Won’t You Take me to Funkytown? – Negative Interest Rates, Asset Taxes and Inflating Markets
Well, I talk about it, talk about it
Talk about it, talk about it
Talk about, talk about
Talk about movin’
- Funkytown by Lipps, Inc.Li Lu On Understanding Competitive Advantage In 2021
On April 9th 2021, Bruce Greenwald, the founding director of the Heilbrunn Center for Graham and Dodd Investing at Columbia Business School, sat down for a Fireside Chat with Li Lu, the founder and chairman of Himalaya Capital as part of the 13th Columbia China Business Conference. Q1 2021 hedge fund letters, conferences and more Read More
On Friday the Bank of Japan (aka, the Japanese Fed) cut the rate on current accounts that commercial banks hold with it to minus 0.1%, adding that it will push the rate even lower if needed. Effectively, this means that banks will be charged to keep excess assets with the central bank. This move sparked a big jump in stock markets around the world. Some mistook the rise as being predicated on the assumption that negative interest rates would work to spur growth and therefore earnings and therefore stocks. This is wrong. Stocks moved because as a financial asset they became slightly more attractive than they were the day before, especially when having cash has a tangible cost, and when the same people that just took rates negative said they will take them more negative if they have to. So asset allocators did the logical thing and decided that the prospect of losing money in stocks was more attractive than the guaranty of losing it in bonds. So stocks went up.
The common explanation for negative interest rates in countries that have implemented them is that negative rates will encourage banks to lend and consumers to spend rather than save. It’s the same argument for keeping rates low all over the world – low rates drive lending which drives consumption by individuals. But this isn’t happening. Japan has had ultra-low rates for years and its economy has been terrible. Trillions of debt in Europe now trades at negative interest rates and its economy isn’t exactly booming. Denmark, Sweden and Switzerland all have negative interest rates, but consumer spending isn’t going up there. In fact, savings rates have been going up in lockstep with the decrease in interest rates, exactly the opposite of what the geniuses at the various central banks expected. Welcome to Funkytown.
Why is this happening? Simply, savers are scared. Lower interest rates have wrecked their retirement plans. Say you were doing some financial planning 10 years ago and plugged in 3% from your savings account. Now its 0%. You still have to plan for your retirement. Plug in 0%. What happens to your planning now? 0% compounded for X years is 0%. The math is simple. So in order to have your target savings at retirement, you need to save more, not spend more. But for some reason, the economists that run central banks around the world can’t see this. They are all stuck in their offices talking to one another and self-reinforcing this myth that they can drive spending up by reducing the rate of return on investments. Want to see consumer spending go up? Don’t wreck their savings plans so that they are too scared to spend. But that’s too simple. Instead, central banks use a chain of causation that doesn’t exist to try to create change 3 or 4 steps down the line. It hasn’t worked, and it won’t work. It isn’t in an individual’s self-interest to go out and spend their money on more “stuff” in order to spur economic growth.
Won’t you take me to Funkytown?
- Funkytown by Lipps, Inc.
So how do you get people to do collectively what isn’t in their own best interest to do individually? Put another way, how to you get people to spend the savings they think they will need in the future to ensure some basic level of survival, and instead spend it today?
I think governments need to be very explicit in what they are doing. Right now, they use terms that the average person doesn’t really understand, or, put differently, people don’t understand how the policies being tried over and over are supposed to affect them. So they ignore them.
Why do central banks want higher inflation (of about 2%)? Because they think that this is the optimal level that will make people spend today instead of waiting for something to be cheaper tomorrow. At 0% inflation, there is no incentive to spend today versus a year from today, as prices will be the same. The Fed targets 2% because it believes that is the “right” level that will make consumers move to spend sooner. They are wrong. Consumers don’t think that way. They think in terms of what do I need, what do I want, and what am I willing to pay for it. Needs are bought somewhat irregardless of price. Think food, and homes. Most people in the U.S. actually like it when home prices appreciate at a level that they can see – like 4-6%. I’d hazard to guess that this is the level of interest that would make them feel comfortable spending a bit of their savings too. The Fed is literally “too cute” by half. No one cares about 2%. It’s meaningless. People don’t shop their credit cards, or even call the issuer of the ones they have, for 2%. It’s seen as not worth their time. So all this talk about quarter point moves, half point moves, negative interest rates, is just that – talk. The people the message is intended for aren’t listening.
So again, how do you get people to do collectively (spend now) what isn’t in their best interest to do as individuals (if the prices of goods are going down or are flat, then saving and waiting for the better quality TV, or car, or clothes, makes perfect sense). Insuring against disaster – like losing your home altogether – carries a lot more weight in people’s minds then losing 2% in purchasing power through some unseen inflation that doesn’t even exist at the moment anyway. Central bankers are so divorced from reality that they really think (or at least act like they think this way) that these small moves in borrowing rates, even to negative interest rates, will scare people enough about their future purchasing power that they will throw caution to the wind and go buy stuff they don’t really need now. Because if the really needed it, I mean, need it to survive, they probably already bought it, don’t you think?
Gotta make a move to a town
That’s right for me
Town to keep me movin
Keep me groovin’ with some energy
- Funkytown by Lipps, Inc.
I think the only way to get people to spend their savings now, especially in stagnant economies like Japan’s, is to skip all the intermediate, opaque steps and just tax their financial assets. Just do it directly. Reduce their purchasing power today. That’s all inflation is – a reduction in purchasing power in the future. So pull it forward, and make it crystal clear to the masses that aren’t reading central bank pronouncements what they are doing. Do it in size. And do it monthly. Charge 25 basis points a month on all financial assets – stocks, bonds, banks accounts. Every month that goes by, savers will see less money in their accounts. This is no different than inflation running at 2% or 4% or whatever the target is, but it is a lot more visible to the people you’re trying to affect. So pull a Nike and Just Do It. I’d bet that after about a year, you’d see consumer spending up, inflation up, growth in the economy, and businesses expanding, at which point you could rescind the tax and go back to normal. But you need to shock the system to get there. Incrementalism hasn’t worked yet and won’t work in the future. Hiding what they are doing – trying to boost the rate at which consumers’ purchasing power decreases – isn’t working either. Sometimes you need to use a defibrillator to shock a stopped heart to restore its normal rhythm. Apparently you need to do the same to a whole economy. So do it.
This week’s Trading Rules:
- When central banks take steps to defend their currencies from depreciating, take the other side of the trade. They will always lose eventually or have to stop floating their currency.
- Don’t short on valuation – when rates approach zero, the NPV of future cash flows approaches infinity. The math stops working. And some people use that math.
Markets have bounced very nicely in the past week and a half. Will it continue? I think the S&P 500 could easily move up to 2000. After that, I expect it to bounce between 1900 and 2000 for a while. What’s really interesting is what is happening beneath the surface. I think a wave of M&A is coming to community banks, and that companies that have been crushed on the back of oil’s decline and aren’t actual oil drillers are, for the most part, interesting investments down here. Leadership in the markets will shift from growth to value and large-cap to small. When? Soon…
SPY Trading Levels:
Support: 188/189, then 181/182, then a little at 175.
Resistance: A ton at 200, 204.5/205, then it’s not going above 209/210 soon.
Positions: Long and short U.S. stocks and options, long SPY and IWM options.