Obfuscated Fundamentals and the Fed (and gold)

Executive Summary: Saving enables investment, growth and higher stock prices, not the other way around.

topology-2

Deranged wag-the-dog strategies by the Fed lead to price distortion, speculation, malinvestment, and eventually a flight to safety in real assets, e.g., gold

Bonus: thoughts on the usefulness of trading courses

Length: medium, 15 minutes?

Quirks: references to “How an economy grows”, “Gödel Escher Bach”, Nobel Prizes 2016, topology, the value of knowledge

wag-the-dog


Real world, Ideal world, Mental model

I recently listened to an interview with the fascinating and brilliant physicist Sir Roger Penrose.

platonic-world

He touched upon his idea of how just a slight sliver of the field of mathematics is used in physics, and how a just as small a piece of physics is used to explain the chemical and physical processes in a brain that leads to consciousness, and finally how a tiny part of that consciousness is used to develop the world of mathematics.

mathematics/Platonic “ideal” world/philosophy

=> Actual world/physics/chemistry

=> Mental realm/perception/consciousness

=> mathematics

So what?

What use can you or I possibly have of his musings?

Just being aware of the recursiveness of nature can enhance our understanding of the economy and financial markets.

And, thinking about the existence of a real, fundamental world every now and then can be refreshing after stumbling around in the hall of mirrors that make up the investing landscape these days. More about that and the current Nobel Prizes below.


Wag the dog

Central bankers, e.g., are hard at work exploiting confusion about cause and effect in the economy/banking/market complex:

– The last few years CBs have distorted various price signals, including interest rate levels and the yield curve. They have tried to make the tail wag the dog, by boosting asset prices in a deranged attempt to stimulate unwarranted exuberance and pull forward demand (leaving a black hole in the future).

Mario-Draghi-laughing

They hope that debt-financed consumption will kick-start other, supposedly dormant, parts of the economy, thus stimulating enough growth to take care of the debt burden. Given that too much debt and pulled-forward consumption already lies behind the current economic woes, hoping more debt will solve the problem is of course beyond retarded.

The real relationship looks like this:

Save => Invest => Tools/Innovation

=> Increased productivity => Surplus

=> Invest/Produce/Consume or Save =>…

This virtuous cycle gives rise to ever increasing productivity, production and profits, creating the basis for savings, investments, higher economic growth, wealth and stock prices.

Surplus (profits, dividends, investment, growth)

=> Increasing stock prices (at constant valuation)

how-an-economy-grows

During this process there are also cycles of irrational exuberance, malinvestments and corrections/recessions. As long as they are identified in time and debts are not too large, they amount to minor cleansing periods and healthy restarts.

Unfortunately, somehow the US Federal Reserve was allowed to hijack the system. With increasing centralization of power, Greenspan, Bernanke and Yellen have focused their attention on masking the most important price signals of the underlying health of the economy, in order to:

…push asset prices higher in a futile attempt of creating a wealth effect,

that would lead to higher consumption and thus more investments in production and employment,

creating the growth and consumption power that could warrant the preceding run-up in stock prices (valuations instead of profits)

wealth_effect

Some believe this chart reflects reality

Distorted price signals and speculation instead of wealth creation

What instead, quite predictably, has happened is that more and more resources have been directed toward financial speculation, stock buybacks etc., while real investments in productive assets and employees have dwindled (with the exception of robots and other means of automation, thanks to the low cost of financing those investments vs. taking on additional employees -or keeping the ones already on the payroll for that matter).

Central bankers have targeted interest rates and the yield curve to distort signals about the economy; and the gold price and inflation measures to distort signals about the health of the monetary system – including the value of fiat money.

The next step is the ban on cash, since negative rates just don’t work when you can hide your wealth from the authorities in the form of dollar bills (or gold, gems or bitcoins).

“The aim of the Kurodas and Yellens of the world, the DI*CKs / DY*Cks, is tantamount to stopping (hiding) global warming by manipulating thermometers” – heard here on the superb podcast MacroVoices I think.

