Recessions in a Zero Interest Rate Environment

Stock Market Analyze

The mind boggles at how utterly clueless politicians are. Driving to the office through foggy Melbourne streets this morning, I was listening to News Radio. The host was waiting for Tony Abbott to start a press conference, where he was apparently going to announce some important new counter-terrorism funding and measures.

Then I thought back to last year when Syria’s Assad government was enemy number one. It crossed Obama’s ‘red line’ and the West wanted to take it out (primarily because it was afraid of an alliance between Syria, Iraq and Iran, which would upset the regions’ dominant power, Saudi Arabia).

But democracy got in the way (mass protests in Britain and the US), so the next best thing was to encourage and arm the ‘rebel’ fighters battling against Assad’s evil regime.

As it turned out, many of these ‘rebels’ were members of the Islamic State (IS), that medieval bunch of religious zealots now running amok through half of Syria and Iraq.

Why has IS’ rise been so dramatic and effective? Because they’ve been trained and armed by the US…with help from Saudi Arabia. Unfortunately, IS weren’t content to just try to take out the Assad government. They saw an opportunity to spread their influence in Iraq too.

And now here we are, with Tony Abbott using the time honoured threat of ‘terrorism’ to chip away at our freedoms. We shouldn’t be involved in the region, full stop…yet, we heard a politician on the radio this morning saying he would endorse Aussie air strikes in the region.

Did he endorse using IS as the main destabilising force in Syria, too?

Politics has descended to such a state in the West that the people running the show are completely out of their depth. War and economic vulnerability are the result.

This is why we called our investment conference, held in March this year, World War D. It was an attempt to encapsulate the descent of everything into some type of war…either real, cyber or economic.

If you missed the actual event, you can now watch a recording. Click here to find out more.

Part of the reason for the general descent of everything is because the dominant global power, the United States, is losing its grip. The balance of power in the world is slowly but surely changing.

But you wouldn’t know it by looking at the S&P 500! The index gave the headline writers an easy job overnight by breaching the 2,000 level for the first time. It didn’t cooperate fully, though, and closed just below that level, at the not so round number of 1,997.92.

Is the ongoing market melt-up a sign of strength or a sign of weakness? On the surface, it’s a good thing. Increasing stock prices represent underlying economic strength, right? Unfortunately, not this time around.

Increasing stock prices represent the market’s rational response to irrational central bank policy. That is, by pushing yields as low as possible on fixed income assets like bonds, central banks force investors into higher risk assets like equities.

The latest excuse for a rally came on the back of Mario Draghi’s speech at Jackson Hole, the place where central bankers meet at the end of each northern summer. Draghi apparently signalled that European QE could be on the table soon, especially given that inflation expectations remain so low in the region. Didn’t he say the same thing last month?

The prospect of more money printing in Europe offset the prospect of less money printing in the US…and markets duly rallied.

Despite Draghi handing out a bit of sugar, I think the imminent end to US QE will be a bigger deal for markets. Which brings me to the point I made yesterday; that is, with interest rates so low and the Fed in such control, can another recession ever occur?

It sounds like a stupid question. In fact, it is a stupid question. Of course recessions will occur in the future.

If that’s the case, why are central bankers so afraid of them?

The answer is simple. In an economy weighed down by debt, recessions are lethal. That’s because a recession increases the risk of deflation.

So what, you may ask?

Well, when nominal interest rates are near zero, deflation actually represents an increase in the REAL interest rate. Therefore, recession coupled with deflation means tighter monetary conditions for the economy in question. This is exactly the opposite of what central bankers try to do in a recession.

That’s why central banks see deflation (and recession) as enemy number one. Since 1980, they’ve used up all their interest rate ammunition. To see what I mean, here’s the chart from yesterday again.

As you can see, every post-1980 recession resulted in lower interest rates. Now, we’ve hit rock bottom. Having a recession when you’re already at rock bottom would be disastrous. It would actually result in rising real rates, and an even deeper recession.

In highly indebted economies, recessions hit hard and are not easy to recover from. No one — neither central bankers nor politicians — want that on their watch. This is why ‘can-kicking’ is such a popular policy tool. Make it someone else’s problem.

So yes, we can certainly have a recession in a zero interest rate environment…and we certainly will at some point. But our ruling elite will fight it tooth and nail first.

This is why the stock market continues to rise on every central banker’s utterance. As long as the economy keeps its head above water (and out of recession), the threat of deflation in the real economy only leads to greater inflation in the financial economy.

Confused? Think of it like a see-saw. As central bankers push down on interest rates and compress risk premiums, stock markets soar higher.

A recession would upset this delicate imbalance, because it would lead to defaults and smash confidence. And everyone knows that banking and modern day financial markets have descended into one giant con game.

On a final note for today, a warning for retirees…the government is coming for you. The Financial Review reports:

Only a fraction of Australia’s ¬half-a-million self-managed super¬annuation funds pay any income tax, experts say, because of generous super concessions and franking credits that are undermining the federal budget.

Tax Office statistics show almost 300,000 self-managed superannuation funds eliminated or reduced their tax bills through exemptions on super and $2.5 billion in franking credits in 2011-12. These are the most recent records available, although experts say the surge in dividend payments since then has further reduced the small amounts of tax paid by these funds, which are often the primary income of wealthy retirees.

If you’ve provided for your own retirement and are not seeking a government handout, you are now a ‘wealthy retiree’. Beware…the taxman cometh.


Greg Canavan
For The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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2 Comments on "Recessions in a Zero Interest Rate Environment"

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slewie the pi-rat
slewie the pi-rat
2 years 1 month ago

ordinarily, this would be correct about deflation and its avoidance.
after all, $Trillions$ for “reflation”, under the chairSatan, remember?
but right now, not so much.
the 1Q 2014 GDP “deflator” was -1.9%.
GDP had to be “adjusted” 1.9% for INFLATION and knocked DOWN.
this took an economic “dip” in 1Q of -1% and TRIPLED it
to -2.9% GDP.

so, ironically, right NOW, we are in a situation where a little monetary “deflation” could help boost GDP and keep us out of a “recession” by helping to avoid two consecutive Quarters of negative GDP.

2 years 1 month ago

I observe the world around me and see that we are actually in a recession, everybody talks about how tough things are.

The longer we ignore the elephant in the room the larger he will loom.

Maybe we need another “recession we had to have”, consider it a hard re-boot.

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