Zervos: The Beauty of Monetary Policy? It's a Tax On the Risk-Averse
More than seven years after the collapse of Lehman Brothers Holdings Inc., investors and economists alike wonder how potent the monetary elixir deployed by central banks really was.
Detractors of aggressive quantitative easing contend it did little except to further enrich the wealthy and had limited effect on real economic activity, with low interest rates merely helping facilitate debt-fueled buybacks. Moreover, it may have spurred malinvestment, contributing to the boom in U.S. shale production that's left the world in an oil glut and dragged down global economic activity.
But on a day when even Goldman Sachs Group Inc. is starting to wonder about the efficacy of capitalism, Jefferies LLC Chief Market Strategist David Zervos offered a full-throated defense of one of its most contentious modern features: the use of unconventional monetary policy to kick-start an economy.
During an appearance on BloombergTV with the famous short-seller Jim Grant, founder of Grant's Interest Rate Observer, Zervos argued that aggressive measures were warranted in 2008 given the severity of the shock—and that they bore fruit. In a disinflationary or outright deflationary environment, measures that seem radical—such as negative policy rates—are actually quite conventional, he said.
"There shouldn't be, in my opinion, a real line in the sand," he said, referring to negative nominal interest rates. "We in the economics world always talk about negative real rates. Nobody has a problem with negative real rates, and in fact, real rates are the lifeblood of any economic model."
The strategist offered a simplified version of the transmission mechanism by which quantitative easing, which pushed investors further out on the risk spectrum, affected real economic activity.
"You don't buy a Treasury bill anymore, you go give your money to a biotech company," he explained. "You buy the debt and that invigorates them to go out and hire people and innovate."
This sequence necessarily entails that your average retail investor might have a riskier set of assets in her portfolio to generate the same return she might have once received from Treasury bonds. But it is this very push toward risk-taking that is the foundation of economic growth and of recovering from a downturn.
"How do we grow? We take risks—if we don't take risks we will never grow," Zervos said. "Some are going to win, some are going to lose. That's the nature of capitalism. You dug a hole in the Bakken? You lose. You invested in some human genome company that's up seven times? You win."
Allowing private economic agents to pick winners (and sometimes giving them a nudge via low or negative real rates) is better than having the government attempt to do so through fiscal policy, Zervos argued.
"Monetary policy just simply does one thing: It takes all of us and taxes us for not being entrepreneurs and not being risk-takers, and it doesn't pick winners and losers," he said. "And that is the beauty of monetary policy."
This entails that savers aren't entitled to a positive real return during a period of stress, if doing so would prolong or worsen economic malaise. In this scenario, the opportunity cost of not being a risk-taker is a guaranteed negative return, explained Zervos.
"You can sit on the sidelines and not take risk, but the Fed's going to tax you. You're going to lose 2 percent of your real wealth every year," he said. "If a guaranteed loss of 2 percent of your purchasing power is what you would like, then that's fair."
Grant contended that although risk-taking was necessary, the Fed's actions constituted a distortion of markets and hindered the proper pricing of risk. Zervos's answer to this was, absent substantial monetary accommodation, the downturn following the financial crisis would have been so severe that it would have torn the social fabric of the U.S. and crippled the political system.
It's impossible to have the perfect counterfactual reasoning that proves Zervos right. But the best possible example we have—the reaction of European policymakers—is telling. Across the Atlantic, both monetary and fiscal policy were tighter than in the U.S. following the crash, and economic outcomes were worse. And there wasn't much relief thereafter, with the European Union's existential socioeconomic crisis, beginning in Greece.