ZIRP is the anagram ‘Zero Interest Rate Policy’, it commonly refers to the monetary policy pursued in Japan which was put in place to get them out of the grinding recession they saw from the early 90’s which was born out of a property bubble. It was one side of a Keynesian approach (minus matching it with a money supply plan) that ultimately failed, and the Japanese were/are no idiots so hopefully we’ll learn something from this.

At one stage the price per metre in the Ginza district Tokyo was about $1,000,000 USD which to this day, 20 years later, makes buying something like a hotel site in D4 for €100,000,000 look like good value, but speculative property purchases, much like tap water in Mexico have a way of tasting fine at the time of consumption but with disastrous results later on. I say that from personal experience of both.

The Japanese recovery has been cited as the ‘path one doesn’t want to follow’ because of the underperforming GDP ever since their crash which is referred to as ‘the lost decade’, the Asian tendency for saving meant that spending was curtailed, deflation set in, and even at a zero interest rate, holding your money is better than losing it in the market which had formerly been a strong point of national reinvestment. A ZIRP is put in place to make credit cheap (so you get the velocity of money and multiplier effect of credit going) and it also punishes savers (hoarders), except that it doesn’t.

The concept didn’t really work out. When you move interest rates to zero a few things happen, firstly savers don’t get punished, they get comparatively rewarded because a bank can’t offer a ‘0% on savings!’ promotion, equally though borrowers will expect a margin cut to the bone, Throw in a few people who are not paying their mortgages and your loan book quickly becomes a flea bitten dog that you wouldn’t even kick for fear of catching something.

The working reality for banks is that the lower rates go the harder it gets to find margin because if you drop the amount you are paying depositors they will move their money elsewhere. At the same time there is (during a bust) immense pressure to pass on rate cuts to borrowers, especially when banks are being saved – as they were in Japan and are in present day in the US, UK, Ireland, EU, etc. You see this in the paper every time there is a rate cut, banks who even hint that they may not pass on a rate cut (even though there is no contractual obligation to do so) get demonized.

This downward press on what you charge and upward move on what you pay depositors is called ‘margin compression’ and its hard to find profit when you are in that situation.
In Japan it got to the point where banks would merely deposit their depositor funds in other banks! The genesis of ‘zombie bank’ came in when Governments propped up unsound institutions who remained largely insolvent, so the approach (at least what we are seeing now) is that you have to engage in quantitative easing with a zero interest rate policy because short term liquidity injections are merely hoarded or used to absorb losses.

One consequence of a ZIRP is that you create ‘carry trade’ and that is where you borrow in one currency and then invest in another keeping the ‘carry’, it’s similar to any arbitrage but normally ‘carry’ implies moving to another currency.

For instance, if I could borrow at 0% in Yen then I do that and buy Bund Bond which are paying over three and a half percent, if the Euro gets stronger I can cash out and pay the Yen loan and keep the difference, if it gets weaker I have a decent margin to play with and time to unwind my position.

The strength in Yen recently is partly due to the worldwide de-leveraging which involves the carry trade intimately, as people ‘unwound’ they did so by buying Yen to move out of their Yen positions and that gave the Japanese currency a cyclical strengthening. The issue with carry, and leverage in general, was that more and more was used to get results, and when results were beaten by others who were really just taking more risk (borrowing doesn’t improve odds in improves risk volatility, bigger gains when it works out bigger losses when it doesn’t), the carry trade moved from one of currency and bonds to the likes of CDO’s, the real estate debacle that is happening globally is owed in part to the carry trade and to Asian savings moving to the USA and elsewhere to fund our spending spree which in this bubble focused on property.

So will Europe get into a ZIRP? No is the residing opinion, that’s from Trichet himself, he has indicated that we won’t see rates go below 1% and that is a wise move, if we look at what the ECB is doing they seem to be (on the rate front) taking a ‘middle of the road’ position, the yield curves demonstrate this, the ECB is tracking a course through the middle, and the Euro is also getting stronger on the markets partly because of the way the ECB are handling the crisis, for all the talk of what they ‘aren’t’ doing they are equally (at least from my twisted perspective) doing many things right too. Getting back to Mexican tap water, if the markets are thirsty giving them something to drink doesn’t necessarily fix the problem.

With that in mind its safe to say that the Dollar (at least from a secular perspective) will have to drive lower, the choice is pay higher rates on bonds – but a borrowers society can’t have that, or kill off the dollar to a degree, I’m betting on the latter.

The UK is also seeing more weakness in their currency and the rise in Euro holding by central banks around the world means we might (this decade) see the end of true dollar hegemony – which will hurt the USA but perhaps put more balance into the world, in particular if there is a ‘new world currency’ as being touted recently by everybody from Paul Krugman to the Chinese.

The Yuan is also one to keep an eye on, the Chinese have established trading lines with fourteen countries in the last two years in which there is no dollar necessary (not as audacious as Iran’s non-dollar oil bourse mind you!), the most recent was with soft commodity rich Argentina.

Part of me has to wonder what role inflationary causing stimulus has to play in the recent market gains? If you keep priming the system eventually it will work and that will kill the people in fixed income, combine that with the dollar issues (mentioned earlier) which will invariably create inflation (gold holding tenaciously to the +$900 dollar mark tells me that inflation is never far away), and you start to see that whether or not this is a ‘bear market rally’ or the start of a ‘primary bull market’ that the recovery may well be an inflation driven one, in other words, nominally we may see ‘recovery’ but in real terms it might be a different picture.

One way of paying bond holders back (but not ‘rewarding’ them) is via a devalued currency with an inflationary environment thrown in, in fact the big robbery of this century is going to be (as it was in the past as per the 1870s first, and then via Presidential Executive Order 6102 in the 1930’s) a dollar based one, the only way the US can pay its debts is to essentially rip off the debt holders, domestically that won’t be so bad, but internationally it will hurt many economies, in particular China. Personally I don’t see the great depression, I see something more akin to the 70’s. Deflation won’t be the long term story, inflation will be as it always has been.

From an Irish perspective we are seeing the savings rates soar, so the paradox of thrift and de-leveraging is well and truly alive, but this is coupled with cash hungry banks which are actually paying more for deposits than some are charging for lending! You can literally create a carry trade on your house, for instance: borrow as much as humanly possible on AIB’s 1yr fixed rate at 2.4% and deposit it with Investec at 4.5% for a 1yr fixed deposit. That would create a 2.1% carry, and you could then knock that off your mortgage the following year, the same holds with longer fixed deposits /mortgages and while I can never advise a person does this, it is confounding why many more are not.

Ireland can’t create a ZIRP environment, but via the ECB we are about as close to one as we will get, mix this with worldwide bailouts, huge increases in the money supply of every major currency and large scale quantitative easing and the question isn’t ‘will this cause inflation’ but more one of ‘when will this cause inflation’.

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