Today I came across Niels Jensen’s The Absolute Return Letter, via John Mauldin’s weekly newsletter Outside the Box. It is a very interesting piece of work that I definitely recommend everyone reading. You can find it here http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/2013_12_03_OTB.pdf
Jensen argues that QE is a dangerous experiment and I couldn’t agree more. He says that it is inherently deflationary and, although I disagree, I know this is only due to a different definition of inflation. Yet, he starts by telling us that QE was the right call and it was only the extension of this program (QE2, QE3/4 and other non-standard measures) that turned it into something harmful, and this is where I cannot follow his argument. In fact I don’t seem to find one, just a conclusion from what some might consider empirical evidence.
According to Jensen, the first QE prevented the post-Lehman financial meltdown while sustaining economic growth in terms of GDP growth. Again it is not so much that I don’t agree QE managed those things (it seems I am only making it worse for myself) it is that those things are extremely overvalued. To make my point I would have to go through a lengthy, yet hopefully entertaining, process. So I will do that probably tomorrow.
Meanwhile, so I don’t leave you completely empty-handed I will just say something about the “rational expectation hypothesis”. Jenson, again correctly, mentions inflation expectations as an important part of price formation in interest rates (It is very hard not to agree with the man). He argues, or so the hypothesis leads to conclude, economic agents make rational decisions based on expectations, thus when central banks say they will keep interest rates low, economic agents postpone their borrowing decisions.
Far from me to want to imply economic agents act irrationally. If anything, I would defend the opposite: individuals cannot act but rationally. My problem with this hypothesis is that it implies that by acting rationally they would all act the same way, t.i. the “right way”, as if differences in cognition, quality of information, past experience, etc. would not make each agent unique and their responses to the same piece of isolated economic data diverse.
True a central bank stated policy works in a way to try to homogenize interest rate expectations, but one thing is what central bankers aim at and a very different thing is what they achieve. The postponement of borrowing due to the expectation of lower rates in the future would not, in theory, prevent borrowing from taking place. We all know computers go down in price or, alternatively, a new more powerful model comes and replaces the old one for the same price. In reality we do not know this, we have expectations that this will continue to happen in the foreseeable future. Yet everybody would rather achieve their goals sooner than later. Individuals possess a time preference that impels them to act to achieve their goals rather sooner than later. Having a computer today is worth more than having one in the future for people who value it as a means to achieve an end, or as an end in itself. Cheaper computers in the future do not prevent people from buying one today. Some people wait for a better or cheaper model but prices on the current models don’t go down until the arrival of the new model (and its wholesale price) is a near certainty.
To postpone a business opportunity today (that by some reason some seem to believe is ready to happen tomorrow) has an opportunity cost that must be taken into consideration. It has to be lower than the expected benefit accrued by those expected lower interest rates. It is a lot of expecting to do and uncertainty to endure. Some potential investors might be doing just that, but it is probably simpler and more accurate to assume no such business opportunities abound than to believe they are waiting for lower interest rates to be grabbed.