* Ingves/Yellen

Janet YellenIngves negative interest rates are FUN

 

Gold or not gold?

Anyway, this is not a post about Bug Out Locations, the merits of gold, Bitcoin or other alternative investments. I just want you to start thinking about everything in terms of recursivity, as in the phenomenal book Gödel Escher Bach by Douglas Hofstadter (e.g., food, environment, education, happiness, exercise, investing).

However, while on the topic of gold, just take a minute to think about what could happen to the demand for gold by criminals, if (when) 100-dollar bills and euro notes are outlawed. Gold doesn’t leave a digital trace, it’s easy to carry or hide, it’s resilient to weather and chemicals…

gold-criminals

Personally, I’ve sold all my listed precious metal assets this summer, including GLD, GDX, PHYS and SLV. Instead I have invested in an unlisted Canadian company that buys gold production options from many different gold producers.

My exit strategy is to either list the company, sell it to a bigger company or to take delivery of the physical gold.

Alrighty then, since you ask… If everything is overvalued, rates are negative and some catalyst or other (falling profits, inflation, chance) topples the system (making banks intolerably risky), where would you, could you, put your money – whether a criminal or law abiding ordinary person? Did I hear gold?

I almost miss my clunky old Hublot Big Bang now. My Jack Ocean bracelet is more nimble but a little light on gold in comparison. 

the-jack-ocean


Investing is hot these days

It’s becoming more and more apparent that this bull cycle is long in the tooth. Everything seems to be related to investing in start-ups, IPOs, growth companies, dividend kings etc. Never before, except for a few brief moments before a major crash, has the willingness to accept risk been higher* – and the prospects for reasonable returns been lower.

* several gauges, including covenant-lite loans, debt levels, valuations, IPO/M&A activity etc

As the icing on the cake, there are courses on macro, investing, risk, technical analysis, derivatives and trading flourishing everywhere and by everybody it seems. By the way, the demand for my presence at various seminars is definitely a manifestation of the latter.

In defense of such courses I have the following to say: They are useless.

However, I still think you should go.

trading-courses

What? Wait. Why?

I think you should go to see what others are thinking, what others are teaching, their lines of reasoning. Then find your own style of fundamental and technical filters, while hopefully avoiding the very worst mistakes you pick up among other course attendees. In addition you might find some new friends or speaking partners. Anything works, except what doesn’t, as I stated in this post.

In line with the recursiveness of nature and of the economic/financial complex, there are important parallels to the world of macro trends, research, technical analysis and investing. They are all interconnected and feeding off each other.

escher-penrose

– Actually, to a certain extent Harakiri Kuroda and Janus Yellen have got it right: you can wag the dog a little, for a while. As long as you ignore the exponential costs that follow.

Thus, study it all, just as Jesse Livermore in Reminiscences of a Stock Operator did, starting with technical analysis and proceeding to global macro strategies and cornering various commodity markets (btw, a friend of mine made a fortune cornering the white fish market back in the 1990s).

Just don’t think you understand it all or can control it (any of it). Remember that investing is mostly about psychological pain tolerance, and much less about mathematics, models and predictions. Please read the books Margin of Safety and The Most Important Thing for a deeper understanding of this crucial knowledge. Check out my other book recommendations here.


I’ll write a full post further down the road on how I think a newbie should tackle the markets, including what to pay attention to in macro, micro, momentum, trading, options, technical analysis etc. Not today.

“Do you remember when people thought TA patterns established decades ago were still relevant today, despite machine learning and rampant algo trading? That was fun”

By the way, have you seen anybody detailing the current likelihood (37%) of a certain pattern (flag) leading to a certain outcome (+/- >10%) or is it all just nostalgia and pretty drawings?

ta


A final note on the Nobel Prizes this year. The physics prize referred to mathematical topology, the chemistry prize to another (shape) topology; and I often refer to life topology (a third notion meaning the schematical principles of a non-uniform and thus worthwhile life).

