Negative Interest Rates – Cat’s Cradle by W. Ben Hunt, Ph.D. – Salient Partners

Cat's Cradle

“I’m not a drug salesman. I’m a writer.”“What makes you think a writer isn’t a drug salesman?”

“No wonder kids grow up crazy. A cat’s cradle is nothing but a bunch of X’s between somebody’s hands, and little kids look and look and look at all those X’s . . .”

“And?”

“No damn cat, and no damn cradle.”

The Fourteenth Book is entitled, “What Can a Thoughtful Man Hope for Mankind on Earth, Given the Experience of the Past Million Years?”

It doesn’t take long to read The Fourteenth Book. It consists of one word and a period.

This is it: “Nothing.”

– Kurt Vonnegut, “Cat’s Cradle” (1963)

 

Negative interest rates are ice-nine. If you don’t know what ice-nine is, read the book. Spoiler alert: the world ends.

TIAA will end the voluntary expense waiver on the CREF Money Market Account by April 14, 2017. This decision was reached after ongoing discussions with the TIAA and CREF boards, as well as our state insurance regulator. It is anticipated that unless interest rates rise sufficiently, one or more classes of the CREF Money Market Account may have negative yields after the waiver ends.

– TIAA Plan Update Review Guide 2016 [italics mine]

epsilon-theory-ben-hunt-cats-cradle-dickinson
A great Hope fell
You heard no noise
The Ruin was within.– Emily Dickinson (1830 – 1886)

Admit it. You assume her poetry is soft because she’s a woman and writes about flowers. Read it again. Emily Dickinson is a total badass. You don’t even feel the slice of her work, but then you see the blood.

I saw her today at the reception
In her glass was a bleeding man
She was practiced at the art of deception
Well I could tell by her blood-stained hands
You can’t always get what you want
You can’t always get what you want
You can’t always get what you want
But if you try sometimes you just might find
You just might find You get what you need
– Mick Jagger and Keith Richards, “You Can’t Always Get What You Want” (1969)

 

Fed Governor James “Bleeding Man” Bullard

The Federal Reserve Bank of St. Louis is changing its characterization of the U.S. macroeconomic and monetary policy outlook. An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

– James Bullard, “The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy” (June 2016)

Jim Bullard’s resignation letter here in the Silver Age of the Central Banker, as he adopts the game theoretic concept of minimax regret theory and the postmodern social theoretic concept of narrative construction.

And the cat’s in the cradle and the silver spoon
Little boy blue and the man on the moon
When you comin’ home, Dad
I don’t know when, but we’ll get together then
You know we’ll have a good time then

– Harry Chapin, “Cat’s in the Cradle” (1974)

 

Though nothing can bring back the hour
Of splendour in the grass, of glory in the flower;
We will grieve not, rather find
Strength in what remains behind;

– William Wordsworth (1770 – 1850)

 

epsilon-theory-ben-hunt-cats-cradle-splendor

Warren Beatty and Natalie Wood’s best work. I experience this movie so differently today, as the father of four teenage daughters, than I did watching it as a young man. In investing as in life, we all love and lose. The question is how you deal with it.

If we will be quiet and ready enough, we shall find compensation in every disappointment.

– Henry David Thoreau (1817 – 1862)

In his classic work on game theory, “The Strategy of Conflict”, Nobel Prize winner Tom Schelling begins by writing about cooperative games, where players are trying to arrive at a common outcome for a mutual benefit. This is a different class of games from the competitive games like Chicken and Prisoner’s Dilemma that we usually consider when we think about game theory, but in truth it’s the cooperative games that account for so much more of our daily lives and social interactions. For example, driving on the right-hand side of the road (or the left-hand side in the UK) is an example of a cooperative game equilibrium. The only thing that matters is that we agree on which side of the road we drive on, not that my preferred side or your preferred side ends up being the final choice.

The most interesting cooperative games are those where — unlike driving conventions — we don’t have a government or other authority telling us what our agreement should be. Even more interesting are those games where we can’t communicate directly with the other players to talk through the appropriate equilibrium behavior that works for all concerned. For example, let’s say that a friend and I agree to meet in New York City at 1 pm tomorrow. Unfortunately, we neglected to agree on a location to meet, and now I have absolutely no way to communicate with my friend, or vice versa. What do we do?

As Schelling writes, almost everyone will, in fact, meet their friend successfully tomorrow at 1 pm in New York City. Where? By the big clock in the middle of Grand Central Station. Why? Because there is Common Knowledge — something that everyone knows that everyone knows — to guide both me and my friend to this outcome. Now Schelling doesn’t call it Common Knowledge — he calls it a focal point — but it’s exactly the same thing. And once you start looking for focal points that drive our strategic behavior in the cooperative games that comprise our daily social lives, you see them everywhere.

Okay, Ben, all kinda interesting, but what’s the point? The point is that when governments undertake emergency actions and extraordinary policies, they obliterate the focal points that make our cooperative games of investing and market making possible.

Specifically, extraordinary monetary policy has obliterated the focal points of price discovery. When you no longer have Common Knowledge regarding the price of money, you don’t have Common Knowledge regarding the price of anything. For more than seven years now, investors have been sitting down at the poker table ready to play the cards they’re dealt, only to find that central bankers with infinitely high stacks of chips have sat down at the table, too. And as any experienced poker player knows, the cards are meaningless if you tangle with an opponent like this. Maybe you think that was a bad flop. Maybe you think Nestle investment grade debt is worth 99 cents. But

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