QE And ZIRP Create Deflation

The Fed and other Central Banks have shifted away from focusing on growth to focusing on inflation.

The explanation here is as follows: they’ve failed to create growth, debt deflation is their worst nightmare, so the best they can hope for is inflation to make debt servicing easier.

However, by leaving interest rates at zero, the Fed has unleashed its worst fear: deflation… particularly deflation in consumer spending and consumer psychology… the lifeblood of the US economy.

It sounds totally counter-intuitive, but let’s consider the following.

If you are retired or close to retired, your primary concern is having enough money to enjoy retirement and possibly leave a little something for your children/grandkids.

Since you will no longer be working (hopefully), your money will come from interest income on the pool of capital you have accumulated by now.

If you’d saved $1 million, and interest rates are 4%, you’ve got interest income of $40,000 per year. That’s not bad at all if you’ve paid off your house and accomplished the other items associated with “the American Dream.”

However, if you’ve saved $1 million and interest rates are 0.25% as they are today, your interest income is $2,500 per year.

This is HIGHLY deflationary because you are making next to nothing, which means that in order to survive you have to spend your savings.

This reduces your total capital, as well as the potential for greater future interest income (the amount of capital you have to produce interest income down the road is shrinking).

If this scenario, you’re not going to go out and start living high on the hog. You are going to start being more frugal and careful with your expenses because money is not coming in at the pace you’d hoped.

Consequently, your spending goes down and you enter a kind of “capital hibernation.” You’re not going to start plunging your money into risky investments because you are more averse to loss of capital than potential gains.

Again, your primary focus is on monthly payouts on interest income, NOT capital gains. How many 60+ year old day traders are there really? How many individuals dream of working their whole lives just so they can retire and start gambling in the stock market?

The answer is next to none. The Fed, by cutting rates lower and engaging in QE, has crippled the potential returns for the Baby Boomer generation. This has killed off consumer spending (baby boomers are the single largest pool of capital in the US) and hampered anything resembling an economic recovery.

And all it’s done is result in active investors taking on more and more leverage to increase returns. Today the financial system is even more leveraged than it was in 2007.

And we all know what came after that.

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