I would encourage you to pay attention to similar quirks of the language as well as the underlying reality. It’s a useful brain exercise that primes you to see things from other vantage points and could help you spot flaws in your reasoning.

In addition, the Nobel prizes serve as a well-needed reminder of the real world, as opposed to the la-la land of monetary policy, economics and stock valuations.

topology-1


A macro course might very well be superficially useless, since you won’t be able to predict the economic trajectory afterward anyway; just as a trading course probably won’t help you identify better trades. Nevertheless, knowing what others think they know, and knowing what biases govern their decisions and what mistakes they are likely to make might prove valuable.

So, go, study their jargon, find others like you, accumulate as much peripheral knowledge as possible; and then find your own personal style of investing in terms of time horizon, preferred asset classes, risk level, short term tactics and longer term strategies. Are you a trader or an investor?


Summary

Oooof, so what was the message here really?!

  • There is a real physical world out there, governed by fundamentals
  • However, over periods shorter than a decade fundamentals can often be ignored altogether, in particular when the real world is deliberately hidden behind Potemkin facades
  • I think such a decade is drawing to an end (thus the shorts and gold), but hey, what do I know; the future is unknowable
  • Nevertheless, keep studying all aspects of markets, fundamentals, science, language and life, to more readily spot cracks in the facade before others – or to identify good buying opportunities where others dare not tread.
  • Don’t forget to wear a high quality tin foil hat at all times to protect you from the authorities

tin-foil-hat-2


Are you new to the site?

Apart from weekly articles on investing and health among other topics, there is a free e-book about 50 investment lessons waiting, if you sign up for my free newsletter. Go ahead, join tens of thousands of other seekers who seem to find value in my work. 

My guess is you and I are similar in many ways; curious, philosophical, looking for truth and happiness. The only material difference is perhaps that I’ve reached a later stage in life than you, which is exactly why my work may provide some utility for you.

I’m writing in order to spread my everyday insights about how to live a happy, healthy and wealthy life in modern society. All I ask of you is to help me in that endeavor – tell others about this site, share it in your social networks, if you think it’s worth sharing. Can you do that for me to keep this going?

FYI: I’m thinking about limiting the maximum number of subscribers, since MailChimp keeps increasing the price to maintain it. I recently deleted 1000+ subs that were too inactive, in an attempt to keep the list clean. Perhaps I’ll have to introduce some kind of latecomer fee sooner or later, or sell something. Well, that’s a question for a later day.

I’ve made a lot of mistakes in my investing career, probably more than most. That’s not least true of my private investments since I retired, in particular my bearish view of stock markets and my short position on the Swedish stock market since 2012-2013.

Nevertheless, or perhaps owing to my many mistakes, I’ve done a few big things right as well. That’s why I am in a position to write my articles and books. I sincerely hope they can be of use to you and others.


Read them, spread them. Help me help you.

Go forth and multiply my site visitors

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The Retarded Hedge Fund Manager

Selling oil, waiting for abundance

Executive Summary

A quick (and simplified) overview of the oil price development, including Iran ramping its production, Saudi-Arabia refusing to cut production, overflowing storage and the risk of rogue contango.

What I’m doing about it, i.e., my personal investments – tactical and strategical.

And some ducks… (and doomsday scenarios). And DIKs

walks talks looks like a duck

Readability: Including the summary, and this, it’s a fairly quick and easy read at 2068 words.


Oil

The table below shows my (simplified) view of the oil situation. I assume you are a grown up that understands it’s not the complete picture. I also assume you understand I’m not recommending anything. It’s all just entertainment. Disclaimer here.

Anyway,

To the left are variables supporting higher oil prices

To the right are variables that could cause significantly lower prices again; possibly new lows

Broken oil producer budgets Iran ramping production
Storage situation exaggerated Saudi-Arabia wants shale out
Price momentum Marginal storage left for futures arbitrage
Potential production cut Recession is coming, lower demand*
Capex cuts Dead cat short squeeze bounce ending
Strategic bombing = prod cuts (renewables – long term)
I’m selling oil :)  Bust shale assets bought cheaply

*incl China


It’s all Bernanke’s fault, just as everything else

The story so far: low interest rates and QE drove higher oil prices as well as heavy (mal-)investments* in shale production. (*investments that only made sense in ZIRP La-La land).

