Permanently low interest rates?

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black_son_of_gray
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Re: Permanently low interest rates?

Post by black_son_of_gray »

In chemistry, if we want to know what state a substance will be in, we can plot out a phase diagram—a graph of temperature and pressure that shows the boundaries of the different states. An example diagram for water:
Image
(Image link if you can't see it)

So, for the intuitive example of water, low temperatures usually give ice, high temperatures usually give water vapor, and in-between, moderate temperatures and pressures allow liquid water. Science 101, sure, but I bring it up for the (hopefully) useful concept of the triple point. The triple point is the intersection point along the phase boundaries where three different states can coexist and easily tip into any of the distinct, bordering states. And I can't help but think that we are close to the economic equivalent of the triple point. Here's my thinking...

A thought experiment
[TL;DR: all of your ideas are correct at the same time.]

If we were to plot a phase diagram for the economy, our two axes might be interest rates and debt load and the states of the economy might be inflation, deflation, and stagnation. In the US, interest rates broadly have been going down since the 1980's, and we find ourselves pretty close to zero, but just above it. Around the world, some places are below zero, some are at zero. This is the economic triple point.

Barring some black swan reorganization of the financial system (global debt jubilee?), the interest rates can go three ways from this economic triple point: up, down, or zero.
  • Up: Debt loads are so massive that slight increases in interest rates tip the system into inflation, because the only policy way to relieve the crushing burden of all that debt is to inflate it away. The problem with intentionally trying to inflate away the debt, outside of the fact that it violates one of the two Fed mandates (employment, stable prices), is that it can easily get out of control and shoot to the moon. Gold bugs might do very well in this state of the system. Holding bonds would be a disaster.
  • Down: In a race to the bottom to devalue currency, interest rates can keep on chugging deep into the negative. The system here is in deflation because spending $130 to get back $100 in the future ultimately reduces money supply (right??). Long term this is unsustainable, because it literally turns the banking business model upside down (borrow short/lend long doesn't work). See Japan and European bank stocks. Without a workable banking sector, modern economies cannot function—the patient can only be bled so long. But in the meantime, falling rates are good for bonds, even if rates are negative because the prices still go up, and bad for stocks because appreciating inventory incentivizes slow turnover/sales/waiting-instead-of-moving-forward.
  • Zero: The system near zero is in a state of stagnation. Real growth in the economy is very slow or non-existent for a number of reasons. 1. Unproductive, zombie companies can keep limping along financed by cheap debt. 2) Any company that can borrow for less than the rate of its dividend will just buy back its own stock instead of make capital investment (it's a no-brainer balance sheet move) 3) etc. The main theme here is that money continues to be so inefficiently allocated that the best the economy can do is tread water. Stocks may be the cleanest dirty shirt here, even "growth" stocks with negative cash flows. Cash and bonds and everything else stink. TINA. But that party can't last forever right? Zombies do eventually die, right?
Looking forward, there are 1) very reasonable/logical arguments 2) championed by very smart, successful investors, and 3) historical precedents/examples for each of these states. That is why I like the triple point metaphor: because it provides a context for understanding how all of these arguments could be correct, just as multiple states of a substance are reasonably possible at its chemical triple point. Another useful observation: because we are near the triple point, a move into any state could rapidly change course and enter another state. This is because the boundaries are still very close to each other in the area surrounding a triple point. In water terms, that is just saying that ice that is close to the freezing point can pretty quickly start to melt vs. ice that is -100C. Economy-wise, this means a rapid switch of states is maybe even likely: for example, my best guess for the near-term trajectory is that rates will plummet globally (deflation) until that course reaches the breaking point (no sure when, but soon-ish?), and will then be followed by a rapid shift toward inflation in a desperate attempt to relieve debt burdens. Straddling the zero line might be possible for an extended period, but I doubt it can be maintained permanently—if for no other reason, simply because the area on the phase diagram that describes stagnation is pretty narrow (spitballing, we might define it as between 0ish and the S&P dividend rate). So even being deep in stagnation territory is still relatively close to either inflation or deflation, and it is too taxing for central banks and the lags in their policy actions to be able balance in this narrow space indefinitely (their track records for soft landings is almost nonexistent/ can they even agree on what r* is?).

