The Challenge of a Low Return Environment

The first question that current policy raises (besides efficacy) is how much do the various Fed machinations distort the interest rate curve. In an attempt to answer that question we had a whole series of posts on financial repression:

Allianz on Repression: "Welcome to a RIGGED Future in a World of Financial Repression "
Rothschild Wealth Management: "Investing in an era of financial repression"
Rabobank on Financial Repression and What Bernanke is Up To
 IMF: "The Good, the Bad and the Ugly: 100 Years of Dealing with Public Debt Overhangs" (Policy Responses to Debt/GDP Over 100%)
"Investing When Fundementals Don't Matter" 

Research Affiliates (Rob Arnott) "Financial Repression and Real Rates"

And from the big daddy of recent research (ref'd above),  Carmen M. Reinhart and M. Belen Sbrancia's "THE LIQUIDATION OF GOVERNMENT DEBT"...

See also "Financial Repression Phase II: 'Is The IMF Now Recommending Capital Controls...?'"

This focus has led to some obvious signs of mental disturbance:
Financial Cypression: Cypriot Banks to Remain Closed Until Tuesday (at the earliest)

Yes, yes, we know the difference between Cyprus and cypress but if the headline was "Financial Cyprussion..." some folks would think we'd gone all misspelled Teutonic-ebonic and not caught the ref to repression.
Not our long-suffering regular readers but, you know, strangers.... 

"Depositor Repression" May Spread To Switzerland, EURCHF Spikes

I went to bed last night wondering how the Swiss National Bank would defend the ceiling on the franc of 1.20 per euro.
I've got to get a life....

In late September Calafia beach Pundit pointed out:
How Much Higher Should Interest Rates Be?

Most observers seem to believe that interest rates were abnormally low because of the Fed's QE program. But as the chart above shows, interest rates actually rose each time the Fed bought large quantities of bonds...

For at least the last six months Izabella Kaminska, on both her personal blog and at FT Alphaville has been arguing a slightly more esoteric point, that savers do not "deserve" a given interest rate (and more broadly, a given rate of return) when they put their money at risk. Here's one recent post from Dizzynomics:
Benoit Cœuré on why savers are not being penalized

From a recent speech he gave in Geneva:

Specifically, I will maintain that persistently low asset returns or, more generally, poor investment opportunities are simply one of the many manifestations of a deep recession. In such an environment, looser monetary policy conditions are not the result of a desire to favour borrowers, but rather the necessary response to bring the economy back on to a sustainable growth path in an environment of price stability. Far from helping savers, higher monetary policy interest rates would only have depressed the economy further, delayed the recovery and contributed to downside risks to price stability. Asset returns would have been dampened for longer and savers would have suffered for longer.

And:

Lenders in stressed countries as well as savers in all countries have suffered from the consequences of financial fragmentation....MORE

Her thinking is crystalized in this sentence:

...The capital must be reallocated to riskier potentially productive investments for growth to return. Old allocations that are not productive cannot be supported ad infinitum out of fear of creating wasteful resource inefficient zombie companies....

As you can see from the above links a lot of very sharp people are trying to figure this out. In June and July we had Grantham Mayo's James Montier:
Interview With Grantham Mayo's James Montier
What If There's No Mean Reversion? (Grantham Mayo Van Otterloo quarterly letter July 2013)
and:
More on The Purgatory of Low Returns

Last week, in a piece I can't recommend highly enough, "The Paradox of Wealth: William Bernstein on Living in a Low Return World " Bernstein tried to tie it all together especially after page 12 of the PDF: The Paradox of wealth.
Here's one of Bernstein's graphs that should disabuse anyone of the notion that we are witnessing a transient phenomena:
European Interest Rates 1200-1800

 

I should probably do a post on Capital Deepening and maybe one on recent scholarship relating to Adam Smith's (and Ricardo's, and Marx's and...) theory that the general tendency of profit rates is to decline.

Finally, where I come down.
1) There is a lot of money sloshing around, I've referred to the hot money as similar to the herds of animals (read prey) thundering across the African savanna.
2)The size of these pools of funds are exacerbated by the leverage in the system.
3) This condition is going to be with us for an extended period.
4) There is a very real risk that, should the extraordinary measures of central banks fail or even just be insufficient, the world economy as a whole would experience a deflationary contraction and negative interest rates at the same time, a situation in which our only trustworthy guide could end up being Lewis Carroll:

“But I don’t want to go among mad people," Alice remarked.
"Oh, you can’t help that," said the Cat: "we’re all mad here. I’m mad. You’re mad."
"How do you know I’m mad?" said Alice.
"You must be," said the Cat, or you wouldn’t have come here.”