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[flagged] Negative Interest Rates Are Going to Ruin Everything (prestonbyrne.com)
68 points by barry-cotter on Jan 12, 2020 | hide | past | favorite | 39 comments

I really believe this premise. I really believed this premise 10 years ago and I believed it would be nearly impossible to continue 10 years further on our current path without facing serious consequences.

One thing I learned in the last 10 years is that reality doesn't care that much what you believe and markets can stay irrational vastly longer than you can stay solvent, if not indefinitely.

And that's the interesting takeaway to me. What if all of this is nonsensical insanity but it's nonsensical insanity that is capable of reaching some local equilibrium that is stable for an extended period of time.

Or what if these central bankers are geniuses manipulating the quantum mechanics of our economy in a way that will just always seem like nonsense to outsiders.

Both of those seem like poor premises to me but I can't disprove either of them.

I'm still proud to say I'm short the S&P because at the end of the day all you can do is look at the cards dealt and make your best call but I'm much more willing to believe that I go bust on that bet than I would have 10 years ago.

>Or what if these central bankers are geniuses manipulating the quantum mechanics of our economy in a way that will just always seem like nonsense to outsiders.

If you think deeper into it, you will see that the U.S. economy does not exist in a closed loop. For instance, most of the physical goods we use gets produced in China. The profits from producing them flow back, since purchasing real estate in the politically stable "West" is much more reasonable than holding your capital in China where you can get killed over it. A similar process happens to the Saudi oil money and the VC market. Although it might look like the central bankers have found a wonderful way to make money from thin air and make everyone happy, I think we are actually just slowly selling off strategic assets to the external buyers and spending the proceeds to buy trinkets.

In America the ownership of real estate is not an absolute right. Your property can be taken by eminent domain, by failure to pay fines, or more commonly it can be taken due to failure to pay property and/or income taxes.

If they ever need to get the foreign owners out they will set a tax on foreign owned real estate for an amount makes the investment not worthwhile.

Except the economy is getting more and more dependent on that external money. Good luck banning foreign owners if 20% of your state GDP is real estate deals (real numbers for British Columbia; they also tried foreign buyer tax, although the Chinese figured out some loopholes). Good luck banning foreign investments if millions of local jobs exist solely to make the companies look like better investments, and millions more are tied to advertising, accounting, cloud and other services provided to VC-backed companies.

You can't stop the slowly accumulating long-term effects without a considerable mid-term depression, and no politician will go for it because the majority of voters is very short-sighted.

The global economy is closed yet it can grow due to technical progress. (Better ways to organize trade, production, life, etc. More specialization more efficiency for the whole system, comparative advantages coupled with trade compound for every trading partner.)

Central banks manage the money supply simply by keeping track of this growth process. (Via closely watching prices, trying to stabilize them, and trying to keep unemployment low at the same time.)

No need to sell off "assets". Changing ownership of capital doesn't matter for economics (naturally public choice economics and developmental economics deals with politics, monopolies and other pathological market states, which cab arise from too much power/capital consolidation.)

The whole system definitely gets more efficient, but it renders entire populations obsolete. The economic role of an average millennial in the West is currently to just get out of the way and be happy with some minimal amount of money that isn't much correlated with their personal efficiency. No motivation to grow, no paths to house ownership, questionable chances of ever affording a family - so the entire generation is pretty much sitting in depression and waiting to die of old age.


Why ... why do you think there's nothing for people to do? There are new kinds of jobs invented by young folks every week. From influencer to vlogger to artisan fart crafter to who knows what.

Sure, it's not as simple as it used to be, that just go to school and work in the factory/office. But that's not the end of the world.

Service industries are booming. Remote work is the way to go. No need to buy a house for 1M USD somewhere near SF/LA and commute every day.

And it works. There are people living in vans wherever they wish and living off money made by content creation.

The problem of looming doom is not because of the economy. It's entirely because there's a culture war going on. Mental health is the first casualty.

The entire generation is waiting for the old guard to die out, so they can enact reforms. (Except as we know reality is a lot more complicated, there are plenty of young folks rooting for both sides, and actively participating in politics.)

Do you actually hold and short positions in S&P or is this just talk? It's easy to say you would bet against it but if you put your money where your mouth is you would have lost a significant amount of your wealth over any timespan.

> Central bank rate setting is basically an adjustable rate mortgage for states and their entire economic systems.

The debt markets are complex but at a high level, this is an absurd analogy. The debt the author is worried about are largely based upon fixed interest rates for the life of the debt. As such, one can write down on a piece of paper the obligations borrowers have, and they will not change over time due to the structure of the debt.

If one is going to write an article about predictions based upon the interest rate markets, one needs to do better than "wow, look at all this debt, surely it will not be possible for parties to meet their expected obligations!" If we were in a high rate environment, would one argue there is less default risk? It doesn't make sense.

