Even J.M. Keynes Knew Better
Once upon a time traders confronted reasonably honest two-way money markets. When they woke up in the morning in 1980-1981 they most definitely did not believe that the money market rate was pegged even for the day–let alone seven years. Instead, by allowing short rates to soar to market-clearing levels, the Volcker Fed laid low the carry trade in commodities, thereby reminding speculators that spreads can go negative—suddenly,sharply and even catastrophically
Owing to the reasonably honest money markets of the Volcker era, the leading edge of inflation–soaring commodity prices—was decisively crushed and the inflationary fevers were quickly drained from the system. But more importantly, the vastly swollen level of capital pulled into the carry trades during the 1970s Great Inflation was reduced to its natural minimum—that is, to the amount needed by professional market-makers to arbitrage-out imbalances in the term structure of interest rates. Under those conditions, fund managers made a living actually investing capital, not chasing carry.
But nowadays, by contrast, the central bank’s free money guarantee nullifies all that and induces massive inflows to speculative positions in any and all financial assets that can generate either a yield or an appreciation rate slightly north of zero. To adapt Professor Keynes’ famous aphorism, the Fed’s quasi-permanent regime of ZERO-COGS “engages all of the hidden forces of economic law on the side of [speculation], and does it in a manner that not one in [nineteen members of the Fed] is able to diagnose”.
Indeed, no less an authority on the great game of central bank front-running than Pimco’s Bill Gross trenchantly observed last week: “Our entire finance-based system….is based on carry and the ability to earn it.”
Stated differently, the preponderant effect of the Fed’s horribly misguided ZIRP has been to unleash a global horde of financial engineers, buccaneers and plain old punters who ceaselessly troll for carry. The spreads they pursue may be derived from momentum-driven stock appreciation and credit risk premiums or, as Bill Gross further observed, they may be “duration, curve, volatility or even currency related…..but it must out-carry its bogey until the system itself breaks down.”
Not surprisingly, therefore, our monetary central planners are always, well, surprised, when financial fire storms break-out. Even now, after more than a half-dozen collapses since the Greenspan era of Bubble Finance incepted in 1987, they don’t recognize that it is they who are carrying what amounts to monetary gas cans. Having no doctrine at all about ZERO-COGS, they pour on the fuel completely oblivious to its contagious, destabilizing and perilous properties. Nor is recognition likely at any time soon. After all, ZERO-COGS is an artificial step-child of central bankers’ writ; its what they do, not a natural condition on the free market.
