{"id":77706,"date":"2015-09-02T04:12:39","date_gmt":"2015-09-02T08:12:39","guid":{"rendered":"http:\/\/countingpips.com\/?p=77706"},"modified":"2015-09-02T07:42:58","modified_gmt":"2015-09-02T11:42:58","slug":"zirp-recession-death-spiral","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2015\/09\/zirp-recession-death-spiral\/","title":{"rendered":"ZIRP + Recession = Death Spiral"},"content":{"rendered":"
September 2, 2015<\/div>
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By WallStreetDaily.com<\/u><\/a> \"Recession<\/p>\n

By Martin Hutchinson<\/a>, Global Markets Analyst<\/em><\/p>\n

Last week, economist Larry Summers and Bridgewater Associates Chairman Ray Dalio called for a new round of quantitative easing<\/a> (QE) bond purchases.<\/p>\n

Meanwhile, New York Fed Chairman Bill Dudley scaled back expectations of a September rate increase. Even though second-quarter U.S. gross domestic product (GDP) growth was revised upward, it\u2019s now unlikely that the Fed will raise rates at its September 16-17 meeting.<\/p>\n

At this point it\u2019s worth wondering whether the Fed will ever have the guts to move off the \u201czero-bound.\u201d<\/p>\n

Under such circumstances, we\u2019re compelled to ponder what will happen if the fed funds rate is still at zero when the next recession hits.<\/p>

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We\u2019re already more than six years into an economic upturn, and unemployment is down to 5.3%. A cyclical recession can\u2019t be far off. The elevated state of the stock market also suggests that a decline is near. If the market had followed nominal GDP since the first monetary easing in February 1995, the Dow would now be around 9,000, little more than half its current level.<\/p>\n

Finally, Austrian economic theory suggests that the prolonged period of ultra-low interest rates has produced an orgy of misdirected malinvestment that will have to be liquidated, causing a recession.<\/p>\n

A Political Matter<\/h2>\n

The timing of the next recession will seriously impact the 2016 election<\/a>, which in turn will influence the Fed\u2019s actions and, ultimately, the future of the world economy.<\/p>\n

If recession hits hard before November 2016, it\u2019ll help the Republicans. Indeed, it will validate many of the criticisms made by the Tea Party wing. If Republicans win the election, we\u2019ll get a new Fed Chair in January 2018, when Janet Yellen\u2019s current term ends, and presumably a different Fed approach from then on.<\/p>\n

On the other hand, if there\u2019s no recession prior to the election, then Hillary Clinton or some other Democrat is likely to win. In that instance, Fed policy will remain unchanged, whether under Yellen or a like-minded successor.<\/p>\n

Assuming current Fed thinking prevails when recession hits, the most likely reaction will be to bring out the big guns of monetary \u201cstimulus.\u201d<\/p>\n

However, if interest rates are still at zero, the Fed will have just two possible courses of action. One would be to set the interest on excess reserves to a substantial negative number (it\u2019s currently 0.25%). That would force the banks to take their money out of the Fed \u2013 though in a recession, they likely wouldn\u2019t lend the money. Instead, they\u2019d simply invest in Treasuries, intensifying the effect of the Fed\u2019s quantitative easing program.<\/p>\n

The other option would be engaging in a shock and awe-sized bout of bond purchases.<\/p>\n

The Bank of Japan (BoJ) has shown how this can be done. Its current QE program is three times the size of the largest U.S. QE program, in terms of GDP. In fact, the BoJ is buying all kinds of bonds, not just government and housing agency bonds.<\/p>\n

In the event of a recession, the Fed could announce a QE program of, say, $250-billion worth of bond purchases per month. This is comparable in size to Japan\u2019s current program. That would expand the Fed\u2019s balance sheet by $3 trillion per year, equivalent to 17% of GDP \u2013 and would satisfy even rabid Keynesians like Summers and, apparently, Dalio.<\/p>\n

With its massive new QE program, the Fed would absorb more than 100% of the new Treasury bonds issued each year. And even though interest rates are already very low, they\u2019d decline further, especially when inflation is taken into account.<\/p>\n

Coupled with bank lending, the Fed\u2019s bond purchases would force $3-$4 trillion worth of extra liquidity into the market annually. Whether or not this caused inflation directly, it would certainly cause the dollar to decline, just as the Bank of Japan\u2019s program has caused the Japanese yen to drop.<\/p>\n

In turn, that would produce a new level of \u201ccurrency war\u201d in which the United States was no longer standing passively by allowing the dollar to appreciate against almost all other currencies. Instead, the United States would be actively trying to depreciate the dollar.<\/p>\n

In 2010, during the first QE program, Brazil\u2019s finance minister accused the United States of waging a currency war. That accusation didn\u2019t take hold then \u2013 but this time, with renewed recession and a massive injection of liquidity into the market, the Fed\u2019s actions would anger China, Japan, and the EU.<\/p>\n

The end result would almost certainly be a round of protectionism, as everybody tried to protect their domestic industries against the effects of other countries\u2019 currency wars.<\/p>\n

A Recipe for Disaster<\/h2>\n

Now, we\u2019ve seen this movie before \u2013 in the 1930s \u2013 and it didn\u2019t end well.<\/p>\n

World trade declined by 65%, while countries like Nazi Germany abandoned the international trading system altogether and set up bilateral arrangements with favored sources of raw materials. Within a decade, of course, the world was at war.<\/p>\n

Better to hope that the Fed\u2019s renewed QE produces a sharp rise in inflation. At least then the policy would have to be abandoned, without wrecking the world economy altogether.<\/p>\n

Good investing,<\/p>\n

Martin Hutchinson<\/p>\n

The post ZIRP + Recession = Death Spiral<\/a> appeared first on Wall Street Daily<\/a>.<\/p>\n

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By WallStreetDaily.com By Martin Hutchinson, Global Markets Analyst Last week, economist Larry Summers and Bridgewater Associates Chairman Ray Dalio called for a new round of quantitative easing (QE) bond purchases. Meanwhile, New York Fed Chairman Bill Dudley scaled back expectations of a September rate increase. Even though second-quarter U.S. gross domestic product (GDP) growth was […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-77706","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/77706","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=77706"}],"version-history":[{"count":2,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/77706\/revisions"}],"predecessor-version":[{"id":77723,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/77706\/revisions\/77723"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=77706"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=77706"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=77706"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}