JIM GRANT: Price of money is called rate of interest. The most consequential price in capitalism, it seems to me. Interest rates do all these essential things, discounting future cash flows, and measuring investment hurdle rates, and giving us a sense of how much credit risk there is in a given transaction. And when you suppress, or otherwise, manhandle those rates, you are withholding, destroying information. You are letting people do business in the dark, or in a hall of mirrors. We are all, to a degree, blinded by the so-called financial repression.
I am Jim Grant. And we are here in these palatial office, from which comes every two weeks Grant's Interest Rate Observer. I'm going to be talking about everything, which seems like a big topic, but we're going to do our best.
INTERVIEWER: What's your framework for thinking about the economy?
JIM GRANT: Well, everyone gets up in the morning and goes to work, and tries to do better. So what's different-- I mean, that's a steady state, people strive to improve themselves, and therefore, the world. So I'm certainly not bearish on that activity. What complicates things is money, credit, and the organization of people in what we call the economy. The economy is kind of a amorphous thing. How's the economy? The economy.
I think the problem is not the humans getting up, going to work, and striving, but rather, the setting in which they do that. And that setting has a great deal to do with such things as interest rates and central banking, and the like.
INTERVIEWER: Can you give us a brief history of central banking?
JIM GRANT: A brief history of the biggest question in the world. Well, central banks were founded to do the government's work. I'm thinking now the Bank of England, beginning in the waning years of the 17th century. It wasn't to lift up the value of equities. It wasn't to iron out the fluctuations of the business cycle, because there were a few equities, and the business cycle was not really invented as a concept, yet the central bank was to have helped the government raise funds with which to carry out the work of the state, including the waging of war. So let's fast forward, shall we? To, say, 1700, 200 years, or so, when the Federal Circuit started in 1913, or '14.
The idea was to iron out the spikes in the rate of interest that seemed to roll around every autumn, which was crop moving season. So that was the big event in a agricultural economy, was financing the movement of crops from the interior of the country to the seaboard. And you needed money to do that. And credit was sometimes tight, so the Federal Reserve, it was thought, would provide seasonal liquidity. It would make the currency elastic, was the term. So that sounds benign enough. What happened next was a succession of mission creeps. And what set out as a neutral institution to provide liquidity to everyday commercial IOUs and to help farmers and wholesalers with the movement of grain, that all-- it kind of snowballed.
Until it has come to, about what? Has come to financial repression. I'm skipping about seven, or eight decades here, but we haven't got all day for this. So now, what we have, is, like, my goodness, what don't we have? We need the Fed to provide ways we learn now, overnight re-purchase facilities, whatever that might be. You can ask about that. And we need the Fed to keep the stock market up. We need the Fed to keep the-- yes, now we learned that the Fed also has a political role. William Dudley now proposed the Fed ought to be, like, targeting the president. So the Fed now is all over the place doing all manner of things. It has supposedly two remits, or jobs--
One is maximum employment, and the second is stable prices, or price stability. But stable prices, it describes there-- it defines-- it chooses to define as a 2% rate of rise in the-- That's not stable. That's inflation, right? And then full employment. Full employment, where, on Wall Street, everywhere? Once, at an open forum, I asked the president of the Federal Reserve Bank of New York, Mr. Williams. I said, has it occurred to you, Mr. Williams, President Williams, I said, has it occurred to you the Fed's actual two remits are to finance speculative bubbles, and then, in the end of those, if they burst, to come in and to clean up the mess. So the remit would be arsonist and fireman. Has that occurred to you?
And he said, no. So you can read books, and books, and books on this topic, on the cycle, and on the central bank's complicity in speculative bubbles. And on the theory of mispriced interest rates. But in about 1818, British statesman called Lord Liverpool summarized this in one delightful short sentence. And here it is. The tendency of inconvertible currencies is to create fictitious wealth bubbles, the collapse of which produces inconvenience, at the lifelong inconvenience, standby for inconvenience.
INTERVIEWER: What's your view of the current rate environment?
JIM GRANT: What is striking about today's rates, such as they are $15 trillion, or so, as we sit here talking, less than zero in nominal terms, what's striking about these rates is they have no predecessor in millennia of interest rate history. Every time I write this line the first time in 2,000 years, and I wrote 3,000 years, and finally I see looking back at some of our issues at Grant's, 4,000 years, and nobody's corrected us yet. Yeah, and we'll keep going until somebody says, no, not 4,000. But anyway, there's certainly capitalists that lead us to zero, which is central bankers, because there's nothing like this in the history of interest rates, as long as that history might be.
