I assume that most of the cooling effect of higher bond yields is that the returns on (effectively) risk-free investments put a floor under the returns of competing investments, and bend the time horizon. But it seems like there might also be some cooling effect from just tying up investor funds for a number of years/decades. Is the latter effect remotely significant?
On the left is the index of the yield of the 13 Week Treasury Bill.
On the right is the Fed Funds rate. (The Fed Funds market is a Potemkin market. It has been a fake 'market', deserving ironic quote marks since 2009)
Now I don't have a BA in philosophy from Harvard but I think I have a general understanding of logic. There is no possible logic to explain this relationship which has the trailing curve, the FF rate, leading.
The universal declaration that the Fed "sets" interest rates is ass backwards. Now I would be glad to discuss the mechanisms by which the Fed has powerful influences on market interest rates but I will have nothing but contempt for the bizarro world logic that says Fed sets rates. Which is a perfect analog for the logic that says guns don't kill people. People kill people.
Higher interest rates benefits banks and harms people with a lot of debt. Put another way--it helps the rich and harms the poor. Higher interest rates induce the rich to cash out some of their investments to be safe. There will be a recession, it will be blamed on Biden--the rich will win again.
> When interest rates are low and “money now” has very little value compared to “money in the future,” it makes sense to take a lot of speculative long shots in hopes of getting a big score.
If interest rates are low, doesn't that mean money now is worth more relative to future money compared to if interest rates were high?
"If interest rates are low, doesn't that mean money now is worth more relative to future money compared to if interest rates were high?"
When interest rates are super-low, close to zero, the value of $100 today is more or less the same as $100 in the future (say ten years from now). When interest rates are very high, $100 now is worth a lot more than $100 in the future. (At 7%, $100 now is worth $200 ten years from now.)
So if there's a bunch of speculative investments that are high-risk but could pay off 100X ten years from now, that 100X payoff is worth a lot less when interest rates are high, compared to when interest rates are low.
No one knows where interest rates will be in the future, not even the fairly short-term future. MY writes "the 10-year rate is also rising, after having been in a period of structural decline for literally 40 years." But the accompanying chart shows frequent periods of similar increases, followed by declines. That's just as likely to happen now as not. Morningstar predicts Fed fund rates and 10-year Treasury yields in 2026 to be well below the historical average (https://www.morningstar.com/articles/1106505/why-we-expect-the-fed-to-cut-interest-rates-in-2023); Krugman writes that the era of cheap money may just be briefly interrupted, not ended (https://www.nytimes.com/2022/11/18/opinion/interest-rates-fed.html).
Anyone thinking the low interest-based economy we had has been left in the rearview mirror is making a pretty bold prediction. We just don't know yet.
I suspect that a complete story would involve real rates, not just nominal. For example, high inflation means that nominal revenue in the future will be higher, partially or totally offsetting the shift in time preference due to the increase in nominal rates. Or not? Am I wrong?
"There are lots of places where more application of software and hardware engineering could do good, but where you’d be trying to hit singles rather than swinging for the fences. Big swings can be great, but I do think there’s something to the idea that such low rates for so long encourage so many big swings that you’re left essentially ignoring big swathes of the economy just because there isn’t a plausible story about creating a winner-take-all market with a strong moat. Lots of the stuff people buy and rely on doesn’t have those characteristics but would still benefit from attention and investment — attention that will hopefully be coming in the new paradigm."
What about the last 50 years makes you think building a slightly better widget or refining that widget is the way to consistent less risky returns? Assuming you do make sone sort of better product, why won't you just be cannibalized by all the other players in your industry, the way any commodity product gets chopped up?
The last All In podcast had some interesting numbers about how upside down the investment in the large majority of tech companies is, how returns are all driven by a few breakthroughs.
“At the end of the day, venture capital is just a slightly odd line of endeavor where flopping a lot is fine as long as you score some hits. I think most of us find this to be an unnatural way of thinking because…”
I’m convinced the educational system is partly to blame with its focus on getting 100%. A software company or engineering firm closing 20% of qualified leads is A+ work. Obviously that means you failed 80% of the time. Similarly a chef might trial 5 things on a menu before finding one worthy of being a long term addition - again that’s A+ work.
There is another part of the story of VC funds (and Wall Street in general) being willing to continue to invest in companies (or boost the stock price) despite continued massive losses. The story of Amazon. Low interest rates are the mechanism by which VC funds and Wall Street can continue to throw away money and not suffer the consequences (or at least meaningful consequences). But as you say, this move only makes sense if you think there is a payoff.
It's interesting to me because for years, you were banging the drum about how Amazon continued to not show a profit and instead focused almost maniacally on growing the company. Investors basically remained patient for I believe over a decade believing there would be a payoff in the end. And they were right! But as you say, stories like this are the exception. And yet it seems like to me there is this hope that a number of tech companies will replicate this story. But it seems like to me that Amazon is a very specific circumstance and likely can't be replicated.
