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Source: The New York Times | DealBook, September 1, 2015 commentary

A Call for a Free Market

SEPT. 1, 2015

Another View




The worldwide turbulence of recent days is a strong indication that government intervention alone cannot restore the economy and offers a glimpse of the risk of completely depending on it. It is time to give the free market a chance.

Since the crash of 2008, governments have tried to stimulate their economies by a variety of means but have relied heavily on manipulating interest rates lower through one form or other of quantitative easing or simply printing money. The immediate rescue of the collapsing economy was necessary at the time, but the manipulation has now gone on for nearly seven years and has produced many unwanted consequences.

It has exacerbated the inequality of income around the world. Money has been artificially allocated by the abnormally low rates to reward speculation and to discourage savings and longer-term investments that produce real economic and employment growth.

The Federal Reserve, waiting for signs of inflation to change its policies, seems to be looking at the wrong data. Actually its policies have been highly effective in the areas stimulated most heavily, but the low interest rate policies have not stimulated the broad economy or made most people better off. In fact, it may have actually hurt those people.

Low interest rates have hugely lifted assets largely owned by the very rich, and inflation in these areas is clearly apparent. Stocks have tripled and real estate prices in the major cities where the wealthy live have been soaring, as have the prices of artwork and the conspicuous consumption of luxury goods.

Cheap financing has led to a boom in speculative activity, and mergers and acquisitions. Most acquisitions are justified by “efficiencies” which is usually a euphemism for layoffs. Valeant Pharmaceuticals International, one of the nation’s most active acquirers, routinely fires “redundant” workers after each acquisition to enhance reported earnings. This elevates its stock, with which it makes the next acquisition. With money cheap, corporate executives have used cash flow to buy back stock, enhancing the value of their options, instead of investing for the future. This pattern, and the fear it engenders, has added to downward pressure on employment and wages.

Similarly, older adults and those on fixed incomes are getting next to nothing on their savings. In a typical bank today, $1 million astonishingly yields only about $2,000 a year. As interest income has fallen for seniors, their spending has understandably moderated. Thus consumer spending, which would have otherwise expanded the broad economy, has been sluggish.

Extended Fed intervention has actually increased the risks of severe trouble ahead. Many pension systems are woefully underfunded because, while their liabilities are fixed, their fixed-income investments yield far below their actuarial assumptions. This forces them to take greater risks or to seek other means to close the gap. Historically this hasn’t ended well.

So, the income gap widens. The rich get richer and most of the country is treading water at best, not what one would expect from a Democratic administration ostensibly committed to the broader public.

Another risk of the current policy is that investors, rather than doing their own thinking, have increasingly been taking their cue from the Fed. They are addicted to stimulus, like a drug. In the short term, markets are gyrating less on an analysis of fundamentals and more, buffeted by the endless speculation of the talking heads, on the basis of whether they believe they can rely on the Fed to enrich them or bail them out.

An even more concerning trend has emerged in the last few weeks. With huge Chinese stimulus failing to support its manipulated stock market through currency devaluation, cash infusions and eased rules, the presumed confidence in the ability of central banks to control economies has come into question. Further, there is a growing realization that, by keeping interest rates at essentially zero, the tools the central banks have available to arrest another decline are very limited.

The Fed should raise rates in September. The focus on a quarter-point change in short rates and its precise date of imposition is foolishness. Expected rates of return on new investments are typically well above 10 percent. No sensible businessman would defer a sound investment because short-term rates are slightly higher for a few months. They either have a sound investment or they don’t. The reluctance to raise rates now would likely do more harm than good as it would suggest to investors that the Fed foresees a more fragile recovery. This might encourage the businessman to hold off on planned investments, further undermining the recovery.

David Rocker is the founder and former managing general partner of the hedge fund Rocker Partners..

Copyright 2015 The New York Times Company


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