Ok, I'll leave it at that. My intention wasn't to be comprehensive—I'm just throwing this idea out there for discussion. Please tear it apart, add to it, ignore it as you see fit.

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Seppia
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Re: Permanently low interest rates?

Post by Seppia »

finity wrote:
Tue Aug 20, 2019 2:48 pm
Germany will emit 30 year bonds at 0% tomorrow.
Fun fact: at current dividend yields (3.5%), a broad European stock index funds would have to lose 2/3rds of today's value (nominal terms) to be a worse investment than those 30y bonds over the same timeframe.
This is assuming dividends have zero nominal growth for the next 30 years, and ETF is held in a tax advantaged account (dividends reinvested and taxed at 0%)

How any sane person could buy those bonds is beyond me.
Last edited by Seppia on Wed Aug 21, 2019 12:22 am, edited 1 time in total.

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unemployable
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Re: Permanently low interest rates?

Post by unemployable »

Seppia wrote:
Tue Aug 20, 2019 3:59 pm
Fun fact: at current dividend yields (3.5%), a broad European stock index funds would have to lose 2/3rds of today's value (nominal terms) to be a worse investment than those 30y bonds.
That's basically the Fed Model, although it uses inverse P/E rather than dividend yield. I like to think of it in reverse: The S&P's "fair value" is over ten thousand, meaning the level at which its component companies would earn the equivalent to Treasuries. So get ready, the stock market is about to triple! No, I don't believe this.
Seppia wrote:
Tue Aug 20, 2019 3:59 pm
How any sane person could buy those bonds is beyond me.
One plausible reason is you think they're going to get even more negative! Also one may believe they will still have a positive real return if deflation exceeds (is more negative than) the interest rate. Although in that case you're still better off mattressing your cash at 0%.

I want to see how negative they can get. I think a full minus 1% in Germany is a done deal. Can they get to -2?

classical_Liberal
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Re: Permanently low interest rates?

Post by classical_Liberal »

Seppia wrote:
Tue Aug 20, 2019 3:59 pm
How any sane person could buy those bonds is beyond me.
Not all investors have a 30 year horizon. Bond convexity allows for some nice returns at very low rates in short/medium term. Also, institutional investors.

CS
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Re: Permanently low interest rates?

Post by CS »

Wow, interesting discussion!

@C_L good point about holding 30 yr bonds short term.

@Jacob

Okay, can you please explain to me like I'm five years old:

What is "a slow rotation into non-cyclical sectors."

Also, what does "cf. non-cyclical" mean?

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Seppia
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Re: Permanently low interest rates?

Post by Seppia »

@ unemployable
I used dividend yield because it’s historically much more stable and reliable VS price.
I also edited to add that I meant European stocks should lose 2/3rd of nominal value over the next 30 years (not today).
Other than nuclear wars I can’t think of a scenario where this may happen.

@c_l buying something at a price that makes no sense, in the only hope that will go up even more, is historically not a winning strategy (in the aggregate).
I know some institutions are obliged to own them, but some people are proactively buying them.

The Old Man
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Re: Permanently low interest rates?

Post by The Old Man »

Seppia wrote:
Wed Aug 21, 2019 12:21 am
I also edited to add that I meant European stocks should lose 2/3rd of nominal value over the next 30 years (not today).
Other than nuclear wars I can’t think of a scenario where this may happen.
During the Great Depression of the 1930s the U.S. stock market was down 90% and took a long time to recover. The Great Depression was world wide, but I am unaware of the impact in Europe.

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Seppia
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Re: Permanently low interest rates?

