Managing Money in a Zero Interest Rate Environment
bridgewater.com
bridgewater.com
From a marketing point of view it reiterates the obvious point that a financial plan built around cash, stocks, and bonds in 2020 that assumes positive returns isn't a plan.
I love Ray's articles that describe how "All Weather" works, how you can put together multiple beta sources with some leverage and derivatives and get "better" results. (e.g. qualified "better" because you have to decide if you'd rather eat returns or eat Sharpe ratio or give up because the Sharpe ratio has nothing quantitative to say about the black swan that's coming)
What he doesn't do is even suggest that sources of beta exist that aren't impacted by the ZIRP catastrophe, or even that there is something much more sinister about it:
So far as we know, there is no end to the ZIR environment. What would happen if interest rates go up? Overleveraged consumers have their $500 mortgage payment become an $800 mortgage payment. Countries that were spending $10 billion a year on interest payments are not spending $100 billion a year of interest payments.
If interest rates go up, everybody will default.
You could color it morally in different ways, but factually, participants in our economic system have been making unrealistic promises to each other for years. ZIRP has let us deny that truth, but someday it won't be possible to deny.
I’m not imaginative enough to come up that scenario. Nor would it seem all mainstream analysts. But I am curious as to what might drive that change.
A conventional answer would be that eventually inflation breaks loose. People are afraid of Weimar-style hyperinflation, but more likely it takes decades for people to make up their mind that inflation is worse than disinflation, just as it took 35 years from WWII to Monetarism. There never has to be a discontinuity, some point where you are denied what you are owed, but boy a pound is not worth a pound.
We've seen cases in the past 20 years where central banks have tried to increase interest rates modestly and were shocked by the contractionary effect and had to reverse it.
Another is "what cannot go on forever will not".
Could the private sector contribute meaningfully to the "saving for retirement" goal of many people under ZIRP? How would that impact CALPERS, e-TRADE, etc.? What sort of discontinuity happens to the financial sector when it fails at job 1?
Interest rates are connected with the discount rate and the idea that a dollar today is worth more than a dollar tomorrow. The growth of the economy (e.g. "our systems work") is reflected by a positive discount rate, so a dollar invested today naturally brings more tomorrow.
Negative interest rates signal that the system does not work, that a dollar is worth more today than it will be tomorrow, that investing dollars today destroys value.
That's a pessimistic take on civilization and at best you get this
https://www.amazon.com/Prosperous-Way-Down-Principles-Polici...
which talks about negative interest rates as a tool in planning declining societies.
If the world is going to be getting poorer instead of richer then maybe negative interest rates reflect that, but you are not going to see honest engagement of politicians, business people, media, etc. because audiences would wither before the despair.
Finally there is the "middle road" where we have the right discontinuity very soon.
For instance, a 30-year old investing for retirement today needs to maximize the productivity of the economy in the long term, not profits. Low interest rates should be sending the signal to phone companies, for instance, to upgrade to optic fiber. If they did so, they would accelerate the long term growth of the economy. In the short-term there is no competition and the phone company sees no reason to retire 70 year old copper lines. But the pool of production that would have been enabled by a small investment up front never materialized and because opportunities like that were rejected in a lifetime that retiree is poor.
It seems some reorganization could get capital flowing again -- what that organization is is less clear.
Thanks for writing this. If I understand correctly at the individual level there is a possible flight to security (gold/bitcoins/housing), but at society level, there is no possible flight to security, because the highest instances of government are planning for declining societies.
If this is the case, people will search inspiration in societies that look successful. This happened after WWII when people felt the American society was much more successful than other societies and therefore was a reasonable role model.
The old theory (pushed by that ecologist Howard Odum) is that we are running out of fossil fuels, so that the "dollar/emergy" ratio peaked around 1970, which was when the US experienced it's own "oil peak" for conventional oil.
(Emergy is "embedded energy" and traces back the energy content of fuels to the sun, liquid fuels and plant-based foods have 200,000 units of emergy per unit of energy)
Circa 2000 I was worried about running out of energy and I did some monte carlo simulations about solutions (use less fuel, find alternative sources, ...) racing problems. It seemed possible to me that problems would win, but I never convinced myself that it was certain or even likely.
In the age of fracking "running out of oil" seems distant, but now we are concerned with climate change. That's a tougher one because market mechanisms automatically push people to solve the "running out of energy" problem but the 50-year time delay prevents that from working against climate change.
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The other theory is that we're experiencing "cultural rot" of some kinds and that our problems can be fixed by fixing a damaged culture.
(The thought of that is exhausting, but you can get further arguing with Republicans than you can arguing with the law of conservation of momentum)
The most interesting culture that "seems to work" is China right now.
In a stable communist society (e.g. post-revolution) the communist party comprises an elite of perhaps 2% of the population. It's not too different from how it is here, but it is institutionalized so that really inferior people (e.g. the Hapsburgs and Romanoffs) don't entrench themselves in power and that superior people have a chance of moving in.
It is a mechanism for enforcing loyalty (communists who fail get sent to the proletariat) but Xi is re-focusing it in on recruiting and developing a person who is more "Expert" than Red". No longer will you get membership in the party because your uncle fought in the cultural revolution.
However, culturally uniform societies have a big problem: they are excellent at covering problems up in the short term. They have a hard time with dangerous technologies such as air travel, nuclear power, etc.
People in the US don't agree about the details, but we all agree that racism is a problem. We ask what race you are on the census. People in France are "all french" so they don't ask. In China they kill the Uyghurs and would block this message because I said that.
A diverse and high-performance society could be more honest and more able to deal with dangerous technology. (e.g. nuclear power, space travel) If we react by stepping on the gas instead of the brake, the U.S. could rise to the "Chinese Challenge" by taking competition to a place where a closed society can't go.