I was at the Buttonwood Gathering in New York this week, a wonderful conference put on by The Economist featuring some of the greatest minds in business and finance.
Legendary investor David Einhorn sat in for a short panel, sharing his views on the Federal Reserve's quantitative-easing policies over the last four years. Below is a summary of my notes.
Einhorn disagrees with the Fed's most recent quantitative easing strategies, and isn't shy about it. He makes an analogy. One jelly doughnut is a great snack. Two is indulging. Six is an eating disorder. Twelve is a fraternity hazing. You can have far too much of a good thing; that's where we are now with monetary policy.
Einhorn said you have to consider the base assumption about a policy like QE and form your opinions from there. When everyone agrees on the same thing, they act reflexively. Most seem to assume that the economy will improve if we cut interest rates indefinitely. Usually, that is the case. If interest rates are 10% and you cut them to 6%, growth will likely increase. But we're in a far different situation today, with interest rates already at zero. Einhorn thinks we've reached a point where incremental monetary accommodation not only suffers diminishing returns, but becomes a drag on growth.
There are two big reasons for that. One, QE has pushed up commodity prices like food and oil, costing people money they otherwise could have spent on goods.
Then there's the larger issue of super-low interest rates depriving households of adequate returns on savings. One of the theories behind QE is that low interest rates will entice people to spend money instead of save it. But Einhorn says it can, in fact, do the opposite. If you earn a negligible rate of return, you have to save much more for retirement than you otherwise would if your assets earned a higher return. That's causing a hording event and driving consumption down, Einhorn says.
It's hard for economists to understand this, because their models have limited sample sets and don't look at what people are actually doing. No one is choosing not buy a home right now because interest rates are too high. No company is putting off building a new factory because borrowing costs are excessive. On the other hand, what are the risks of QE? We have created enormous tail risks, Einhorn says. That scares people and drives up risk premiums while driving down valuation multiples.
This will only get worse as time goes on. We are still in a zone where most people likely think super-low interest rates will be temporary. But if low rates continue for another three or four years, expectations will change. If savers come to believe that they will never again earn an adequate return on savings, the hoarding will grow on a multiplied basis, Einhorn says.
A questioner pointed out that there's another side to the story: Savers may not be earning a high interest rate or divided yield, but asset prices have been boosted by QE, increasing wealth. Ben Bernanke has mentioned this before. Einhorn doesn't buy it. He's not aware of any study showing that the asset inflation of QE is enough to offset the lost income from lower interest rates. He suspects that if someone studied the issue, they'd come to the opposite conclusion of Bernanke. And we've just gone through 15 years of trying to boost incomes by inflating asset bubbles -- and each has produced worse outcomes once the bubbles unwind. Einhorn asks: "Why would we want to keep doing that?