The High Cost Of Low Rates: 3 Examples from Bill Gross -- Barron's Blog

       

By Amey Stone
        After reflecting on the power of prayer in his monthly commentary, veteran bond fund manager Bill Gross, now at Janus and formerly of Pimco, turned his attention to the Federal Reserve and interest rates.
        He thinks the Fed will raise rates in September. But he qualifies:
        The reason will not be the risk of rising inflation, nor the continued downward push of unemployment to 5%. The reason will be that the central bankers that are charged with leading the global financial markets -- the Fed and the [Bank of England] BOE for now -- are wising up.
        Gross contends that central banks are starting to realize that there is a downside to prolonged periods of low interest rates.
        Here are three negative effects of low interest rates that Gross highlights:
        1. They allow "zombie" companies to issue junk bonds that allow them to stay afloat longer than they should. He writes:
        Because BB, B, and in some cases CCC rated companies have been able to borrow at less than 5%, a host of zombie and future zombie corporations now roam the real economy. Schumpeter's "creative destruction" -- the supposed heart of capitalistic progress -- has been neutered. The old remains in place, and new investment is stifled.
        2. They allow high quality companies to take out debt at such cheap rates that they can use it for the risk-free benefit of buying back stock rather than "deploying the funds into the real economy."
        3. They prevent bank, insurance companies and pension funds from prospering. Here he references the annual report of the Bank for International Settlements:
        The BIS emphatically avers that there are substantial medium term costs of "persistent ultra-low interest rates." Such rates they claim, "sap banks' interest margins...cause pervasive mispricing in financial markets ... threaten the solvency of insurance companies and pension funds...and as a result test technical, economic, legal and even political boundaries.
        Circling back to the prayer theme, Gross concludes:
        Say a little prayer that the BIS, yours truly, and a growing cast of contrarians, such as Jim Bianco and CNBC's Rick Santelli, can convince the establishment that their world has changed.
        (END) Dow Jones Newswires

        July 30, 2015 11:39 ET (15:39 GMT)

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