Once enough new capacity was in place (it took a few years to complete the malinvestment projects), sub-par economic growth (and thus lower demand) contributed to storage all but overflowing and consequently a sharp drop in oil price.

 

They key is OPEC and shale budgets

Saudi-Arabia, Kuwait and UAE have exacerbated the situation by increasing production in an attempt to fix their broken budgets (they need to sell more at lower prices) while crushing the shale industry at the same time.

 

Oil prices have jumped on hopes alone

Very recently, the oil price has bounced by more than 40%, due to short covering and speculation amid hopes of an OPEC production cut. Several countries, including Russia and Nigeria happily fuel such speculation (to mitigate their budget deficits).

 

Productions cuts are highly unlikely

In the real world, however, Iran is looking to ramp its production back to “normal”. Before that is accomplished, there is very little chance of any production cuts anywhere. This will take some time.

My guess is that oil speculators will be sorely disappointed when production cuts meetings are postponed or cancelled, while storage inches closer and closer to full capacity.

 

The storage crisis haven’t even begun

Nota Bene that storage isn’t full yet; that the storage crisis haven’t even begun. Also note that Iran is just starting to ramp, they aren’t actually producing more yet… It will probably take several more months to reach absolute full capacity in storage facilities, and several quarters or more for Iran to reach normal production levels.

 

Without arbitrage, exploding contango could obliterate ETFs

When there is no more room for front end/next month futures contract arbitrage, through temporary storage (when back yard containers of barrels are full, as well as tankers and ordinary storage), there could and should be a devastating price plunge in the front end contract. The resulting massive contango (Next month’s price less this month’s price; which could be repeated month after month) will erode any investment based on rolling oil futures forward, e.g., through an ETF like USO or Olja S.

 

Just knowing about it doesn’t fix it – that takes time

This situation could go on for several quarters, maybe a year… or more, while Iran is increasing its production and OPEC is falling short of promises of production cuts again and again, perhaps most notably at the supposed meeting on March 20.

 

I’m selling

Due to the reasons stated above, I have sold my Brent ETF (Olja S) as well as the oil junior ShaMaran (which is still waiting for its “first oil” and has some cash flow problems, but trades at what might turn out to be just 1x P/E a few years hence).

I’ve also sold some but not all of my DNO shares. DNO could be a strong Buy for the coming 3 years, but there is a definite risk of a deep downturn before that, even if the company doesn’t have the same financial problems as ShaMaran.

DNO is probably a much better bet already at current prices than any oil futures ETF or derivative.

 

Don’t short what should eventually double

I won’t go short though. And I’m actually not that confident in cancelling my longs either. The reason is that a sustainable oil price probably is somewhere between 60-100 USD per barrel for the coming few years (rather than the current $40), once the current storage crisis is sorted out. In between however, the front end contract could easily fall back to 30 and even below 20 USD/barrel. 

In any case, I’m expecting a quite prolonged storage crisis, up until Iran is content, shale is dead, and Saudi-Arabia, Kuwait and UAE can agree on the necessary cuts. I plan to buy more DNO, ShaMaran and USO long before that of course, but only when Iran has ramped significantly or we’ve hit new lows for oil, oil companies and the stock market in general. This might happen already this April,or as late as April 2017.

We’ll see. I’m not sticking around for the downturn, except maybe with a marginal position in DNO.


 

Ducks

If it walks like a duck, talks like a duck and looks like a duck, it probably is a duck. 

Oil prices pass the duck test of a recovery: unsustainably low prices, rising, breaking key levels, talks of production cuts…

On the other hand, so do storage problems (which pointy in the opposite direction): almost full, meaning the real problems haven’t even started, Iran not backing off, neither is Russia or Saudi-Arabia. Shale still lingers as the walking dead.

