Via SeekingAlpha.com

Interest rates are back in the news again. The Fed held its meeting and press conference this week. The official statement is here. The economic projections are here. If you don’t want to bother reading them, you can watch the press conference here. But rates are not back in the news just because the Fed met. St. Louis Fed economists Yi Wen and Brian Reinbold published a research report to the Fed website on Friday, May 29, 2020, saying that we’ll need negative rates to push a V-shaped recovery. I first saw it reported on CNBC’s website, but you can also find their research at the St. Louis Fed’s website.

Messrs. Wen and Reinbold are not the first Fed official to push for negative rates. Last summer, the Chicago Fed held its annual gathering, and the very first keynote address of the event was a push for negative rates. You can either watch that gem or scroll down to find the research paper here. On page two, it was suggested that, had we lowered interest rates by 8%-10% at the onset of the GFC, we could have totally avoided recession. The overnight rate at the onset of the GFC was 5.50%. Translation: -3% to -5% would have cancelled the whole thing.

Come on, really?! That’s like saying, “If you eat the raw liver of the dog that bit you, it will cure you of rabies.”

Negative interest rates will not cure anything in the economy. The only thing the Fed has been able to do until now with ZIRP, and the only thing the Fed will be able to continue to do with NIRP, is prolong the delusion that everything is okay because the stock market keeps rising. The stock market is totally detached from the reality of where the economy stands at this point. Just like a person needs proper medical intervention to cure rabies from the dog bite, an economy needs appropriate measures to maintain growth and stability, including all the ebbs and flows that are natural to a complex system as big as ours in America.

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Negative rates really don’t help anyone who doesn’t have access to the negative rates. Who has access? The US government. Negative rates in the USA will benefit the biggest debtor in the world, the USA, with a national bonded debt of over $26T and growing.

The other benefactors of negative rates in the USA are as follows:

  • Foreign pension funds and foreign institutions domiciled in either Japan or the Eurozone, who, given the choice between bonds that are a little bit below zero versus bonds that are a little bit more below zero, will choose the bonds yielding closer to zero rather than farther.
  • Traders at the bond trading desk of domestic pension funds and institutions who think that someone else will buy the bonds from them at a higher price than they bought the bonds for. They are counting on the capital appreciation outpacing the loss induced by the negative rate.

The problems with negative yielding bonds are many. First, any investment that is guaranteed to lose money between the time the investment is made and the time it matures is highly destructive of capital. It is a deflationary pursuit by nature, because the Treasury takes in cash at par value for the treasury bond, bill, or note, and returns it at a later date for less than par value. The investor will be able to buy less stuff than when they began. This is counter-productive for investors, and this is also counter-productive for the Fed who wants inflation running symmetrical to 2%.

Another problem is anyone who is approaching retirement or already is retired relies upon pension funds and other indirect investments in bonds, or they directly invest in bonds. The point of those bonds is to provide positive cash flow in the form of income to meet their expenses. They no longer rely upon cash flow from earned income, so they must make that up somewhere else. Traditionally, that role is filled with bonds. Retirees who are very heavily invested in bonds will not only lose income to negative rates, but they’ll also lose principal. The less the principal, the more ground they’ll need to make up in the future to maintain their lifestyle and standard of living. According to the Social Security Administration, over 65 million Americans are retired. Imagine the amount of financial pain these people must endure if their portfolio yields a negative return!

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A third problem with negative rates is misallocation of capital in markets. That means stocks, bonds, commodities, forex, futures, etc. Low rates have distorted, and negative rates will further distort how capital is allocated. How else can one explain an economy in recession, over 40 million people unemployed, manufacturing indices from several regional Fed branches showing the severest contractions on record, and Atlanta Fed GDP Now showing a contraction in the economy of nearly 55%, yet stocks are still climbing? Whiskey Tango Foxtrot!

Businesses that are near bankruptcy have risen in the last several weeks, like Ford (NYSE:F) rising 50% since mid-May. Investors are allocating good capital to bad businesses because the interest rate environment makes those zombie businesses look much better than they are, much like a pair of beer goggles at a frat party. When it all crashes, those companies will be the first and hardest to crash, totally destroying the capital along the way.

The fourth problem is a misallocation of capital by businesses. Business executives will misinterpret what is happening in the economy for many reasons, and therefore, they will allocate capital to ventures they should not pursue in the current economic climate. It will lead investors on to thinking they are growing, when, in fact, these companies will crash that much harder when reality actually sets in.

I’ve written about the negative impact of negative rates in the past. If you want more information about what to expect of negative rates, you can read my negative interest rate theory here. And while I really don’t like to pat myself on the back, I’m going to do that now and ask you to reread my outlook for 2020, which I wrote at the beginning of this year. The point of both is that I went into a little more detail about what is happening right now. I also urge you to read this article I wrote in October 2018, and focus on the section about the trade war tariffs with China. Not for the tariffs, but rather apply the concepts I discussed with how tariffs distort markets. The same concepts can be applied to ZIRP and NIRP.

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Recommendations

My recommendations are no different now than in the last article I posted. In short, here’s the list:

  • Pay off margin debt.
  • Hold a cash position of 50% or more.
  • Own physical gold and silver bullion bars and coins, as well as the major miners.
  • Own discount retail, utilities, and healthcare.

And the bonus recommendation – stay out of the trading chat rooms. These rooms are replete with penny-pimp pump and dumpers, and you’ll lose your shirt if you follow their advice.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.