Post by Seppia »

IIRC in the usa there is no period of 20 years in recorded history with real negative returns

EDIT: apparently those 30 year bonds are now yielding.... drumroll....
MINUS 0.19%!

YAY!
https://www.bloomberg.com/news/articles ... n-set-at-0
Last edited by Seppia on Wed Aug 21, 2019 6:31 am, edited 1 time in total.

jacob
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Re: Permanently low interest rates?

Post by jacob »

The Old Man wrote:
Wed Aug 21, 2019 5:47 am
The Great Depression was world wide, but I am unaware of the impact in Europe.
In Europe, the Great Depression, which in some places started earlier than in the US lead to various populist combinations of fascism, nationalism, and socialism. Aggressive expansionary foreign politics then lead to WWII. The impact on the stock market of the losing nations of WWII is why their historically based SWRs are so low.

7Wannabe5
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Re: Permanently low interest rates?

Post by 7Wannabe5 »

Picketty writes quite a bit about the early 20th century loss of wealth in Europe. Before WWI the average 80 year old held significantly more wealth than the average 40 year old, this demographic completely flipped by mid-century.

I can think of quite a few, known unknown 3 punches that could do the same. For instance, extended Midwestern Bread Basket Drought X Major Effective Multi-Corporate CyberHacking Incident X military crack-down in Hong Kong triggering WW4.

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Re: Permanently low interest rates?

Post by jacob »

@bsog - I once read a paper on option pricing that IIRC started with the axiom that the market always strove to maximize disagreement. (If you think about it, this is a rephrased version of the EMH. When the market clears, there's about equally many bid and ask orders sitting across the price.) I like the triple or N-ple point theory, but I fear that the market is ALWAYS in such a state unless it's moving rapidly. Therefore, it's not directly useful.

Indirectly, I use this idea a lot. There are always several reasons for why to buy or sell something. This comes about because whereas information is rapidly transmitted, opinions develop rather slowly in the market. The benefit of reading a lot (of news, etc.) is to be able to see the rate as which other investors/players change their opinions. (A recent example would be how the VTSAX people in the FIRE movement suddenly had the fear of god put in them. JL Collins even put out a meditation youtube video to calm them down :-D . Another example is the WH's changing narrative on how stronk the economy actually is.) I think of these as different votes that haven't been polled yet---this doesn't happen until they start pulling the trigger---but the more people willing to pull the trigger, the greater likelihood of a price move.

If I wanted to write this out, I'd present it as a table with faction labels e.g. "Silly speculators", "Dogmatic indexers", "Econ undergraduates", "Jim Cramer", ... for the rows. A belief for each column, e.g. "The economy is great", "The economy sucks", "Tariffs are going to help the steel industry", and then a list of check boxes or rather probabilities for each field.

I overlay this matrix on my general idea of where the market is going (my opinion being another vote)---where the actual market is going would correspond to the "temperature". But basically, I don't cast my vote until I'm reasonably sure that many other "factions" are ready to cast their vote in the same direction. If I "go early" I just end up sitting on a position that goes nowhere.

Jason

Re: Permanently low interest rates?

Post by Jason »

@ 7W5

I believe Picketty would partially explain loss of that generation's wealth to rise of early 20th century totalitarian regimes and the interruption of the accumulation of private capital due to state controlled economies and pilfery i.e. the Nazis seemed to love art as much as they hated Jews and Gypsies. That being said, he states individual age has always been and remains primary determinate of capital accumulation.

7Wannabe5
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Re: Permanently low interest rates?

Post by 7Wannabe5 »

@Jason:

Right. I was just noting that you don't have to be insane to purchase 30 year Treasuries, just a certain mix of deeply pessimistic. I am trying to get the hang of Bayesian analysis, so I try to practice whenever I can. Kind of like I am the annoying character in "Green Eggs and Ham."

"I do not like the Treasury Buy. I do not like it 7WB5!"