Another walking, talking, living, sitting duck is the economy. Most pundits talk of low risk of recession. However, a select few, very mart people, point to a combination of factors: duck tail, duck beak, duck feet, duck feathers, duck calling sound etc., all clearly pointing toward there being a recession duck swimming around in plain sight.

I’m squarely in the “dead cat bounce” camp regarding the oil price and stock market, and in the “given these variables, including the stock market there is almost invariably a recession” group of people.

One caveat though: In 2009-2012 I used to say “this won’t be too bad if we normalized rates to 4% and some other things“. Now I’m leaning more and more toward “we are beyond thinking about investments, and more about defending civilized life as we know it“. I’m sure many more make the same assessment, including policy makers.

 

There is no turning back from full retard central bank policies

That means the powers that be truly will do “whatever it takes” (as Draghi’s Full Retard Threat went back in 2012) for as long as they can, thus making the final crash even worse.

As time passes and policy makers venture further and further into retarded measures, I’m becoming less and less certain of my forecast of a “pretty bad but not catastrophical outcome quite soon“. Instead I see increasing risk of a blowout on the upside followed by something on the downside we haven’t seen since the 1920’s crisis in Germany and the Great Depression in the U.S. in the 1930’s. 

The best long term outcome would be a normalization of stock markets, interest rates and debt burdens as soon as possible. There actually are some promising signs in that direction. But then again, there is Draghi (ECB), Ingves (Sweden) and Kuroda (Japan) trying to get into the history books with a particularly toxic variation to the Rio Spread Theme*. Maybe war is the only “solution” after all.

*The Rio Spread means taking a huge bet in the market and going to Rio for unlimited celebration. If it works out, it works out. If not, you stay there. The DIKs (to which Mark Carney of the BOE is very close to being added) will either miraculously save the economy, or (much more likely) ruin it completely. Either way, they will get their place in the history books.

I think the ECB reaction was quite expected (except the rebound afterward). The Fed is more important though. My guess is we’ll get the exact same reaction after the FOMC meeting (except the rebound) as after ECB, i.e., reflexive buying followed by heavy selling.

 

How an economy grows

I listened to a typical economist today (on the Swedish podcast Fondpodden), and she said the same stupid interventionist and illogical things about deflation and growth that most academics do (except that she didn’t defend negative interest rates). I just want to set the record straight as an antidote to the brain poison she helps spreading:

Saving enables investments which lead to better tools and infrastructure and thus increased productivity and falling production costs and selling prices.

Falling prices typically lead to increased consumption, but if it doesn’t, it means more room for even higher savings and investments and higher growth


 

Somehow many economists have misunderstood this completely and think that lower prices (like spring sale, summer sale, Christmas sale etc.*) mean less consumption. And even if it does, what’s bad with that? Nothing! people will buy what they want and need, no matter the direction of prices. And if they were to limit their purchases somewhat that only means more saving and room for investments and even higher growth.

So, saving=>investment=>low prices and high growth=>both increased consumption and investment and thus even higher growth in a virtuous cycle.

Most economists want higher prices, which lead to less room for consumption and investments and thus both lower supply and demand => lower growth, less wealth, even less room for saving and investment, and so on and on in a death spiral.

*Actually, they claim there is a difference between sales and declining prices. They think lowered prices increase consumption while falling prices decrease consumption. Eh? Somehow, falling prices on TVs. cell phones and computers increase consumption, while falling food prices lead to people eating less… Eh*2?!


 

Invest responsibly. Remember that investing is 80% psychology. The other half is patience.


Summary – selling oil, waiting for abundance

In short, I’m selling oil due to the storage situation, that will only get worse until Iran has reached full production and OPEC cuts can be seriously considered.

I don’t dare shorting though. Quite the opposite; I’ll look for (oil company) stock bargains in the expected carnage (blood in the streets).

I’ve gradually had to “refine” my general outlook from “bad” to “binary”. I’m staying short the stock market but even that feels less and less palatable these days. Gold and silver are the only things that feel OK. I’m even leaning closer to getting some physical gold to complement my paper gold. So far, however, I haven’t, and I just don’t want to be that pessimistic.

