The crazy world of negative interest rates.
For the past 33 years, the estimable James Grant has published Grant’s Interest Rate Observer, a newsletter covering in remarkable depth, as you might possibly have guessed, Jim Grant’s observations on interest rates. If that doesn’t sound like much of a business, you don’t know niche publishing. Grant’s commands an annual subscription price of $1,170 for its fortnightly letter, which compares with a subscription to the daily, home-delivered New York Times, for those of you still hungry for sexual-harassment news, of only $488. The Grant’s renewal rate, I’m reliably informed, is considerably higher than that of the Times.
While an issue of Grant’s is only twelve pages long, it’s not a quick read. Readers don’t flip through it before tossing it on the coffee table next to last April’s issue of House Beautiful. They read it, ponder it, and, many of them, act on it by rearranging their financial affairs so as to bring them into alignment with Grant’s expensive observations. Readers come for the information and stay for the insight, all of it delivered in a pellucid style that is rare in the murky world of monetary affairs.
Why all the fuss about interest rates? Here’s Grant’s unanswerable answer: “Interest rates are prices. They impart information. They tell a business person whether or not to undertake a certain capital investment. They measure financial risk. They translate the value of future cash flows into present-day dollars. Manipulate those prices — as central banks the world over compulsively do — and you distort information, therefore perception and judgment.”
When he’s not observing financial markets — and I can’t imagine in what small hour that might be — Grant writes books, seven of them so far, including studies of Bernard Baruch and John Adams. Faithful to the governing criterion for these Firing Line Conversations – that the guest must be smarter than the host — I sought him out.
Freeman: This won’t require much of an imaginative leap, Jim, but let’s pretend that I’m underinformed about the appeal of negative interest rates. Why would I want to pay somebody to borrow money from me?
Grant: Conservatives don’t take naturally to negative interest rates: Today’s are the first in at least 5,000 years. Nor do savers of any political stripe. A negative rate of interest means that the lender pays the borrower and it would seem to defy common sense. You can think of interest as the reward for waiting — for laying aside something for tomorrow. Alternatively, you can view negative interest as the cost of impetuousness. Negative rates penalize thrift and reward consumption.
Freeman: Peak Keynesianism?
Grant: The Keynesian economists say we need less thrift, more “aggregate demand.” Negative interest rates, imposed by central banks, are the means to the end of more impetuousness. The myth that we can spend and borrow our way to prosperity dies hard.
Freeman: In one estimate I saw, there is now $10 trillion of negative-rate debt sloshing around. If it’s designed to be a demand-side incentive, how has it performed in the real world? Is it working?
Grant: Sub-zero rates have unleashed no new wave of spending. Nor would they, once you think about it. Put yourself in the position of a Scandinavian saver or a Japanese businessman. Your central bank announces that it will drive nominal short-term rates where they have never been before. You think, “Something must be wrong. The economists must know something I don’t know.” Your second response might be, “Hold on a minute. My savings yielded little enough when deposit rates were zero. They’re not going to be any more productive at minus 1 percent, or minus 2 percent. I’ve got to save more for retirement. Maybe we shouldn’t go out to dinner tonight.” The unintended consequences of economic policy are always more interesting than the intended ones.
Freeman: One of the consequences, intended or otherwise, is that we now have this massive debt sitting on the national balance sheet. Can we just let it sit there, rolling it over from time to time? Or is there a circumstance in which we’ll be obliged to pay it off?
Grant: You hear it said that “posterity will pay.” Well, what are we if not someone’s posterity? Yes, we pay the interest on the $14.2 trillion of Federal debt — that’s debt in the hands of the public, excluding the obligations held in various government trust funds. But we don’t pay the principal because the world’s investors don’t want their money back. They continue to regard this country as a superior destination for money. In the twelve months through September 30, the U.S. government added $795.5 billion to its towering pile of IOUs — and refinanced $8.2 trillion of IOUs previously incurred.
Freeman: How long can that go on?
Grant: Until the world comes to doubt the creditworthiness of the U.S., or the integrity of the U.S. dollar.
Freeman: Let’s make the wild assumption that, under either a Clinton administration influenced by Bernie Sanders or a Trump administration influenced by Donald Trump, doubts might begin to creep in. We could then pay off the debt by debasing the currency, paying off dollars with dimes; or we could raise tax rates to pre-JFK levels; or we could default and stiff the creditors. Is there any other way to go?
Grant: Why, yes. We could reduce taxes, reduce spending, reduce regulation, and institute sound money.
Freeman: Now you’re talking. Leave aside the challenges of fiscal policy for a moment. Every politician in the country is talking elliptically about “Fed reform.” If the next president turns to you for advice, what specific changes would you recommend in the monetary arena?
Grant: Interest rates ought to be discovered in the market, not administered from on high. They can’t do their essential work if someone, say a central bank, is muscling them around. Let’s get the central banks out of the business of using interest rates — and stock prices and exchange rates, too – as instruments of national policy. Today, investors live in a hall of mirrors: They don’t know which values are real and which are distorted by monetary manipulation. Market-determined rates will help restore clarity.
Freeman: And then?
’Interest rates ought to be discovered in the market, not administered from on high,’ says James Grant.
Grant: That chore out of the way, the next administration ought to open a debate on the nature of the dollar. As it is, the Fed materializes it on a computer keypad to pursue its macroeconomic agenda.
George Gilder correctly asks: Is money a measuring stick or a magic wand? The former is the correct answer.
Freeman: It is hereby stipulated that money is a measuring stick. Now, what is your recommendation on the fiscal side? Other than electing the next Thomas Jefferson, how might we “reduce taxes, reduce spending, reduce regulation,” given the structural problems in Washington?
Grant: Forgot to mention a prerequisite: civic virtue.
Freeman: Yes, there’s not much civic virtue in evidence these days and we can agree, I hope, to put Rich Lowry on that case. But let’s finish up here with your own threat assessment. As you look around world markets, what bubbles do you have on your watch list?
Grant: If by “bubble,” you mean a palpable distortion of value, I rank sovereign debt at the head of the class. A bond is a promise to pay money. Governments, which make the promises, also print the money. They are inherently conflicted, for which reason Comte de Mirabeau was known to say, “I would rather have a mortgage on a garden than a kingdom.”
Freeman: Any specific counsel?
Grant: I would advise the owners of ETFs to look inside the portfolios of their holdings to see what they really own.
Freeman: Thanks, Jim.