In the depression there were no-- Great Depression, but there is nothing like this. There have been before negative treasury bill yields. It's not uncommon. But what is unprecedented is negative nominal note yields and bond yields, never before. And I think that's the result, not of natural market forces but rather of central bankers. The question is, did rates fall, or where they pushed? And they say, well, they fell on their own accord after the events of 2008. That was natural enough. But to go below zero, no, that's the artifice of the central banks.
INTERVIEWER: Are demographics and deflation pushing rates down?
JIM GRANT: Well, there are a lot of reasons that people give why rates should be low. And some of them are, kind of-- they're persuasive. They'll say that the rate of growth in the world's economy, as if we could measure it, is going to dwindle because the birth rates worldwide, and many of the developed countries are dwindling, certainly, in this country, they are. OK, that makes sense, since debt levels are high, that makes sense, too. Debt is a kind of a weight on production. The miraculous advances in digital technology ought to bring down costs, therefore, prices. That, too, is a plausible reason.
But we've had deflation before in the world and never before have we had negative nominal rates. We've had deflation in the final quarter of the 19th century, the 1875 period in 1900. And great innovation prices fell because it became cheaper to produce things. Wages fell, but less than prices, therefore, real wages went up. It was a time of disappointment for some. But on balance around great prosperity and advance in the human condition.
So I don't buy it that these rates are some sort of natural outgrowth of deflationary conditions. They say that they're the creation, the willful creation of people like Mario Draghi, and the BOJ, and, indeed, the, kind of, brain children of Ben S. Bernanke PhD, who was one of the intellectual leaders on all of this.
INTERVIEWER: What's the role of corporate debt in rate policy?
JIM GRANT: The president of the Dallas Fed, early in springtime, say, 2019, said approximately this. He said, we ought to not raise rates and perhaps lower them, because the burden of corporate debt is so heavy. And you think about that, and it is very low rates that encourage, indeed, insight the creation of debt, because after all, if you can borrow for next to nothing after tax, why not do it and go buy a company, or create a private equity fund, or something? But the accumulation of those debts makes the economy more fragile, because when incomes fall, revenues fall, indebted people, indebted companies struggle to pay interest expense. And if you don't pay interest expense, you lose the ownership, you lose control of the company. You file for bankruptcy.
So the more net debt there is in a society, the more fragile is the economy, and the more reluctant are the central bankers to raise interest rates, and the more disposed they are to lower them. So it becomes rather a vicious circle.
INTERVIEWER: Why did WeWork bond prices plunge?
JIM GRANT: Well, the question to me about WeWork bonds is not why they were roughed up so badly in the past couple of weeks but how they ever got to par. Here's a company that wanted you to know that it wasn't going to cover fixed charges. You knew that because of the way it did its own business, because the way it spent, because of the accounting adjustments that the-- community adjusted EBITDA, that is adjusted, adjusted, adjusted, adjusted, adjusted EBIT. As I count, I think I got all those in there. And certainly, WeWork is not alone.
I mean, Wall Street forever has generated accounting metrics to accommodate the deal doers and the promoters. EBITDA itself was a creation of the investment banking generation in the late 1980s, early '90s to facilitate leveraged buyouts. But what is new now a little bit is the extreme of the accounting adjustments, or the add backs to pro forma EBITDA. The investment banks will have you believe that after this merger, or this roll up is completed, they will have two companies, one company will have all of these efficiencies, and then they'll fire people, and they'll save money. But it turns out that these promised add backs don't really add up.
But The root, root cause, the fundamental remote cause of all this debt issuance and the mispricing of credit, it seems to me, is the scramble for yield at a time of artificially low rates. People have to have interest income, at least they feel they must. People don't have to have interest income, or they certainly want it. And they bend over backwards to get it. In the bending, they take considerable risks. And those risks roll up together and they constitute one of these bumps in the night that tips us over into a panic, or a recession.
INTERVIEWER: What's your view of China's trade surplus with the US?
JIM GRANT: The United States is either the beneficiary, or if you like, the victim of that currency, which we call the reserve currency. The reserve currency is the world's principal monetary brand. Way back when it was a pound of sterling, today it's the US dollar. And if you own the reserve currency, that means that you can spend more than you save. It means that you can consume more than you can produce. That's what a deficit in trade means. And everyone seems happy for a while, maybe a long time. So we import things. Well, we like that. The things are sensibly priced. Indeed, they seem cheap to us.
Go to Walmart and you're astonished at how cheap things appear. That's good. The Chinese, for their part, keep factory chimneys smoking when people give employment to factory workers. And you got these financial claims called treasury bonds, which yield something. So that's OK for them, too. Until such time, the as the lack of factory jobs in one country, say, this country, and the paucity of yields in the other countries, say, China, crystallize into a trade dispute, maybe there's more to it than merely a sense of a poor bargain. But in the case there is a dispute, and one side says, we really need more manufacturing jobs, and we're going to put up import barriers, we call them on tariffs on imports, and we don't want so much of your manufactured goods. But you, please, continue to buy our treasuries.