I mean, the 2020’s promise to be the best era ever (so far) for humanity, with widespread abundance provided by AI (did you see AlphaGo’s victory?), nanotech, biotech, robotics etc. Billions of people coming online, sharing knowledge and using ever accelerating technological tools to create more and better solutions to everything than at any time in human history. And then we haven’t even mentioned the 2030’s!!

We just have to pass this little “bump” provided courtesy of Draghi, Ingves, Carney, Kuroda etc. (including Yellen of course, but she’s no DI…)

What goes bump in the night?

Mario-Draghi-laughing

Ingves negative interest rates are FUN

Carney

kuroda

Janet Yellen

 

I want to put my wisdom in you

I may have gone overboard with that Will Ferrell-inspired book cover I tweeted the other day (the Tweet, viewer discretion is advised).

The message is the same though. I’m not blogging, podcasting and writing for financial gain, I just want more people to become aware:

Aware of themselves, aware of the world, aware of their career possibilities, of their investment opportunities, of the fantastically bright future that awaits.

So, please share this article, bookmark this site, subscribe to my newsletter and download and read my first e-book about the investment guidelines I picked up during a decade and a half as partner, managing director and portfolio manager at Futuris – The European Hedge Fund Of The Decade.

If you have already downloaded the book but never opened it, try just the first page summarizing my ten most important investment rules. Please.

 

Negative interest rates – what does it mean and what must you do?

Negative Interest Rates Everywhere

Negative interest rates are all the rage among central bankers these days. Today even the usually so moderate swedes lowered the policy rate to a negative -0.1 per cent.

What should you do about it? What does it mean for your job security, stock portfolio, pension etc.? Read on…

(or skip to the very end for a few quick points on education, mortgage and stock market strategies in a NIRP world; Negative Interest Rate Policy).

Earlier this year, the Danish central bank did the same (several times, actually, over the course of a few weeks; going deeper and deeper into negative territory).

The European central bank, ECB, had since long cast off its previously conservative German heritage and gone negative. The same goes for the Swiss National Bank.

Not even the U.S. or Japan have gone negative (yet)

Amazingly, neither Japan or the U.S. have tried negative rates – otherwise strong advocates of monetary experimentation.

They prefer the more “moderate” stratagem of printing trillions of new dollars to purchase newly minted treasuries and bonds from their friends at the big banks instead. (The Treasury issues bonds that the banks buy. Moments later, the latter turn around and sell the bonds to the central bank at a slightly higher price, pocketing the difference. It’s a nifty way to enrich banks while simultaneously circumvent the rules against central banks buying bonds directly from the Treasury).

What Draghi (ECB) & Ingves (Sweden) et al. are trying to do vs. what actually happens

In theory lower interest rates, including negative ones, are supposed to:

lower  borrowing costs for companies (Lower borrowing costs mean more investments will be profitable and thus companies borrow more, invest and hire more people. Higher employment means more consumption and even more hiring in a virtuous cycle)

make banks safer (increased profits and strengthened balance sheets, thanks to lower funding costs due to, e.g., lower deposit rates paid to clients and lower coupons, or yields, on issued bonds)

lower the costs for households (lower interest rates on loans both directly and indirectly, as real estate and other companies get lower interest costs)

lower the borrowing costs for the government (reducing the burdens of a welfare state, enabling more transfers and subsidies)

stimulate more risk-taking (moving savers from zero-interest investments, like accounts and bonds, to equity and start-ups, thus promoting growth)

Increase inflation (higher prices and stable tax rates mean higher tax income for the state, thus making more room for welfare transfers. Higher prices on everything also means that loans [that are nominal] will fall as a proportion to income and asset prices. The latter is good for everybody with loans, but bad for everybody with savings)

What’s so special about negative rates?

Nothing really. What matters is the difference between nominal rates and inflation, adjusted for risk.

