Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates, backed up by measures to prevent cash hoarding by financial firms, can do the job.
CAMBRIDGE – For those who viewed negative interest rates as a bridge too far for central banks, it might be time to think again. Right now, in the United States, the Federal Reserve – supported both implicitly and explicitly by the Treasury – is on track to backstop virtually every private, state, and city credit in the economy. Many other governments have felt compelled to take similar steps. A once-in-a-century (we hope) crisis calls for massive government intervention, but does that have to mean dispensing with market-based allocation mechanisms?
Blanket debt guarantees are a great device if one believes that recent market stress was just a short-term liquidity crunch, soon to be alleviated by a strong sustained post-COVID-19 recovery. But what if the rapid recovery fails to materialize? What if, as one suspects, it takes years for the US and global economy to claw back to 2019 levels? If so, there is little hope that all businesses will remain viable, or that every state and local government will remain solvent.
A better bet is that nothing will be the same. Wealth will be destroyed on a catastrophic scale, and policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit, a process that will play out over years of negotiation and litigation. For bankruptcy lawyers and lobbyists, it will be a bonanza, part of which will come from pressing taxpayers to honor bailout guarantees. Such a scenario would be an unholy mess.
Now, imagine that, rather than shoring up markets solely via guarantees, the Fed could push most short-term interest rates across the economy to near or below zero. Europe and Japan already have tiptoed into negative rate territory. Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to, say, -3% or lower.
For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this – negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. So, before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?
A number of important steps are required to make deep negative rates feasible and effective. The most important, which no central bank (including the ECB) has yet taken, is to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies. Various combinations of regulation, a time-varying fee for large-scale re-deposits of cash at the central bank, and phasing out large-denomination banknotes should do the trick.
It is not rocket science (or should I say virology?). With large-scale cash hoarding taken off the table, the issue of pass-through of negative rates to bank depositors – the most sensible concern – would be eliminated. Even without preventing wholesale hoarding (which is risky and expensive), European banks have increasingly been able to pass on negative rates to large depositors. And governments would not be giving up much by shielding small depositors entirely from negative interest rates. Again, given adequate time and planning, doing this is straightforward.
Negative interest rates have elicited a blizzard of objections. Most, however, are either fuzzy-headed or easily addressed, as I discuss in my 2016 book on the past, present, and future of currency, as well as in related writings. There, I also explain why one should not think of “alternative monetary instruments” such as quantitative easing and helicopter money as forms of fiscal policy. While a fiscal response is necessary, monetary policy is also very much needed. Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates can do the job.
A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic. Even with negative rates, many countries would still need a debt moratorium. But a weaker dollar, stronger global growth, and a reduction in capital flight would help, especially when it comes to the larger emerging markets.
Tragically, when the Federal Reserve conducted its 2019 review of policy instruments, discussion of how to implement deep negative rates was effectively taken off the table, forcing the Fed’s hand in the pandemic. Influential bank lobbyists hate negative rates, even though they need not undermine bank profits if done correctly. The economics profession, mesmerized by interesting counterintuitive results that arise in economies where there really is a zero bound on interest rates, must share some of the blame.
Emergency implementation of deeply negative interest rates would not solve all of today’s problems. But adopting such a policy would be a start. If, as seems increasingly likely, equilibrium real interest rates are set to be lower than ever over the next few years, it is time for central banks and governments to give the idea a long, hard, and urgent look.
Warren Buffett struck some of his famous deals — taking lucrative stakes in Goldman Sachs Group Inc. and General Electric Co. — by swooping in when others panicked during the last financial crisis. He’s treading more carefully this time around.
With a record $137 billion of cash piled up at his Berkshire Hathaway Inc., Buffett fielded questions over the weekend from shareholders who wanted to know why he hadn’t acted as companies clamored for liquidity amid the pandemic-related shutdowns. This crisis is different, Buffett said.
“We have not done anything because we don’t see anything that attractive to do,” Buffett said at his annual shareholder meeting, which was held by webcast. The deals in 2008 and 2009 weren’t done to make “a statement to the world,” he said. “They seemed intelligent things to do and markets were such that we didn’t really have much competition.”
The famous investor’s reputation allowed him to serve as a lender of last resort during the 2008 financial crisis, racking up deals that generated 10% annual dividends from household-name companies. But as panic about the virus and shutdowns assaulted equities in March and even began to freeze debt markets, the Federal Reserve beat him to the punch with an unprecedented set of emergency measures.
“There was a period right before the Fed acted, we were starting to get calls,” Buffett said at Saturday’s meeting. “They weren’t attractive calls, but we were getting calls. And the companies we were getting calls from, after the Fed acted, a number of them were able to get money in the public market frankly at terms we wouldn’t have given.”
Buffett’s cautious reaction to the latest crisis drew plenty of attention from investors. While Berkshire bought back $1.7 billion of its shares in the first quarter, it was a net seller of stocks through April as it shed stakes in four major U.S. airlines.
