In Wednesday’s note, he wrote about the danger of near zero interest rates around the world. He’s concerned about our near future:
Investors cannot make money when money yields nothing. Unless real growth/inflation commonly known as Nominal GDP can be raised to levels that allow central banks to normalize short term interest rates, then south instead of north is the logical direction for markets.
I hate to say it, but…I disagree with Bill Gross. I know, it’s not a good look for me. The guy is a billionaire. I’m not.
The nature of investments
Stay with me, though. Let’s start with a simple question: what’s an investment? Here’s my answer: a machine that turns a given input into a more valuable output.
When we think of investments, we care about what the machine itself looks like. Different machines behave in very different ways, even though they all turn inputs into more valuable outputs.
What’s the simplest investment you can imagine? Think about it for a second. I don’t think there’s a right answer. But try to come up with something.
For me, I think the simplest investment vehicle is a loan. As an input, I’m supplying money (as a creditor, to a debtor). As an output, I’m receiving more money (a return of my loaned dollars, plus interest). It’s tough for me to come up with a simpler investment machine than that one.
What’s a more exotic investment machine? Stock in a publicly-traded company. At first glance, it looks super simple. My input is money to buy the stock. My output is the money I get when I sell the stock, presumably for more than the purchase price.
But the devil is in the details. For a loan, I have a contractual agreement in place. There is only a small risk that I don’t generate the return I expect. For stock in a publicly-traded company, there’s no similar agreement. I’m entitled to an ownership stake in the company. Either the company succeeds or it fails. My return hangs in the balance.
These two investment machines (loans and publicly-traded company stock) are clearly very different. Loans turn money into more money. Companies turn money, plus a whole host of other assets (people, real estate, machines, etc.) into more money. And because I have an ownership claim on the company, I certainly care about the company’s inputs and outputs.
The impact of low interest rates
Near zero interest rates mean that, in a relative sense, making money only with money becomes less attractive. The returns are smaller.
As an investor, I’m seeking to turn my money into the most money possible, given my risk allowance. If I want as little risk as possible, I have little choice but to make money only with money. If, however, I’m willing to take on more risk, then I can try to combine my money with other resources (people, real estate, machines, etc.) to make more money.
Here’s one place we have to be careful. Take a large company like Coca-Cola. Coca-Cola is going to run its business the way it’s going to run its business…regardless of its stock price. If low interest rates steer more investor money toward Coca-Cola, its stock price goes up. But that’s about it. Our economy doesn’t appreciably change.
The economy really wins, on the other hand, if low interest rates cause people to start companies they wouldn’t otherwise start. Or if existing companies decide to expand, using cheap loans, in ways they wouldn’t otherwise expand. It’s the companies on the interest rate margins that really determine how much stimulus the economy sees from lower interest rates.
Clearly you don’t want interest rates so low that no one chooses to lend money. The whole point of low interest rates is to encourage borrowers to use cheap money to start or grow businesses. If no one is willing to lend money in the first place, the deal breaks down.
That’s an interesting part of our current predicament. You can’t really drop rates any lower, and yet lenders are still willing to lend. Their risk tolerance and/or business model demands it. As long as you have both lenders and borrowers, you have a chance to ignite the economy.
Why aren’t we seeing more growth?
I read somewhat regularly about the world’s recent history with low or negative interest rates. The most common theme? People wonder why we haven’t seen more growth. The US, Europe, and China are all under-performing their historical growth trajectories. Why hasn’t easy money spurred more growth?
First, I’m not an economist. So the short answer is I don’t know.
Second, I’m going to hazard a guess anyway, because this is my site, and what’s life without a little wild conjecture? I think the world’s economy is built around making money with money. It takes time to shift our global infrastructure toward more exotic growth opportunities.
Money is a commodity. Two $100 bills? The same. Two pieces of real estate? Not necessarily the same. Two manufacturing plants? Not necessarily the same. Two people? Not at all the same.
Making money with money had a good run. But it’s a commodity business. It’s returns are being driven down to zero, because any two people, or institutions, with the same amount of money bring the exact same value.
Making money with people, with facilities, with ideas and intellectual property…that’s not a commodity business. Not even close. We have huge potential for differentiation. You’d expect to generate much better returns with such a unique value proposition.
Fear or excitement. Your choice.
And that’s why you can be scared or excited. If your existence is built around making with money, well, you might be out of luck. But if you intend to make money with other assets, chiefly your brain and your dedicated effort, then you should be excited.
As scientists and engineers, we fall into this latter bucket. We bring unique intellectual value. We can put pieces together in clever ways. We can drive the innovation that will generate the returns investors seek.
If anything, there’s been no better time to contribute with your brain. The market values money less than it practically ever has. It’s valuing all the intangibles much more. The intangibles make you who you are.
Don’t let the worries of rich folks get you down. Yes, they’re super wealthy. They’re highly respected. They have great judgment. But a lot of them are economic dinosaurs. The game is changing. It’s our turn to play.