Europe Cuts Rates to Below Zero, Good or Bad?

Posted: Jun 14, 2014 12:01 AM
Europe Cuts Rates to Below Zero, Good or Bad?

The European Central Bank, under Italian banker Mario Draghi, cut its bank deposit rate below zero in an effort to “avert the dangerous threat of deflation” and to spur the “sluggish” euro-zone economy.

European monetary policy gradually has shifted toward more and more inflation. It started off with a hard-core resistance to inflation under a Dutch president of the European central bank, then made way for a Frenchman, and now an Italian has taken over.

The idea is to encourage bankers to start making loans instead of depositing their funds with the central bank. In the United States, the Federal Reserve actually pays interest on bank deposits. Not surprisingly, U.S. banks are not lending to small business like they used to.

Stocks in Europe and around the globe (especially emerging markets) rallied on the news, and we’re profiting with new positions in India and Greece.

Is deflation really a “bugbear?” According to the standard view, “Deflation cuts into business profits, raises real debt burdens and discourages consumer purchases, hampering investments and jobs. The strong euro has not helped because it has damped inflation by lowering import prices, while also making Europe's exports more expensive in foreign markets.”

Yet there have been times of robust growth in the midst of deflation — look at the United States in the 1890s, the 1920s and the 1950s. Deflation does not necessarily hurt business profits if costs are falling, too.

My fear is that the never-ending low-interest rate strategy by the Federal Reserve and the European Central Bank will create an artificial boom and more asset bubbles that will end badly. Only time will tell.

Top investment managers and advisers will debate in full the implications of these permanent low-interest rates at this year’s FreedomFest. Join Peter Schiff, Alex Green, Adrian Day, Joel Stern, and yours truly in our "All Star Prediction Panel" July 10:

You Blew It!
Could Walmart’s Walton Family Buy Seattle?

The Huffington Post last week ran a creative story, “Walmart's Founding Family Could Literally Buy Every Home in Seattle.”

According to the reporter, “Walmart’s founding family could afford to buy every home in Seattle. Literally. The Walton family's combined wealth of $154.8 billion is enough to purchase all 241,450 homes in the Emerald City, which are worth a total of $111.5 billion, according to an analysis published Thursday by real estate brokerage firm Redfin.”

Or the Waltons could buy every house in Dallas at $109.4 billion, Washington, D.C. at $109.2 billion or Miami at $92.8 billion.

The reporter went on to say that Bill Gates’s $78.4 billion could buy all of Boston and Warren Buffett’s $65.8 billion could buy Charlotte, N.C. In addition, Google co-founder Larry Page’s $30.8 billion could buy Boca Raton, Fla. and the Koch brothers’ $78.1 billion could buy Atlanta.

“In this fictional real estate investment, the 30 billionaires on our list, with a combined fortune of $582 billion, could afford to own a staggering 6 percent of the total U.S. home equity,” Nela Richardson, Redfin’s chief economist, said in a statement.

But there’s a fatal flaw in this creative story. It is dead wrong. None of these billionaires could come even close to “literally” buying up all the houses in any of these cities.

The reason? Supply and demand. The current prices of houses (or any other product) in Seattle, Boston, Miami or anywhere else is based on a small marginal number of homes for sale at any one time.

If the Walton family suddenly started buying up every home in the Seattle area, prices would skyrocket. Instead of selling for an average price of $200,000, homes suddenly would be going for $300,000 or $500,000 and would keep increasing as word spread that the Waltons were coming.

In fact, the idea that Bill Gates is actually worth $78 billion is a fiction. Imagine, if he tried to sell all of his Microsoft stock. The price of the shares would plummet. The only way he could get his money out is if he sold gradually over a long period of time.

Always remember this: all prices are determined by marginal buying and selling. If the margins change, watch out.