Taps Coogan – July 12th, 2022

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Jim Grant, creator and editor of the esteemed Grant’s Interest Rate Observer, recently had Edward Chancellor, financial historian and author of ‘The Price of Time,’ on his ‘Current Yield.’ The two esteemed interest rate authorities talk at length about the history of interest rates as well as the long term outlook for rates and in light of the 40-year bond bull market potentially having come to an end.

In the wide ranging interview, Mr. Chancellor describes the misuse of interest rates by central banks:

“They view interest as a lever to either prevent the economy from overheating, in which case, in theory at least, they might raise the interest rate or lowering it when the economy is cooling too much. So it’s sort of a joystick in an aircraft… They way I see it, the question of interest as a way to control inflation is only one, and perhaps almost the least important, of the functions of interest… I argue in the book that the low hurdle rate actually contributes to two forms of capital misallocation. One is that it keeps capital trapped in businesses where it shouldn’t be any longer. I think this is behind the rise of the so-called zombie companies, companies whose interest charges, even at low interest, actually exceed their earnings… The zombie phenomenon is associated with lower returns on capital and falling productivity. Now, there is another area where a low hurdle rate is very problematic. You can also have very speculative capital allocation. The unicorn phenomenon, the amount of money that has gone into Silicon Valley since 2008 and the extravagant often slightly absurd companies that have been funded with very cheap money… is another feature… Unicorns graze on low interest rates…”

On the outlook for rates:

“Investors and everyone else tend towards linear extrapolations… They spot a trend and they think it goes on to the moon… In the near term… I think we are going to have a much more volatile inflation experience than many people think… We don’t know the path but if we are thinking… where we are likely to be in ten years time… ? The market is pricing in less than half the inflation over this current cycle than the 7.5% inflation that the US had over the so called ‘Great Inflation’ …The only way to get out of this situation where low rates were begetting low rates, was for an inflation to burn off the excess of debt that had accumulated during this period… I always thought this has to end in an inflation in some stage, a bonfire of the paper liabilities that we have accumulated… The keeping of interest rates below the rate of inflation is the only way to burn off the debt… I’m reckoning that the (2020 low in Treasury yields) was the turning (point)… I think it is… likely that we are beyond the turning point of a multi-decade cycle. There are other things that point in that direction…, Charles Goodhart arguing that the ageing populations, contrary to what was said in the whole secular stagnation hypothesis…, the aging of global populations and in particular the aging of China’s population and other forces leading to the unraveling of globalization will drive interest rates up… Periods of so-called ‘Globalization’ seem to coincide with bond bull markets. Take the late 19th century, and there is sort of a reason to think why that might be the case. If developed countries are trading more with developing countries where labor is cheaper that is a downward drag on wage and inflation and those are two components that go into interest rates. So, I think interest rates are trending up…”

A small point of contention, the evidence that aging populations lead to deflationary forces and lower interest rates is borne out by over 20 years of history in Japan, ten years in Europe, so on and so forth. Aging and shrinking populations save more and consume less, reducing endogenous money growth and resulting in excess production capacity. The areas where they do consume more, primarily healthcare, often fall on government balance sheets. In other words, corporate and government debt goes up, which doesn’t increase the money supply, while bank lending goes down (on a relative basis). That’s why inflation in Japan is still just 2.4%, despite having the most accommodative monetary policy in the world for decades.

The rapid aging and shrinking of China’s population, which began this year, is going to soften demand for nearly everything ex-healthcare in the country responsible for nearly all of the world’s marginal demand growth.  

As for de-globalization, despite all the talk, the US trade deficit has never been bigger.

The best cases for sustained inflationary pressures are probably the high resource intensity of the ‘energy transition,’ the low levels of capital investment by the world’s major resources producers, rising living standards in India or Africa, and/or any escalation of global conflicts. 

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