If you're going to make a prediction, make a prediction. Don't just say "countries will default" if you can't explain what chain of causality gets you there. High debt loads with low rates do not cause defaults: other events do, ones that are hard or impossible to predict. So the analysis contains zero real predictions or information, other than claiming that somehow an unexpected crisis will be made worse by the debt. It seems equally likely as not that debt will exacerbate whatever the next crisis is, it seems extremely unlikely that it will be the root cause.

> Well of course we shouldn’t have funded state entitlement programs with trillions in low-interest debt and ensured our governments and, by extension, our societies were addicted to low interest rate revolving credit facilities writ large.

The author doesn't mention the single largest source of increase in federal debt the last few years: the military and tax cuts for the wealthy.

Are you talking just discretionary budget only? Mandatory budget of the federal government has been growing as much more than discretionary.

You forgot about Government Bailouts. There was $3 trillion dollar bailout last year.

The author provides no proof that asset prices are the result of inflation or that the 100k salary for a restaurant manager is. The latter is normally used as an example of how tight labor market right now not inflation.

I'm not surprised they don't show any statistics as the lack of inflation in the past decade has been quite a surprise to economists.

A large undiscussed issue here is that low (and negative) interest rates have hidden the risks of wage stagnation on consumer demand. That obviously has economic consequences, but it could get to socisl unrest pretty fast.

Your dad could afford to buy a Toyota Corolla and a new mid-line TV in 1980. You can afford to finance one with low interest rates in 2019. But your son won't be able to afford those things with spiked interest rates and more restrictive lending paradigms.

A tangible example is carmakers offering 0% loans at 5-6-7-8 year terms. Even though fewer customers can afford the price in cash, or with a more conservatively priced 10%-APR 4-year loan, sales numbers remain high.

If the day of reckoning comes, and interest rates return to historically normal levels, or dramatic 1980s levels, it's going to break that illusion. Will consumers be angry when they realize they can't even have the quality of life they've grown accustomed to?

>> Your dad could afford to buy a Toyota Corolla and a new mid-line TV in 1980. You can afford to finance one with low interest rates in 2019. But your son won't be able to afford those things with spiked interest rates and more restrictive lending paradigms.

This is a misrepresentation of the real statistics around wage stagnation. Real wages (adjusted for inflation and/or purchasing power) hasn’t changed much for the lower and middle classes in the USA for the past few decades. So, the average American can afford to purchase exactly what they could a couple decades ago.

Source: https://www.pewresearch.org/fact-tank/2018/08/07/for-most-us...

The cost of "a normal middle-class lifestyle" doesn't completely track a CPI basket-of-goods. This is in part due to changing consumer expectations, and because some products simply change over time.

A mid-size sedan you buy today will typically have more airbags and better efficiency than dad's '80 Corolla. It's going to cost more.

Conversely, dad's mid-range TV was probably a 21" NTSC CRT. Yours is a 60" ATSC "smart" LCD , a product that no amount of money could buy in 1980.

A new house today is likely to be a few square metres bigger than a house of similar market position 40 years ago.

There are expenses that are everyday today that would be exotic or unthinkable in 1980: internet service, cable/satellite TV, and mobile telephone are obvious, but I'd also include 401(k) contributions (instead of employer-funded pensions), and college expenses, both your student loan debt service and the need to proactively safe for your children's attendance. Child care is also a changed factor, given the increase in two-income households.

Saying "well, you make as many inflation-adjusted dollars as Dad did" doesn't mean you've kept my position on the social treadmill. When cheap credit goes away, that becomes more obvious.

> So, the average American can afford to purchase exactly what they could a couple decades ago.

Sure, if you ignore the cost of health insurance and medical bills. Also if you ignore the cost of higher education.

No, the price index used incorporates both healthcare and education costs.

Source: https://en.m.wikipedia.org/wiki/Personal_consumption_expendi...

Those numbers don't pass the sniff test. According to that, the adjusted cost of education has gone down!?!?! That clearly ignores college, or is just factually incorrect. I also don't believe that the cost of medical treatment has gone down, although admittedly I don't have numbers to support that assertion.

Price and medical care should be approached as though there's a giant sign that says "Here there be dragons." There are a lot of weird incentives to have multiple prices for the same medical good. For uncompensated care the incentive is to have the price be as high as possible within the bounds of sanity. The prices that insurance companies pay on the other hand tend to be much lower while those same insurance companies have an incentive for a high price for those without insurance i.e. the higher the un-insured pay for procedures the more the insurance company is saving its customers.

It's hard to argue with what the author describes as a hunch, but his threshold for "end of the world" is pretty low.

I was working in an adjacent milieu at the time, and I wasn't happy when S&P tanked, but really, no one cares about unemployed bankers, unless you're in the position of the author and you know them personally. Even then, it's not the end of the world.

