaining greater control over many of the traditional levers that central banks like to push and pull. While I think that trend is generally a good thing, it means that central banks are going to have to lean even harder in their policy directions if they want to affect the markets. And since they do like to interfere, it won’t be long before we embark on a “whole new set of circumstances.”
But before we turn to the ups and downs of credit, in keeping with my pre-Christmas tradition, I want to commend to you a most worthy cause that will pay fabulous dividends in the future and help bring peace to our troubled world.
My friend Niall Ferguson introduced me to a young former hedge fund manager, Jonathan Starr, who in 2009 started a prep school called the Abaarso School of Science and Technology in Somaliland with a sizable personal donation and the investment of his time. When Jonathan first went there, he and the completely volunteer staff of foreigners did not know the local customs, did not speak the language, and were not professional educators. To say their task was challenging is a huge understatement. The local Muslim community looked on them with suspicion, and there were efforts to close them down. But they persevered and have been wildly successful. If you meet Jonathan and his team, you quickly understand why they have prevailed. Jonathan has invested 100% of his time in Abaarso and has had no other job for 6+ years. Continue reading