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Great Interview with William White


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Do yourself a favor and read this great interview with William White, former Head of the Monetary and Economic Department of the BIS. Two excerpts:

 

The thing that strikes me about NIRP is the possible analogy between the zero lower bound and quantum mechanics. The Newtonian laws of motion apply as long as the body in motion is not too small and is not going too fast, otherwise you need to make use of quantum mechanics and the theory of relativity. And maybe with monetary policy there is a similar kind of a phase change that occurs at the zero lower bound.

 

The Europeans were concerned about this, based on earlier Danish experience when the central bank started charging negative rates on excess reserves held by the banks at the central bank. The expectation is that this will lead to lower lending rates. But you can easily think of a story where this is not the outcome because those negative interest rates cut the banks’ profit margins. And then the question is what will the banks do to restore them?

 

Well, one thing they could do is lower the deposit rate. I read in the Financial Times a few days ago that Julius Baer in Switzerland is thinking about doing just that. But then the worry is that people will take their money elsewhere, take it out in cash or whatever. If this is not possible, then what is possible is increasing the lending rate. What you end up with is a counterintuitive but highly plausible alternative description of what these policies are going to give you. So in the end they may end up being contractionary and not expansionary.

 

So totally experimental in any event.

 

and

 

Smithers of the Financial Times has offered a compelling explanation as to why business investment has also been so weak in spite of monetary conditions being so easy. It relates to the unexpected interaction between lower interest rates and corporate compensation schemes. When interest rates go down it becomes cheaper to borrow money, which can then be used to buy shares thus pushing up equity prices and the value of the associated option compensation schemes.

 

So from the perspective of the senior management – and for that matter, the “sharp” holders of equities who know that the shares are overvalued – it makes a lot of sense to buy back shares because they are personally making a lot of money out of it. But in the process they are also hollowing out the corporation because they are cutting investment to hoard cash for the same reason. And the “dumb” holders who did not sell the shares in the buyback are left holding the bag. That shell of a corporation is not going to be able to produce the returns in the future the way it did in the past. And this is an unexpected consequence of the interaction between easy money and corporate compensation schemes.

 

https://www.linkedin.com/pulse/what-more-can-central-banks-do-interview-dr-william-white-tavares

 

Pure gold.

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Great interview. Thanks for posting. Once I think about what WW is saying in regards to banks and spending I agree NIRP will cause reduced spending because of fear of running out of money during retirement and it will hurt bank profits. NIRP harms banks even if there is no cash because there are always safer and cheaper alternatives compared to paying negative interest rates. One of the best place to hide money is to overpay government tax accounts then roll them forward to the next year when you file your return. Companies will all pay each other sooner and some like Amazon might accept credit deposits like 10 years prepaid Prime membership. Almost everyone has some form of debt and it is safer to pay down debt rather than deposit in banks in this deflationary environment. People with lots of equity in their home might be able to borrow at extremely low interest rates as secured debt would be safer than risky unsecured deposits to banks. So NIRP will reduce the amount of bank loan interest. Investors will be more likely to hold Berkshire rather than deposit money in the bank. The policy is so bad for banks that I wonder what BIS intends other than to hasten change.

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I am still reading an absorbing it but I don't understand or agree with one thing he says:

 

He says low/negative interest rates causes companies to use debt to buyback shares.  That is clearly true, companies are swapping equity with cheap debt. But he then says that this is causing a hallowing out of the companies. The companies are using cash to fund buybacks instead of investment for growth. I don't see that. What caused the past two crashes were over investment and wasteful investment in tech and housing. If anything we need to tone down on trying to grow to fast.......

 

any thoughts? anyone?

 

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I am still reading an absorbing it but I don't understand or agree with one thing he says:

 

He says low/negative interest rates causes companies to use debt to buyback shares.  That is clearly true, companies are swapping equity with cheap debt. But he then says that this is causing a hallowing out of the companies. The companies are using cash to fund buybacks instead of investment for growth. I don't see that. What caused the past two crashes were over investment and wasteful investment in tech and housing. If anything we need to tone down on trying to grow to fast.......

 

any thoughts? anyone?

 

Two separate debates here IMHO.

 

First, to prove the hollowing out thesis you would need to show that companies invest a smaller proportion of their cash flow into growth/maintenance capex than they used to.  I believe I have seen this data, but I can't remember where.  Either way, I would argue that there is a dangerous incentive at the moment for executives to issue themselves stock options, borrow cheaply to pump their stock, and take a whacking pay packet at a nice low capital gains tax rate.  It would be very interesting to know how many of those same executives are taking out cheap loans *personally* (secured, perhaps, against their ill-gotten stock) to buy more equity.  I'm guessing not many.

 

Second, I would say that what caused the last two crashes (and the next one) was the bubble that preceded them, and that was caused by too-easy money.  That has nothing to do with trying to grow, and everything to do with the rather strange idea that although prices of individual goods ought to be set in a free market of willing buyers and willing sellers, prices of goods in aggregate should be set by all-knowing, all-seeing bureaucrats in central banks. 

 

To put it another way: free markets incentivise a continual hunt for efficiency.  That's a key part of how we make economic progress - we find out a way to do something using fewer resources, and direct the saved resources to something new.  But if we are continually getting more efficient, shouldn't the price of a fixed basket of goods generally trend down over time?  And if that is true, why do central banks target 2% inflation?  And if they target inflation when there ought to be deflation, won't that mean that monetary policy is way too easy sometimes, and won't that create bubbles?

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I am still reading an absorbing it but I don't understand or agree with one thing he says:

 

He says low/negative interest rates causes companies to use debt to buyback shares.  That is clearly true, companies are swapping equity with cheap debt. But he then says that this is causing a hallowing out of the companies. The companies are using cash to fund buybacks instead of investment for growth. I don't see that. What caused the past two crashes were over investment and wasteful investment in tech and housing. If anything we need to tone down on trying to grow to fast.......

 

any thoughts? anyone?

 

Though I don't have the data at hand, I'm reminded of this part of an interview with Stanley Druckenmiller from 2014 (and I'd trust him to know the data): http://video.cnbc.com/gallery/?video=3000293518

 

[Edit: After googling a bit, this is a CS research report which shows capex/sales until mid 2015 on p. 45 – basically energy was the only sector where capex/sales went back to pre-crisis levels; wonder how that turned-out…]

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