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A Brief History of the Past 10,000 Years of Monetary Policy
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This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author(s). It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. Epsilon Theory will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results. Statements in this communication are forward-looking statements. The forward-looking statements and other views expressed herein are as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Epsilon Theory disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. This commentary has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Epsilon Theory recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Great stuff - and here’s a request for a sequel note on the effects of the undoing of the decades-long artificially suppressed interest rates – on global supply chains, globally organized conglomerates, and last but not least, the freedom of movement.
If you’re already knee-deep wading in Austrian waters, might also go the roundabout way into the production theory and its relation to time preference, that underpins everything of the current global organization of the production and shipping of intermediary and consumption goods.
The UK has a special kind of pension system that is not clearly demarcated in the common knowledge spectrum. Public sector employees have been granted (by themselves) defined benefit pensions (defined liability to issuer [treasury]) in contrast to private sector employees who have to bear the slings and arrows of outrageous fortune (defined contribution schemes [no legal liability to issuer other than, ahem, diligence]), except the scale of the government richly defined benefits has set the pace and expectations of all pensions because well it has to be fair and equal and all that. Everyone has become certain that all pensions always pay out except sometimes in the quiet backwaters of private industry when a corporate pension scheme falls of its yacht.
Is it worth mentioning how ridiculous it is that the blame goes no further than the fund manager rung, or how actual macro monetary risk is distorted by hate focused blame from a public who have almost no control of the lens?
First of all - the note is really good. I do appreciate when someone with a lot of knowledge goes through the trouble of making something super complicated - less so!
As I read I only made a couple of mental notes, in no particular order of importance:
even for cynic, it is perhaps not super useful to define government on only a singular dimension- as “the people with a local monopoly on the legitimate use of violence”. It’s not that it is not correct, perhaps I just think it is not a very useful simplification at this particular point in history where populism is on the rise everywhere and democracy is facing serious challenges… It will be a popular take though, so perhaps it is worth it.
perhaps in a similar vein, to let the equation of “the rich” with “job creators” stand unchallenged, is also perhaps not ideal at this point in time - as “trickle down economics” is having a tough old time these days.
Primarily, reading your note (and your recent tweets about ZIRP etc) has me thinking of a recent book review I read in the Financial Times. I tried to post the link but I believe there is a paywall.
It is an article by Martin Wolfe, writing about a new-ish book called “The Price of Time” by Edward Chancellor. A friend of mine (at a UK investment house called Ruffer) recently sent me a copy and I guess I was trying to figure out if it was going to be worth my time reading it… As it happens, I very much suspect that you and Edward Chancellor agree on the world at large, as his main assertion is the the price of money and therefore time has been far too low, for far too long.
So, in summary - I really enjoyed the article. And if I got to wish for a follow up note it would be one that goes deeper into the “time preference of money” topic. I find this subject really interesting as it is yet another area of economics that exists very close to philosophy and is therefore probably also closely related to the power of narrative.
I forgot to insert my [sarc] notation on that one, Em! I think the whole “job creators” word play on tax cuts is absolute bollocks.
Pensions are similarly skewed in the US. The private sector has nearly no defined benefit plans anymore, other than in companies that have been around 50+ years. The public sector historically paid less in direct compensation but offered much more generous defined benefit pensions. As defined benefit plans disappeared for private sector workers they continued to flourish for public employees. And, the impossible 7-8% return promises in a world of high valuation and minuscule interest rates has led to all manner of behaviors that also involve consultants and hidden leverage. The massive shift to private equity and private credit has the money flow from public pensions as the motive force.
Johannes is correct: any close reading of this note ends with the question of “How did we get here, and why?” And while many of us here have our suspicions, and they are likely pretty similar - central banks choosing to inflate assets, and keep them inflated, to avoid political consequences - it certainly warrants further exegesis.
And of course, “Against the Gods” by Peter Bernstein should be required reading for anyone looking to further understand the history of leverage.
I hope the note breaks through due to how well it lays out the issues and walks the reader along the path to where we are. I fear that investors still aren’t internalizing the cost and risks from putting interest rates back to a level that nominally covers inflation.
I attended a dinner with five other couples in my peer group. White collar, upper middle-income, empty nesters. All now have children trying to join the homeowner’s club as they start careers and families. The overwhelming sentiment remains 6.5% mortgages are sooo reasonable! Lots of anecdotes of each couple’s first mortgage cost (all between 9% and 14%). None are connecting the dots that they were financing $100k @10% ($878 monthly for a 30 year loan). In neighborhoods with schools they want their grandchildren attending, their kids need to borrow $600k, and cobble $150-200k in a down payment! That is a $3792 per month. Worse, the house price moved up $50k from when junior started looking and got prequalified for a 3% mortgage. So, they budgeted $2319 (3% on $550k) and the market has completely moved beyond their budget. Our generation got the benefit of the value change as rates fell. Our kids face paying record valuation and not having persistent refi cycles to build or extract equity.
There are substantial risks to the market clearing, and a loss of equity when home prices fall 10-20% and a job related move becomes necessary. Similarly, institutional investors are deer in the headlights to the simple math of higher cap rates impairing any deal structure with leverage done in the last decade.
is absolute bollocks.
I see what you did there
Great note Ben , I might add that in addition to all these pensions turned hedge funds are the hedge funds themselves and some of them are on the wrong side of all this volatility. I think the global estimate for derivatives is 1 QUADRILLION dollars.
That is how biased and naive I am to believe in somewhere that is not twisted out of shape by neo-Keynesian legerdemain. Does Europe have them also?
On the note of deer in the headlines, I came across a pretty solid article from Bloomberg published yesterday:
European Real Estate’s Decade-Long Party Is Coming to an End – likely paywalled, archive.ph might help here…
A place where you can already see the transmission mechanism between higher interest rates and lower asset prices: real estate companies. So much so that Vonovia SE, biggest corporate landlord of flats in Germany, finds its stock is two thirds off the highs from Q3/2020 – and that’s before having to write off significant amounts of Euros on those assets it does retain (i.e, cannot offload fast enough).