Joining the Zero Fan Club

Posted: Jul 10, 2012 12:01 AM

Mario Draghi cannot say, like the line from Star Trek, “where no man has gone before” because his predecessors have all been there. 

I’m referring to his recent reduction of the ECB’s benchmark interest rate to 0.75%.  Let’s travel back in time for a moment. 

In 2004, Alan Greenspan knew full well that a 1% interest rate would have a positive effect on the economy, and most specifically, housing. 

In fact, Greenspan’s own consulting firm indicated that in the early 2000s, over 70% of GDP was attributed to the housing explosion. 

Unfortunately, the boom was followed by the bust and Greenspan was publicly ridiculed for keeping rates artificially low for such a long period of time. 

Then, true to his predecessor and not learning a thing, along came Ben Bernanke who did a one-up by reducing rates from 1% to 0%. 

The ultimate objective was to create an environment in which lending would be profitable to all concerned. 

For a while, the appeal was genuine and the effects were positive. 

Much like Greenspan’s initial low- interest rate lending period, Bernanke found his very own success as insurance companies were saved, automobile companies continued to survive, and banks flourished. 

Regrettably, everything else, from employment to housing, continued to decline.  The surface seemed to gleam like a shiny tooth; however, after the x-rays were taken, deadly decay was truly discovered. 

The impact of an artificially low-interest rate environment is almost irreversible.  For example, in order to receive somewhat of a yield on their investments, this type of situation forces investors to take chances they would normally never take.  It also compels companies to reduce employment in order to protect the capital on which they can no longer make a return. 

In addition, it influences banks to invest outside of their normal comfort zone as they seek potentially dangerous money making opportunities which are too lucrative to resist.  Mario Draghi is well aware that the end result will be no different than Greenspan or Bernanke, but it will buy him a little more time. 

After all, by reducing the ECB benchmark interest rate by 0.25% every few months, he can extend the game at least until the end of the year. 

In this case, the buying of time seems very important as summit after summit tries to reverse the irreversible.  Contraction, the allowance of failure and collapse, is the only solution to a system that has been perpetuated by many falsehoods, not the least of which is artificially low interest rates (with a big nod to Libor.) 

Alan Greenspan would not accept the inevitable, nor would Ben Bernanke. 

And now it seems Mario Draghi has joined the club, a membership that history will not fondly remember.