The main reason Matt was wrong about Amazon was probably AWS, right? If that's true I'm inclined to be charitable to that prediction failure, since none of Amazon's boosters were building their case on unforeseeable moonshots, either.
“Inflation was higher in 2021 and stayed high longer in 2022 than most forecasters predicted. And it’s important to remember that these were general errors. Joe Biden and his administration and their supporters made those mistakes. I made those mistakes. But so did Jerome Powell (a Republican), the Fed staff (a very nonpartisan group of professionals), and most private sector forecasters at the big investment banks. And crucially, the collective forecast of bond investors got it wrong.”
This true but I think misses the question as to why most everyone missed this. And generally why most experts fail to forecast major changes like this.
The two obvious reasons are:
- This is something that can’t be predicted.
- Groupthink and circular analysis.
Either way, it’s more evidence that long-term economic predictions from experts are not reliable, and this is what should be factored into future plans, not assumptions that the status quo ante will inevitably return.
I came here to reply that certainly not everyone got this wrong. It was a very frustrating 2021 watching our leadership accelerating towards the easily predictable cliff while they continued to get high on their own copium supply.
I think Matt and others should do deeper reflection on why they got it wrong and how they will prevent future mistakes. I agree with the assessment that it appears to be largely groupthink.
Had the #TeamTransitory circlejerk ended a few quarters sooner, the Fed wouldn’t have needed to slam the brakes so hard.
“When you’re surprised, you’re supposed to consider changing your mind” - Larry Summers
But beyond groupthink, I think there’s an issue of fighting the last war, and just not really wanting to accept that progressive economics can get it wrong, which is maybe also groupthink.
You're right that not everyone got this wrong, but I think it's an open question whether they were correct because they were lucky or correct because of better analysis. And if it's the latter, then what is the analysis and is it repeatable?
There are always a few people who correctly predict some big change whether it is inflation in 2021-2022, or the financial crisis in 2007-2008, but it's not often clear if they arrived at the correct conclusion via objective and repeatable analysis.
"There are lots of places where more application of software and hardware engineering could do good, but where you’d be trying to hit singles rather than swinging for the fences."
I know noahpinion is the resident neoliberal otaku, but this article (esp the title) made me think of this anime soundbite:
https://www.youtube.com/watch?v=6p773SIdp1s
A case of delayed discounting. We are not teaching rhe behavior of delayed gratification and how aweer and rewarding it can be for those who wait!
I assume that most of the cooling effect of higher bond yields is that the returns on (effectively) risk-free investments put a floor under the returns of competing investments, and bend the time horizon. But it seems like there might also be some cooling effect from just tying up investor funds for a number of years/decades. Is the latter effect remotely significant?
I hate to break this to Mr. Yglesias but the market has raised interest rates. The Fed has just ratified the increases. Here is the proof.
https://ibb.co/VWN8wJQ
On the left is the index of the yield of the 13 Week Treasury Bill.
On the right is the Fed Funds rate. (The Fed Funds market is a Potemkin market. It has been a fake 'market', deserving ironic quote marks since 2009)
Now I don't have a BA in philosophy from Harvard but I think I have a general understanding of logic. There is no possible logic to explain this relationship which has the trailing curve, the FF rate, leading.
The universal declaration that the Fed "sets" interest rates is ass backwards. Now I would be glad to discuss the mechanisms by which the Fed has powerful influences on market interest rates but I will have nothing but contempt for the bizarro world logic that says Fed sets rates. Which is a perfect analog for the logic that says guns don't kill people. People kill people.
Thanks for writing this. Been trying to communicate this to folks outside tech with difficulty. Happy to have traded for your writing services.
Holy poop emoji this is a good post.
Higher interest rates benefits banks and harms people with a lot of debt. Put another way--it helps the rich and harms the poor. Higher interest rates induce the rich to cash out some of their investments to be safe. There will be a recession, it will be blamed on Biden--the rich will win again.
> When interest rates are low and “money now” has very little value compared to “money in the future,” it makes sense to take a lot of speculative long shots in hopes of getting a big score.
If interest rates are low, doesn't that mean money now is worth more relative to future money compared to if interest rates were high?
"If interest rates are low, doesn't that mean money now is worth more relative to future money compared to if interest rates were high?"
When interest rates are super-low, close to zero, the value of $100 today is more or less the same as $100 in the future (say ten years from now). When interest rates are very high, $100 now is worth a lot more than $100 in the future. (At 7%, $100 now is worth $200 ten years from now.)
So if there's a bunch of speculative investments that are high-risk but could pay off 100X ten years from now, that 100X payoff is worth a lot less when interest rates are high, compared to when interest rates are low.