"Would you could you in a war? Would you could you if Bull turned Boar?"

"I would not could not 7WB5! I do not like the Treasury Buy!"

"Would you could you if oil up post-peak? Would you could you based on Fed scandal leak?"

Etc.

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Re: Permanently low interest rates?

Post by jacob »

@CS - See e.g. https://www.investopedia.com/articles/t ... 020305.asp

I meant "cf. cyclicals". In the link non-cyclicals (laundry detergent) is are called staples---something that always has a demand. An example of a cyclical stock would be a manufacturer of washing machines---something that only has a demand when people have money.

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Re: Permanently low interest rates?

Post by Seppia »

https://www.bloomberg.com/news/articles ... ction-year?

Unless Trump loses in 2020 (unlikely), this era may be remembered as the USA’s equivalent to Italy’s 80s: a debt fueled, unsustainable sugar high of prosperity for a declining nation, ultimately setting the stage for decades of going nowhere.

Obviously the USA is 102727384748 times more resilient and stronger than what Italy ever was, but when short term thinking, opportunistic, old politicians use debt any time they can, things ultimately get to a level where it’s impossible to turn back.

Italy has been running “primary surpluses” (meaning before debt interest payments) for years now, but even with interest rates so low in Europe, zero growth + 140% debt to GDP ratio = an unwinnable war with math.
Once you get there, you’re screwed.

In this Nth disproval of a theory that has never worked (see Kansas VS California for another recent example), it is literally unbelievable that trickle down economic theorists aren’t getting laughed of any room on this planet, and that some politicians still present this bullshit with a straight face.

classical_Liberal
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Re: Permanently low interest rates?

Post by classical_Liberal »

Seppia wrote:
Wed Aug 21, 2019 2:12 pm
Italy has been running “primary surpluses” (meaning before debt interest payments) for years now, but even with interest rates so low in Europe, zero growth + 140% debt to GDP ratio = an unwinnable war with math.
Once you get there, you’re screwed.
Italy has no direct control over it's own currency. It can't inflate away it's debt, this is the number 1 problem, IMO. The US can, and to top it off much of the debt is owned by foreign governments/investors, so the negative affects are spread thinner and globally. Not just centered on decreasing the purchasing power of it's own citizenry.

black_son_of_gray
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Re: Permanently low interest rates?

Post by black_son_of_gray »

jacob wrote:
Wed Aug 21, 2019 7:30 am
I once read a paper on option pricing that IIRC started with the axiom that the market always strove to maximize disagreement. [...] I like the triple or N-ple point theory, but I fear that the market is ALWAYS in such a state unless it's moving rapidly. Therefore, it's not directly useful.
A fair point, and I agree with it—but it requires disagreement to work, and there isn't always disagreement on some market-related variables. Which is to say, in any given market and at any given time, there is a common knowledge among investors that almost no one disagrees with. Or maybe a small minority of dissenters exists, but the market's so thin on a particular trade for that position that no one even tries to make it.

For example, let's tease apart inflation, disinflation, deflation, and interest rates in the US over the last 60 years or so (since leaving the gold standard). Here's a graph of inflation data:

Image
(Image link)

Prior to ~1970, the US regularly flipped between inflation and deflation states. As a result, deflation was definitely a possibility in the minds of investors, and investors might disagree on that—and then the axiom of maximum disagreement would apply. But some time after 1970, after the US had been solidly in an inflation state for a while (akin to the ice at -100C), serious consideration of deflation dropped from the common knowledge of investors, and the disagreements that arose when considering interest rate changes ceased to be between inflation/deflation and shifted towards inflation/disinflation. That is, there weren't any disagreements that there would be inflation, just with how much inflation at a given interest rate (which weren't anywhere near zero). And over the decades (i.e. longer than just about every investor has been in the market) that has slowly morphed into market common knowledge. But now that interest rates (and inflation) have crept down towards zero over the past decade, deflation is starting to poke its way back into investment consideration. The ice is still frozen, but sitting at -1C instead of -100C.