Moreover the world isn't turned upside down when a Taco Bell manager makes $100K. And ordinary people experience an absence of money at the ATM on a regular basis when it runs out of their money the day before payday.

Negative interest rates are uncharted territory, but the anecdotes supplied as background information aren't that persuasive.

Negative interest rates basically mean: "We accept your money to store it safely, for a small fee".

Didn't banks do just that at the times when gold was the world currency? That continued for quite some centuries, e.g. during the explosive growth of the industrial revolution.

Most banks charge a monthly service fee already anyway. So we're basically already under negative interest rates; it's just regressive ones that are a higher percentage the less money you have.

A lot of what the author said is negated by the fact banks build into their loans that the rate can not drop below zero and that is before their spread (profit) is added to the rate. What is correct is the rate cannot continually go down further but it will actually make banks even more profitable because they essentially have built in floors to the loan at zero. Meanwhile the bank may borrow below zero. As for the effect on the overall economy, it does mean that actions taking interest rates negative will be mostly ineffective should they be used. However the fed has been slowly crawling back to a better balance sheet with QT and higher rates over the last few years and even though there have been 3 cuts in a row last year the fed is still better prepared than say 3 years ago.

So if we accept the premise that’s there’s (as a minimum) a significant correction or (at worst) a major financial crisis coming... where/how would you invest to either ride it out without too much of a haircut, or even make some profit?

You can sell an interest rate futures. But be warned you if you had done that 10 years ago when everyone thought low interest rates weren't sustainable you would have lost a great deal of money.

Traditionally, gold, treasury bills and cash if a crash is due. However, time in the market beats timing the market. If you are 10-20 years out then just focus on buying and buying in the dip. Dollar cost average is what it's called.

If rates go lower, current bond’s prices will increase. I’d look into TLT if you believe America’s rates will go lower.

This entire article tries to use an abundance of idioms and truisms to hide that there is not a lot of substance here. And the little substance present is confused.

The article is all over the place. For instance, the author worries we're going to end up in a world with both a debt crisis AND hyperinflation. However, none of the current debt is inflation-adjusted, so how can companies be unable to pay off their debt when they have tripled their revenue(due to hyperinflation).

He completely misunderstands the quotes from Larry Summers and the CEO of Deutsche. He believes they support his case when they have the exact opposite worry. Imagine you live in a house with a heater but no thermostat. The furnace is failing, so even on a typical day, you crank the heater up to its max setting to keep warm. Larry Summers and the Deutsche CEO worry that now the heater is maxed on a typical day, we have no spare capacity for a cold front. The author is worried that since we maxed out the heater that we're going to overheat because he doesn't understand that there is an intermediate step between adjusting the heater and making the house warm.

> I leave it to folks with advanced degrees in mathematics to model and quantify this hunch.

All you need to understand and dismiss his concerns is to have taken an intro to macro class at your local community college.

Negative rates In Europe resulted from the Germans refusing to borrow more to stimulate their economy after the financial crisis and from the EU failing to find a political solution to deep structural issues that have constrained growth. It’s those underlying problems that are the real problem.

There is inflation all over the world. Housing is not counted, although it's the major cost for everybody at this point.

The only way to remain sane in this manipulated fiat environment is to calculate gold/housing, stock/gold and Bitcoin/stock market and similar asset ratios.

This is false. Housing is almost a third of the CPI.

I think for many people housing as a fraction of money spent is much higher than that. I have had periods where around 75% of my spend was rent.

Depends where you live. In San Francisco you might. But when I graduated college I moved to Houston and over the last 10 years I've never spent more than 10% of my income on rent. Sometimes spending as little as 6%. (When I graduated I made 40,000 and spent $300 a month sharing a 2 bed room in a nice neighborhood, a couple of blocks away from a bunch of nice museums.)

This is 100% false. The cost of housing(i.e. rent) is counted.

The prices of purchasing a houses is not. This is because the CPI(Consumer Price Index) is an index of the cost of consumption. And rent is the cost of housing consumption. Purchasing a house is the cost of buying an asset that produces housing.(which you can then consume yourself or sell to someone else.)

In addition to buying BTC, I also long shorted select QE-related IPOs, such as Pinterest. When the bottom falls off, these will fall with vengeance.

Non troll question: What about Pinterest is more QE dependant than other stocks?

Pinterest is where you go to fantasise about major home improvement projects - suggesting when people are cash-poor they’ll spend more time there.

...but if you’re cash-rich and planning a project you’ll definitely start you’ll also have a Pinterest page for that too.

So I’m 50/50 on this.

Note that QE is not something that is directly felt by the general public - it’s definitely something for behind-the-curtain so this whole thread is bollocks.

QE is shorthand and not entirely accurate. OP likely meant dumb money chasing yield down the abyss that is unprofitable tech IPOs.

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