E In Defense Of Economic Sanity: An Essay On Investment Logic


I had a college professor once tell me that people are irrational, thus we need the government to intervene in the markets to fix distortions. I quickly stood up and said that is contradictory. He narrowed his eyes and waited for me to continue. I said, "If people are irrational, then governments must also be irrational, as they are people themselves." 

Investing and economics have always shared a unique attribute: They are wholly subjective. Up until the 1950s, economics was considered a social science along with politics and philosophy. After WWII, educators became obsessed with teaching economics alongside positivism and quantitative models instead of subjectivism between consumer tastes and constantly changing values. Economics quickly went from a social science into a crude attempt at being an actual science. Carelessly add misleading models combined with artificially low interest rates, and one has a recipe for a speculative boom. The Austrian economic school of thought has done irreplaceable work regarding the sphere of booms and busts and subjectivism within the markets. 


In a world of new economic monetary frontiers i.e. quantitative easing (open currency printing), there are bound to be unintended consequences. Either investors have completely gone insane, or they are clinging to a group of Federal Reserve officials to take care of the next crisis. Something should be said about the Fed's completely mediocre projections of where the economy will go, but that is for a different article. Sticking to the classical subjective investment and economic theory, this article will clearly and concisely give investors a commonsense approach to the markets and global economies to stimulate investor minds on important topics.  Continuing on, this article will give investors arguments for challenging commonly held investment precepts that are irrational, illogical, potentially devastating and deserve serious explanations.

I. 0% Rates: A Poor Replacement for Due Diligence 

Since 2008, the Federal Reserve has embarked on pushing ZIRP (zero interest rate policy) to allegedly stimulate growth. In fact, the Euro zone has recently began NIRP (negative interest rate policy). Adding insult to injury, not only do banks speculate with depositor money/tax payer bailouts, but they receive all the profits as the rest of us actually lose money by depositing it in these banks (inflation rate - nominal deposit rate = real return). For simplicity, if inflation is at 3% and the interest rate on savings account is 0.10%, the depositor is actually losing 2.90% annually. With rates held at and below zero, the institutions get rich while everyone else loses. 

0% rates are a double-edged sword that the Fed ignorantly ignores. The governments are subsidizing the young and reckless and indebted to go out and get loans and more debts at lower financing, while simultaneously punishing the retired and prudent and savers. The Fed, famous for ignoring the law of unintended consequences (I have written another article about the governments contradicting flaws on housing, banking, and monetary stimulation), is creating another problem with low rates: How on earth can the baby boomers retire with no yield for their life savings? Not only were many just recently burned in the housing bubble debacle, but the Fed is actually encouraging individuals with low rates to do the same thing again. Corporate America has also taken advantage of these low rates to borrow cheap money and buy back their own shares in record amounts, artificially boosting their own earnings and share price. 

The most important dilemma from the ZIRP is by far the mis-allocation of wealth and the disruption of due diligence. Interest rates are key to distinguishing risk. Example: If John is more likely to pay back the bank loan than Zach is, John will receive a lower rate due to his security while Zach will be offered a loan at a higher rate due to the lender's risk of giving him money. Rates uniformly held at zero mix the good with the bad. At next to nothing interest rates, one loan looks identical to another loan. And for a return of merely nothing, what demands any diligence? Add inflation into the analysis and the creditor is risking capital for a mere couple percentage points by either a borrower defaulting or a loss of purchasing power. Do investors honestly believe that after the over $3.5 trillion printed dollars since 2008, the CPI (consumer price index) won't go above 4% within the next three decades? Any creditor financing debtors a 30/yr fixed mortgage at 3.5% is committing suicide once the United States, Japan, and the Euro finally get their inflation. It has sadly become a rush to the bottom that will leave no one better off. 

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Joe Black 6 years ago Member's comment

A great read! Thanks.