However, psychologically, nobody wants to pay money for the “privilege” of owning a bond or keeping money at the bank. Hence, people and decision makers feel forced to do just about anything with their cash, except keeping it idle at the bank.

In theory, when rates go negative, people spend their cash on more shopping and shares on the stock market.

Quantitative Easing (bond buying for newly printed money) aims to boost the effects of low rates

The Swedish central bank (SCB) today decided to accompany the negative policy rate with some bond buying. Most central banks do that nowadays. The Bank of Japan, of course, has done it for several decades (all but proving it doesn’t do any good).

The SCB started carefully with 10bn SEK (1.2bn USD), which would be equivalent to approximately 40-50bn USD in the US. The Fed typically buys in the trillions (1 Tn/year) so don’t worry; the Swedes still honor their heritage of moderation.

A 500% interest rate was the best they could do

A historical note: 23 years ago, when I was still at business school, the SCB raised its policy rate to 500%, manifesting beyond all doubt that it had no clue at all to what it was doing. Now the SCB is trying negative rates instead. I dare predict future economists won’t look back with admiration to today’s experiment either.

QE is thought to relieve weak hands of their bonds and put cash in their hands.

That cash then needs to be reinvested (and hardly in anything paying negative interest). The cash thus moves up the risk ladder into, e.g., longer term bonds, large corporate bonds, or even stocks with historically stable dividends. Gradually, investors at all levels are pushed further up the ladder and some money ends up at the very top; in new investments and start-ups, which should promote economic growth.

So, why ever have have positive or high, instead of negative interest rates? (or, what really happens is this)

If you buy into the Keynesian world view, where it’s a good thing to have politicians manipulate the economic cycle by varying interest rates and budget deficits, why not go “all in” and set negative rates once and for all?

Why not have ever falling rates, plunging deeper and deeper into the negative every year? Why have taxes at all, why not just issue debt to cover all welfare costs and let the central bank buy it all?

The intuitive answer is easy: It’s impossible, you can’t print wealth.

Money isn’t worth anything if you can’t get anything for it. Somebody has to work and produce. Somebody has to postpone consumption (a.k.a. “save”) for there to be anything to invest, for there to be anything produced. With negative rates there will be very little saving going on, but a lot of speculation and consumption instead.

Everybody knows you never go full retard in monetary policy.

The lessons from Zimbabwe, Venezuela and not least Germany (1923), are still fresh and raw in the memory of most economists. The death of money or hyperinflation is the most devastating economic phenomenon there is. Production ceases completely and an ever increasing bulk of money chases after an ever diminishing pool of assets and goods, fueling wild speculation and zero long-term investment.

Apart from doomsday scenarios, this is what negative rates means for you

In short, it actually means a doomsday scenario, just very slowly. The lo-down:

You’ll earn less interest on your bank account. Since most people don’t have any cash this is probably not a problem for you. If you have retired and live off a state pension, cash savings or bond coupons – tough luck!

Your variable interest housing loan becomes cheaper. Good for you, more money over for other things. Get out there and splurge!

Share prices, house prices and other asset prices rise for a number of reasons (most of them temporary and psychological). Good for you if you have all the assets you want. Bad if you were planning to buy more.

Companies start investing in anything they can find that might produce more return than the cost of borrowing. This means a lot of investments with lower return than usual get done. These lower quality projects fail more often. In addition, if interest rates rise, investors lose money even if the projects deliver as promised.

Short-term, the economy gets a boost, unemployment falls etc, as it did in 1996-2000 and 2003-2007, but when the low quality projects mature or interest rates rise, the true costs of low quality investing (malinvestment) become obvious. Remember that central banks lowered interest rates, to no avail, all the way down in the 2001-2002 and 2008 stock market crashes.

Longer-term, jobs disappear, banks fail.

The economy’s resilience and growth potential has been hollowed out by low quality investments. The easy job gains in real-estate, financial markets, service industries and consumption during the NIRP* induced boom are soon lost again. The loans for second houses, stocks, third cars, watches and other consumption go bad, consumption fall, and banks fail (subsequently rescued with tax money – congratulations all tax payers, they’re doing it again. But, no worries, the bankers will get to keep their bonuses from the boom).