And the other side, called this side China, might say, well, actually, you can do that, you can put up tariff barriers, but we think we're not going to buy so many soybeans, or treasury bonds. And that is a problem. And that's kind of where we are now.
INTERVIEWER: What's the risk of ultra low rates?
JIM GRANT: Well, the central bankers, especially in Europe, seem not to consider the possibility that lower and still low rates, verging on low rates, that this succession of policy initiatives might actually be counterproductive. There is an analog in medicine, if you administer a drug to a patient, the drug doesn't seem to be working. And you give some more and the patient seems actually to be getting worse. And if you give some more, still, the patient really is not feeling well. A thoughtful doctor might pause and say, I wonder if this medicine is actually efficacious, if it isn't perhaps poisoning my patient. You might at least consider that thought.
That's something that seems not to cross the minds of the mandarins in Europe. And I think it ought to. I mean, the European economy, again, they use this grandiose-- the economy, but the functioning economic system of all these countries seems not to be thriving-- it seems not to be thriving. Whatever we call this economy, it's not thriving. And it has thrived in times past, but has not thrived, ever, under a regime of negative rates. When it has prospered, interest rates were positive. Not to say that positive interest rates cause it to prosper, but certainly negative rates may conceivably be responsible for helping it to suffer, causing it to suffer. So I think that these central bankers are a pretty incurious lot. They don't consider the opposite case of what they're doing. Never admit error.
On Wall Street, the really successful people always think of the opposite case. They invert things. Charlie Munger is always telling us to invert. What about the opposite? You ever heard a central banker, say, oh, gee, I wonder, who seems not to be doing what we're supposed to be doing. Let's think, at least, about doing something else. Never. They might say it in private, but their public affect is omniscience, and an unqualified confidence. Maybe they feel they have to project that, but intellectually it is barren.
INTERVIEWER: What's your view on Austria's century bonds?
JIM GRANT: In 2017, Austria issues a bond maturing 100 years, 100 years. The 2.1's whatever it was-- 2.117. And I said to myself, I am 73 years old, but still, I will be in better shape when those bonds mature than will be the people who own that security. All right. That was a couple of years ago. All right. So I was wrong. Because they now yield, not 2.1 but 0.76, less than 1%.
Now, an interesting way to look at these bonds is to go back 100 years. How would you have done if you had bought Austria's century bonds in the year 1917, World War I still raging? How many defaults, deep basements, inflations, political upsets would there have been until you got paid? Answer, many. So people who buy these things are buying, like, no yield, in a currency that's been in existence for, what, 20 years? Is that a really compelling opportunity? The people who bought it have done very well.
They've seen the price on these things has gone from, in part, like, it's almost doubled. And if it goes to zero, it's going to go to 300 from 200. So the people who buy these things aren't stupid. They think they are going to sell to someone who might be stupid, but they themselves expect great things. The ECB is going to come in and make these yields go to zero. They're looking at huge capital gains on a piece of paper you would not want your least favorite mother-in-law to own.
INTERVIEWER: How do negative rates impact the banking system?
JIM GRANT: Negative rates are no friends of financial institutions, whether they be banks, whether they be insurance companies. Negative rates are poison for people who deal in money. And, yes, you can do clever things with negative rates. You can manipulate them. You can hedge against them in some ways. You read about this all the time. But fundamentally, negative rates are driving people to take unsustainable credit risks.
You see, especially in Japan, where they have, I think, the first negative nominal rates where on view in 1998, maybe. It was a long time ago. And the regional banks in Japan are dwindling, dwindling. And you can see that the banks in Europe are judged by their valuations, are likewise in trouble. Price to book ratios in Europe are in levels which you assume there is some latent crisis, if not immediate crisis.
INTERVIEWER: How do markets function when money is free?
JIM GRANT: Well, the price of money is called the rate of interest. The most consequential price in capitalism, it seems to me. Interest rates do all these essential things, discounting future cash flows, and measuring investment hurdle rates, and giving us a sense of how much credit risk there is in a given transaction. And when you suppress, or, otherwise, manhandle those rates, you are withholding, destroying information, you are letting people do business in the dark, or in a hall of mirrors. We all are, a little of us, we are all, to a degree, blinded by the so-called financial repression. Value investing is in a bit of a crisis.
It hasn't worked for a dozen years. But it's not really an everything bubble. Well, people are finally saying, well, zero rates gives you an everything bubble. No, there are plenty of pockets of neglect, and, perhaps, opportunity.
INTERVIEWER: What happens to value at or near the zero bound?
JIM GRANT: Well, when you've got negative rates, you have a lot of confusion and you have a lot