I also totally agree with you on the Keynesian beauty contest angle of keeping tabs on how all the different factions are interpreting the situation. I guess my argument as to why the current situation is different (uh oh—I've done it now!) is that I'm saying there is a new category in beauty standards that hasn't been considered for the last few pageants. If you feel like you've got a good idea how the audience judges bikinis in the swimsuit competition, what do you do when a guy comes out on stage in a Speedo?

This triple point idea is almost certainly not directly useful in predicting which outcome is most likely to happen. Where I think it could be useful is in understanding the dynamics of whatever happens (e.g. rapid switching between inflation/deflation states) or in understanding that each of these states is actually possible and maybe even probable, which helps an investor keep an open mind to outcomes and hedge appropriately.

Or, y'know, maybe I just went too far with a metaphor. It's not like I don't do that constantly anyway. :mrgreen:

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Seppia
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Re: Permanently low interest rates?

Post by Seppia »

There was a recent, very interesting, Twitter thread by Paul Krugman on the subject

https://twitter.com/paulkrugman/status/ ... 90112?s=21

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Re: Permanently low interest rates?

Post by jacob »

@bsog - On way to describe [any] market is WLOG to see it as a battle between P("V") and dP("V")/dt, where P is the price and "Value" is some esoteric quantity calculated by fundamentals, pop culture, mouse clicks, or whatever. Let draw a graph where P is on one axis and P' (the time derivative) is on the second axis.

I submit this covers a large fraction of most investment strategies. Two important ones it doesn't cover (which consequently are not efficient and thus sources of alpha ... at least they were 10 years ago) are quant-strategies based on price momentum based on volume instead of time (this drives day traders up the wall, because volume is just not a natural independent variable for the human trader) and gamma strategies which would be based on P''. (That's why I said WLOG ... feel free to draw more dimensions.)

Now the P and the P' axis are best drawn logarithmicly. WLOG again, think of it as ms, s, 1000s, 1000000s, .... so from millisecond holding/focus (computers), seconds (clicker traders), hours (day traders), ... months, years, decades, forever.

Now if it was actually possible to know, it would be really interesting to see each trader---perhaps with a dot signifying their size---and where they concentrate in this 2D-land.

This goes to the comment you made about agreement/disagreement. Disagreement is 100% on the microscale for a "stable price", this being the very definition of a clearing market. But as you note, the agreement tends to be HIGH on the global scale to the point where the perception of other dimensionalities are completely lost. (Like how humans only perceive 4 dimensions of spacetime even though there are likely 10, 11, or 26 dimensions in "reality".)

For example, if we look at the plot, there are very few people who act as if they take a long term view. 10 years of pain is enough to cause 99.99% of investors to switch strategy. This is kind of where we are now. P("V") are beginning to throw their hats into the P'("V"). In lowbrow terms, value investors for whom stocks have been overvalued since 2014 and have consequently been sitting in cash and moving(*) towards the momentum side (prices always go up). I just saw that Hussman gave up on the previous strategy in 2017.

It's well-known that moves stop just when the last person who will ever change their mind changes their mind. That is, a bull market stops when there are no more convertible bears left. Reasoning being that the source of buying pressure is gone and so prices must go down. This is the point where the "unseen agreement" breaks and prices move a lot. (One unseen agreement is that interest rates will remain permanently low---that central banks can successfully engineer a sustainable zombie economy.)

All this is just to explain the dynamics (why prices move). You're mainly talking about the dimensionality of the problem---which dimensions.

Jason

Re: Permanently low interest rates?

Post by Jason »

I searched the site engine for Silvio Gesell and it appears a poster named Haplo posted a paper of his in 2012. But the link has expired.

https://www.npr.org/sections/money/2019 ... ed-prophet

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