The Federal Reserve is considering its most reckless policy ever…

At a Congressional hearing earlier this week, Fed chair Janet Yellen said negative interest rates are “on the table…if the economic outlook were to deteriorate in a significant way.”

It would be the first time in history the Fed has used negative rates.

The idea of negative interest rates sounds bizarre to most people. And it should. The whole point of lending money is to earn interest…

With negative interest rates, the lender pays the borrower. If you lend $100,000 at negative 1%, you only get $99,000 back.

•  Negative rates are a telltale sign of an unhealthy economy…

Interest rates are the price of borrowing money. The past seven years of near-zero interest rates have already made borrowing absurdly cheap. They’ve also made it painfully clear that people borrow a lot when borrowing costs next to nothing…

Over the last seven years, Americans have borrowed trillions of dollars to buy stocks, cars, houses, commercial property, and college degrees. When borrowing money is laughably cheap, no business idea is too dumb to fund…no $120,000 car goes unsold to someone who can’t afford it…and no overpriced house sits on the market for more than a month.

Few people ask, “Does it make sense to borrow this much money?”

Instead they think, “How much can I get?”

•  Yet zero percent rates have done little for the U.S. economy…

The real median annual income in the United States has fallen from $57,795 in 2008 to $55,218 today. There are now twice as many Americans on food stamps than before the financial crisis.

Instead of helping the economy, easy money policies have created an “Alice in Wonderland” world… where financial asset prices are detached from economic reality.

The S&P 500 has gained 211% since bottoming in March 2009. U.S. commercial property prices hit an all-time high in August. The global art market hit a record high of $54 billion last year.

•  Negative rates would send us further into Wonderland…

That’s exactly what the Fed wants. When asked why the Fed would use negative interest rates, Yellen said it was to “spur lending.”

Yellen continued (emphasis ours):

It would be undertaken as a measure to support the economy and to encourage additional lending…and to move down the yields on interest-bearing assets to stimulate risk taking and investment spending.

In other words, negative interest rates would be a more extreme dose of the same bad policies the Fed has been using for years.

•  Stan Druckenmiller says zero percent rates have already done enough damage…

Druckenmiller is one of the world’s most successful hedge fund managers. He generated an incredible average annual return of 30% from 1986 to 2010.

Druckenmiller was also George Soros’ right-hand man at Quantum, Soros’ famed hedge fund. Quantum’s now-legendary 1992 trade shorting the British pound was Druckenmiller’s idea. It made Quantum about $1 billion. People say the trade “broke the Bank of England.”

At an investment conference this week, Druckenmiller said the Fed is mortgaging America’s future with its easy money policies.

This is not some permanent boost you get. You're borrowing from the future. I think there's been such a misallocation of resources that this has gone on so long and unnecessarily (and) the chickens will come home to roost.

•  Druckenmiller says rock-bottom rates have pushed investors “out the risk curve”…

Easy money has made it almost impossible to earn safe, decent returns. Savings accounts pay next to nothing. The yield on a 10-year Treasury is just 2.3%…less than half what it was eight years ago.

This has forced investors into stocks, junk bonds, commercial real estate, and other risky assets. Negative rates would only encourage more risky decisions.

Druckenmiller says he doesn’t know exactly how the Fed’s dangerous monetary experiment will end. Like us, he just knows it won’t end well.

This is unnecessary. You’re causing irrational behavior by governments, investors, corporations. And we’re going to pay the piper at some point.

Druckenmiller continued to explain that he’s investing very cautiously:

I'm working under the assumption that we may have started a primary bear market in July…

I can see myself getting really bearish. I can't see myself getting really bullish.

As you may recall, Druckenmiller made a $300 million bet on gold over the summer. He put 20% of his fund’s money into the bet.

•  Druckenmiller’s massive bet on gold shouldn’t surprise longtime readers…

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Chart of the Day

Negative interest rates have failed to help Europe’s economy…

Today’s chart shows the European Central Bank’s deposit rate. This benchmark rate “sets the tone” for interest rates across Europe.

Like the Fed, the ECB slashed its key interest rates during the financial crisis. In July 2012, the ECB dropped its deposit rate to 0%. When that didn’t help Europe’s economy, the ECB dropped its key rate below zero in June 2014.

The ECB has now used negative rates for 18 months. Yet, Europe’s economy continues to struggle. It grew less than half as fast the U.S. economy during the second quarter. Europe also has a 10% unemployment rate…twice as high as the U.S. unemployment rate.

Regards,

Justin Spittler
Delray Beach, Florida
November 6, 2015

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