(August 22, 2012) – Central banks made deals with the devil when they tried to print and spend their way out of the last recession, according to Scott Minerd, chief investment officer at the asset management firm Guggenheim Partners.
“By abandoning monetary orthodoxy and pursuing large-scale asset purchases, global central banks have increased the risk of inflation and compromised their ability to stamp it out,” Minerd argues in a new paper entitled “The Faustian Bargain” after Goethe’s 19th century drama.
In Minerd’s analogy, Ben Bernanke and other central bank chiefs take the roll of Goethe’s bankrupt emperor, and their actions threaten to have similarly disastrous consequences.
“Unlikely as it seems in a world of zero-bound interest rates, someday, as the economy continues to expand, the demand for credit will increase to the point that interest rates will begin to rise,” Minerd writes. “As interest rates rise, the market value of the Federal Reserve’s assets will fall…This could leave the Federal Reserve without enough liquid assets to sell to protect the purchasing power of the dollar, resulting in a downward spiral in its value.”
Institutional investors can hedge against a potential fall in the purchasing power of the US dollar by allocating funds into real assets, such as commodities and real estate, according to Minerd. Asset managers should let go of US Treasury bonds—which he suggests are “shifting from representing risk-free return to ‘return-free risk’”—in favor of high-yield debt and European equities.
“Inordinately higher leverage ratios and the extension of central bank portfolio duration means governments now face the potential for central bank solvency crises,” Minerd concludes. “It is too early to predict exactly how this Faustian bargain will play out; but, with each additional paper note that rolls off the printing press or gets conjured up in the ether, the likelihood of a happy ending becomes increasingly evanescent.”
Minerd is not the first high-profile CIO to criticize central banks’ policies of low interest rates and quantitative easing. In July, Pacific Investment Management Company’s Mohamed El-Erian argued that rock-bottom interest rates hurt institutional investors without lifting the global economy. “Lower borrowing costs are not enough to convince companies to expand given the [current] list of domestic, regional and global uncertainties,” he asserted.
Minerd’s entire paper is available here.