*NIRP=Negative Interest Rate Policy

Inflation takes hold. Sooner or later inflation takes hold, due to more money and less goods. Then interests rise and many holders of variable rate mortgages will be toast. There actually already is rampant inflation – it’s just that it’s in assets, instead of goods. Whatever inflation there is in goods, the authorities choose not to include in the calculations, but there is a limit to how much they can hide.

Banks take more risk (and sooner or later go bankrupt) since they know the state and central bank will save the bank with tax payers’ money when needed. Up until the bankruptcy/state rescue bankers can pocket their bonuses and get to keep the money after the inevitable collapse.

Financial markets fall (they always do, sooner or later – and have already halved twice in less than 10 years; 2001-2002 and 2008-2009). Whatever artificial appreciation of stock prices accomplished today will be gone tomorrow. Bank failures in the wake of higher interest rates, malinvestments and bad loans is often a reliable way to start a market crash.

The value of a stock today is the discounted sum of about 25-50 future years of cash earnings after tax. Those earnings are being eroded, due to easy money, by current malinvestment and speculation, instead of sound long term investments in production. A mania in the wake of negative interest rates actually reduces the value of stocks, leading to lower lows in the downturn than what otherwise had been the case. Thanks Draghi! Thanks Ingves!

Enough with the economics and Fimbulvetr stories. What should you do now?

Should you fix your mortgage rate, borrow more, buy stocks, study, WHAT?

To start with, -0.1% isn’t that different from 0% or +0.25%, so you really could ignore the whole circus. As you were. In theory though… (and ceteris paribus):

In the short term things will look better. More employment, higher stock prices, higher house prices. In the long term things will still turn ugly.

This is how I would prepare:

Make yourself change resistant; don’t take your job for granted. Acquire more skills, make yourself indispensable, look for future-proof work places. Many will relax in the easy times of negative rates, but you should work harder than ever to secure your place in the job-less future to come.

Amortize your loans, or fix the rate for 7-10 years. Interest rates have never been as low as they are today. Don’t just do as all the other lemmings and go deeper into debt with variable interest rate – be contrarian and either reduce your debt (you can afford to amortize now that your monthly interest cost is so low) or fix the rate for a long time, in case inflation eventually ramps.

The family of two medical doctors I lived with when I studied finance asked me in 1990-92 whether I thought they should change their mortgage to variable interest (10-12% or so) or continue with 5-10 year fixed rates at around 12-15%. I repeated what I had learned in school (“you have always gained from variable rates”, except the very recent period). I hope they listened, because they were quite worried that rates might rise again, from 12%!

The coming decade, 2015-25, we are due such an exception again, where fixed rates are better than variable. Do you dare to time your fixing? Early 2015, late 2015? 2016? 2017?

I wouldn’t buy stocks or more living space. A very short summary of the entire article and the consequences of ultra-low rates would be “This already happened“. As I said, the small increment lower doesn’t change anything much. Stocks (everywhere) and house prices (Sweden; they never fell in Sweden during the financial crisis) have already skyrocketed due to ultra-easy money.

Stocks: Guess what will happen when rates rise, when profits fall, when speculation loses its luster, when growth expectations crumble… Do you think stocks will rise or fall then? Once again, remember that stocks crashed more than -50%, twice, while the Fed kept lowering its policy rate.

Once speculation fades and stocks are seen as risky (potentially negative returns to the tune of -10-60%), then zero or even negative rates in risk-free instruments will be seen as superior investment alternatives. As John Hussman keeps telling his readers, the writing is already on the wall in that respect, as gauged by increased dispersion of market internals (yield spreads, stock sectors etc).

In other words, investors are becoming more and more anxious and any little thing can topple that first crucial domino that fells the rest.

Stocks overshoot, and stocks undershoot. Respect that cycle and use it to your advantage rather than the other way around.

 

Obviously no consequence coming...

Obviously no consequence coming…

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