Quote of the day: Mainstream Economy Slowly Cooked Alive while Central bankers Focus on their Taylor Models

Because zero bound interest rates destroy the savings function of capitalism, which is a necessary and in fact synchronous component of investment. Why that is true is not immediately apparent. If companies can borrow close to zero, why wouldn’t they invest the proceeds in the real economy? The evidence of recent years is that they have not. Instead they have plowed trillions into the financial economy as they buy back their own stock with a seemingly safe tax advantaged arbitrage. But more importantly, zero destroys existing business models such as life insurance company balance sheets and pension funds, which in turn are expected to use the proceeds to pay benefits for an aging boomer society. These assumed liabilities were based on the assumption that a balanced portfolio of stocks and bonds would return 7-8% over the long term. Now with corporate bonds at 2-3%, it is obvious that to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10% a year to meet the targeted assumption. That, of course, is a stretch of some accountant’s or actuary’s imagination.

Do central bankers not observe that Detroit, Puerto Rico, and soon Chicago, Illinois cannot meet their promised liabilities? Do they simply chalk it up to bad management and inept governance and then return to their Phillips Curves for policy guidance? Do they not know that if zero were to become the long-term norm, that any economic participant that couldn’t print its own money (like they can), would soon “run on empty” as Blackstone’s Pete Peterson once expressed it in describing our likely future scenario? The developed world is beginning to run on empty because investments discounted at near zero over the intermediate future cannot provide cash flow or necessary capital gains to pay for past promises in an aging society. And don’t think that those poor insurance companies and gargantuan pension funds in the hundreds of billions are the only losers. Mainstream America with their 401Ks are in a similar pickle. Expecting 8-10% to pay for education, healthcare, retirement or simply taking an accustomed vacation, they won’t be doing much of it as long as short term yields are at zero. They are not so much in a pickle barrel as they are on a revolving spit, being slowly cooked alive while central bankers focus on their Taylor models and fight non-existent inflation.

This is from bond guru Bill Gross from his monthly outlook at Janus Capital