Is the U.S. Economy Addicted to Financial Methadone?

February 7, 2017 at 9:03 am 1 comment

William Gross, Manager of the world's biggest bond fund at Pacific Investment Management Co. (PIMCO) participates in the Obama administration's Conference on the Future of Housing Finance in the Cash Room of the Treasury Building in Washington, August 17, 2010. The Obama administration will pick the brains of housing finance leaders on how to fix the two government-controlled mortgage finance firms Fannie Mae and Freddie Mac, but made one thing clear on Tuesday: there is no going back to their pre-crisis structure. REUTERS/Jason Reed (UNITED STATES) REUTERS/Jason Reed (UNITED STATES) REUTERS/Jason Reed (UNITED STATES - Tags: BUSINESS POLITICS) - RTR2HCS5

I am back and better than ever, having watched the greatest Super Bowl ever played, at the 41st annual Meier Family Super Bowl party. That is no exaggeration; we take our football seriously.

As I was scouring the internet on the train ride home yesterday afternoon, the most provocative bit of news I found was this analysis by Bill Gross. Get by his new- age gobbledygook about happiness and his comments are a reminder that Quantitative Easing, the buying of mortgage backed securities by central banks to keep bond yields artificially low, is alive and well and having a direct impact on your credit union and its members.

Why should you care about what Bill Gross has to say? Gross is perhaps the nation’s most prolific bond investor, He cofounded PIMCO from which he was either fired or resigned in 2014, depending on whose side of a lawsuit you want to believe. He currently manages the Janus Fund.

QE hasn’t gotten as much attention as it used to since the Federal Reserve stopped buying additional Mortgage Back Securities in 2014. But the Fed is still maintaining its existing portfolio and other central banks have taken up the practice with gusto. According to Gross, central bank balance sheets have risen from approximately $2 trillion in 2003 to a “now gargantuan” $12 trillion at the end of 2016.

This buying binge has had a profound effect on the economy. He argues that it has distorted capitalism by making it more attractive to reinvest cheap money in a company’s shares than investing in economic growth. For example, “$600 billion in the U.S. goes into the repurchase of company stock, whereas before, investment in the real economy might have been a more lucrative choice”.

Furthermore, to critics such as Gross, this cheap money has come at the expense of individual savers, pension funds, and insurance companies which are now “robbed of the ability to earn rates of return necessary to maintain long-term solvency”.

QE was envisioned as a temporary fix to stimulate economic growth. Gross argues that it is now the equivalent of financial methadone, controlling the negative consequences of excessive debt but doing nothing to solve underlying  economic problems. Central Banks must keep bond rates artificially low or they would skyrocket putting an end to expansion.

While it is undoubtedly true that QE has tremendous downsides, the question is, is the world’s economy better off on balance, because of it? Remember, the Fed Reserve only started QE as a result of the unwillingness of legislators to stimulate the economy. While we can point to examples of the harm QE has done, we should not lose sight of just how much worse the post mortgage meltdown economy would have been but for the aggressive actions of central banks.

Entry filed under: General.

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1 Comment Add your own

  • 1. RIP To The Twist | new york's state of mind  |  September 21, 2017 at 9:01 am

    […] had two primary concerns: First, they argued that by keeping interest rates artificially low, the Federal Reserve was effectively subsidizing large banks and companies that had the ability to […]

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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