The approach seems to put him in the camp of other notable investors who think markets may not have seen the worst of the impact from the pandemic. Buffett said the prospect of buying back Berkshire’s own stock isn’t much more attractive than it was in January, even as the share price dropped.
“He received much more demanding questions,” said Tom Russo, who oversees investments including Berkshire shares at Gardner Russo & Gardner LLC.
The sale of stakes in Delta Air Lines Inc., Southwest Airlines Co., American Airlines Group Inc. and United Airlines Holdings Inc. continues Buffett’s tumultuous history with the industry. He swore off the sector years ago after a troubled bet on USAir, then in 2016 he dove back in. In March, he told Yahoo Finance that he wouldn’t be selling airline stocks.
“Well, he just rejoined Airlines Anonymous,” said Bill Smead, chairman and chief investment officer of Smead Capital Management, which owns Berkshire shares.
Buffett, Berkshire’s chairman and chief executive officer, gained fame for turning a struggling textile company into a conglomerate now valued at $444 billion. But as Berkshire swelled in size, the billionaire investor struggled to supercharge its growth amid soaring valuations in the recent bull market. That’s weighed on Berkshire’s stock price, as the Class A shares fell 19% this year, more than the 12% decline in the S&P 500 Index, and have trailed the benchmark’s returns over the past decade.
In the meantime, Berkshire’s companies keep throwing off earnings, building the $137 billion cash pile that’s equal to nearly 31% of Berkshire’s market value. Buffett acknowledged that Berkshire doesn’t need that much on hand, adding that he still aims to keep his company as a “Fort Knox,” stout enough to weather the pandemic.
Buffett said he couldn’t promise Berkshire would outperform the S&P over the next decade, but he could vow not to be reckless. Maintaining that discipline is gratifying to longtime investors, said James Armstrong, who manages money, including Berkshire shares, as president of Henry H. Armstrong Associates.
“He bears a lot of responsibility and he never has any trouble remembering that Berkshire isn’t his,” Armstrong said. “Despite the criticism in the press and the public eye that he should deploy that cash, he continues to, every day, make his calculation of price to value and say, ‘I either see a good investment or I don’t.”’
Berkshire’s meeting lacked the familiar presence of his longtime business partner, Charlie Munger, as well as the thousands of audience members who normally attend the event in Omaha, Nebraska. Buffett said that Munger, 96, was still in fine health, but it didn’t make sense for him to travel from California or to have another vice chairman, Ajit Jain, come in from the East Coast in this age of social distancing.
Buffett, 89, instead was joined by a top deputy who lives just hours from Omaha, Greg Abel. A vice chairman overseeing the non-insurance units, Abel is considered a candidate to take over the CEO job someday. While Buffett still dominated the time, Abel spoke up about incoming calls before the Fed acted and gave investors a taste of his leadership style and his knowledge of Berkshire’s varied operations.
Buffett’s businesses haven’t been spared the effects of the shutdowns. The railroad BNSF reported reduced volumes as Covid-19 disrupted commerce, while footwear and apparel businesses were hit with a 34% decline in first-quarter earnings.
Munger said earlier this year that some small Berkshire units might not reopen after the pandemic. Buffett clarified the point, saying Berkshire was never willing to prop up a business amid unending losses. “There are businesses that were having problems before and that have even greater problems now,” he said.
Buffett remains cautious about the current crisis, saying that the range of economic possibilities was “extraordinarily wide.” Still, he ended the meeting on his classic optimistic note that people should never bet against America. And he left open the possibility that Berkshire’s dealmaking days will return.
The panic in markets “changed dramatically when the Fed acted, but who knows what happens next week or next month or next year? The Fed doesn’t know. I don’t know and nobody knows,” Buffett said. “There’s a lot of different scenarios that can play out. And under some scenarios, we’ll spend a lot of money. And under other scenarios, we won’t.”
Most investors have way too much cash. Wealthy investors really have too much.
This is a phenomenon Citi Private Bank’s David Bailin has observed whether the markets are soaring, stumbling, or stagnant.
According to Federal Reserve figures, retail investors had about 18% of their assets in money market funds and in U.S. bank deposits, considered cash alternatives, at the height of the financial crisis in 2009. But today, they still have a high percentage in cash—around 14%... “If a client has US$100 million, why would they need US$15 million or US$20 million in cash?” Bailin asks. “They should have it fully invested—they may need US$5 million [in cash]”.Where to Put Cash InsteadCiti is recommending clients consider fixed-income managed accounts that can include a range of options, from a variable rate demand note—which is a municipal security with a weekly maturity, meaning it reprices each week—to a variable rate bank fund, backed by floating-rate bank loans that reset when interest rates rise or fall.
“We want things that won’t lose value in a rising rate market,” Bailin says.
For Citi’s clients with large cash positions, the cost of putting together a fixed-income managed account with varying maturities would be 0.20%.