Wilbur Ross - Funding Permanent Deficits with Short Term Funding Will Not Have a Happy Ending
Sitting in his 25th floor office with a sweeping view of the Manhattan skyline, billionaire Wilbur Ross is the master of all he surveys, but he does not like what he is seeing. Ross’ composure is legendary, but this time irritation comes to the fore as he opines on the current state of affairs in the US. The King of Bankruptcy is not only frustrated by the regulatory overkill under the Obama administration, he is also worried that the US could lose its educational edge over the years. With visible agitation, he mentions, “The regulatory agencies are out of control and that is a huge problem for the economy.” Outside, his assistants’ phones ring incessantly, indicating that Ross continues to be a much sought-after financier and the distress hunter in him is very much on the prowl. Only, this time his sights are set far outside the United States. Financial services and energy continue to be his favourite hunting grounds and this quest has taken him across the Atlantic to the UK and Ireland and as far as China. Among his existing US investments, he is gung-ho on shale gas and believes a lower cost of energy will play an important role in reviving the US economy.
The Fed is pushing as much liquidity as possible with the aim of getting businesses to start investing, but bank lending does not seem to be taking off. Why?
First of all, I don’t think that the most recent quantitative easing (QE) is going to have any noticeable effect whatsoever. Even before QE3, banks here had almost $2 trillion of excess reserves. They have not been lending that out. By giving another few hundred millions of reserves to them nothing will change as they are not going to lend that out either. So I think it is an effort by the Fed to push a string. You can cut a string and tie knots in it, but to push a string is impossible. That is what they are trying to do.
Where I think it will have effect is, it might weaken the currency because of more printing. Two, it will help mortgage refinancing a little bit. We have been having a lot of refinancing anyway. In the first half of this year we had $79 billion of mortgages for refinance, probably saving the borrowers $10 billion. That is money sent to the consumer’s pocket that can be spent. That is important because consumption is 70% of our economy. So that will help marginally. If the dollar does weaken, then that will help exports. It may push commodity prices as well as other speculative assets up a little bit. But other than that it is not going to have any real effect. Each QE that is done has less effect than the last one.
As for the banks, they are still not lending for several reasons. One is that you can only lend if there is a customer who wants to borrow. Now, big American corporations have lots of cash on their balance sheets. They also have access to the long term bond market, which they have been hitting pretty regularly as rates are very cheap and they want to lock them in. So there isn’t that much demand for bank loans.
So, it is not that corporates have stopped investing completely or doing new capital expenditure?
No, we would be in a severe depression if they stopped everything completely. But they are certainly not doing anything aggressively. Part of the reason for that is the uncertainty. Is the fiscal cliff finally past us? What will Obama Care really mean to corporate costs? What will the corporate tax rate be? What will individual tax rates be? There are so many unknowns right now that it is difficult for businesses to make long-term decisions like capital expenditure. Most of the important business decisions are long-term ones. How can you make those decisions when you don’t really know the rules of the game?
What do you think will be the long-term implication of this artificially low interest rates?
The real problem to me is that the Fed through QE has basically funded the deficits that the Obama administration ran up in the last couple of years. In their attempt to keep rates down, they have almost tripled their balance sheet. And how did they finance that? They financed the purchase of 10 and longer year bonds with overnight deposits from the excess reserves of banks. There are two problems with that. Interest rates now are very low. They are eventually going to revert to some higher level. If interest rates on US treasuries went to the average level that they were at between 1993 and 2010, instead of the interest burden being $250 billion a year, it would become $650 billion. That is a $400 billion a year increase in the deficit simply by interest rates reverting to normal. The treasury has also been issuing shorter and shorter securities. Both the US Fed and the US Treasury are really having a classic mismatch. The treasury is funding permanent deficits with very short-term funding. The Fed is buying 10-year and 20-year bonds with overnight deposits. That is not going to have a happy ending. The Fed is also having a hard time getting inflation back in. With unemployment at 8.25% you are not going to have wage inflation. With China slowing down you are not going to get commodity inflation other than in, perhaps, food. But food is not a big component of spending by American consumers because the standard of living is so high.
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