Time value of money: https://www.investopedia.com/terms/t/timevalueofmoney.asp
No one knows where interest rates will be in the future, not even the fairly short-term future. MY writes "the 10-year rate is also rising, after having been in a period of structural decline for literally 40 years." But the accompanying chart shows frequent periods of similar increases, followed by declines. That's just as likely to happen now as not. Morningstar predicts Fed fund rates and 10-year Treasury yields in 2026 to be well below the historical average (https://www.morningstar.com/articles/1106505/why-we-expect-the-fed-to-cut-interest-rates-in-2023); Krugman writes that the era of cheap money may just be briefly interrupted, not ended (https://www.nytimes.com/2022/11/18/opinion/interest-rates-fed.html).
Anyone thinking the low interest-based economy we had has been left in the rearview mirror is making a pretty bold prediction. We just don't know yet.
I suspect that a complete story would involve real rates, not just nominal. For example, high inflation means that nominal revenue in the future will be higher, partially or totally offsetting the shift in time preference due to the increase in nominal rates. Or not? Am I wrong?
Wonderful topic; needs unpacking into multiple columns.
"There are lots of places where more application of software and hardware engineering could do good, but where you’d be trying to hit singles rather than swinging for the fences. Big swings can be great, but I do think there’s something to the idea that such low rates for so long encourage so many big swings that you’re left essentially ignoring big swathes of the economy just because there isn’t a plausible story about creating a winner-take-all market with a strong moat. Lots of the stuff people buy and rely on doesn’t have those characteristics but would still benefit from attention and investment — attention that will hopefully be coming in the new paradigm."
What about the last 50 years makes you think building a slightly better widget or refining that widget is the way to consistent less risky returns? Assuming you do make sone sort of better product, why won't you just be cannibalized by all the other players in your industry, the way any commodity product gets chopped up?
The last All In podcast had some interesting numbers about how upside down the investment in the large majority of tech companies is, how returns are all driven by a few breakthroughs.
Because a small but safe return probably isn't worth the investment needed to cannibalize it.
Tell that to everyone trying to sell products like wall plugs or cables on Amazon.
“At the end of the day, venture capital is just a slightly odd line of endeavor where flopping a lot is fine as long as you score some hits. I think most of us find this to be an unnatural way of thinking because…”
I’m convinced the educational system is partly to blame with its focus on getting 100%. A software company or engineering firm closing 20% of qualified leads is A+ work. Obviously that means you failed 80% of the time. Similarly a chef might trial 5 things on a menu before finding one worthy of being a long term addition - again that’s A+ work.
Or like World Cup football where you fail to score 99.99% of the time.
I accept that the entire world loves soccer/football and that that population will never ever include me.
There is another part of the story of VC funds (and Wall Street in general) being willing to continue to invest in companies (or boost the stock price) despite continued massive losses. The story of Amazon. Low interest rates are the mechanism by which VC funds and Wall Street can continue to throw away money and not suffer the consequences (or at least meaningful consequences). But as you say, this move only makes sense if you think there is a payoff.
It's interesting to me because for years, you were banging the drum about how Amazon continued to not show a profit and instead focused almost maniacally on growing the company. Investors basically remained patient for I believe over a decade believing there would be a payoff in the end. And they were right! But as you say, stories like this are the exception. And yet it seems like to me there is this hope that a number of tech companies will replicate this story. But it seems like to me that Amazon is a very specific circumstance and likely can't be replicated.
The main reason Matt was wrong about Amazon was probably AWS, right? If that's true I'm inclined to be charitable to that prediction failure, since none of Amazon's boosters were building their case on unforeseeable moonshots, either.
“Inflation was higher in 2021 and stayed high longer in 2022 than most forecasters predicted. And it’s important to remember that these were general errors. Joe Biden and his administration and their supporters made those mistakes. I made those mistakes. But so did Jerome Powell (a Republican), the Fed staff (a very nonpartisan group of professionals), and most private sector forecasters at the big investment banks. And crucially, the collective forecast of bond investors got it wrong.”
This true but I think misses the question as to why most everyone missed this. And generally why most experts fail to forecast major changes like this.
The two obvious reasons are:
- This is something that can’t be predicted.
- Groupthink and circular analysis.
Either way, it’s more evidence that long-term economic predictions from experts are not reliable, and this is what should be factored into future plans, not assumptions that the status quo ante will inevitably return.
I came here to reply that certainly not everyone got this wrong. It was a very frustrating 2021 watching our leadership accelerating towards the easily predictable cliff while they continued to get high on their own copium supply.
I think Matt and others should do deeper reflection on why they got it wrong and how they will prevent future mistakes. I agree with the assessment that it appears to be largely groupthink.
Had the #TeamTransitory circlejerk ended a few quarters sooner, the Fed wouldn’t have needed to slam the brakes so hard.
https://www.cnn.com/2021/05/26/economy/inflation-larry-summers-biden-fed/index.html
“When you’re surprised, you’re supposed to consider changing your mind” - Larry Summers
But beyond groupthink, I think there’s an issue of fighting the last war, and just not really wanting to accept that progressive economics can get it wrong, which is maybe also groupthink.
https://auth.jacobinmag.com/2021/09/larry-summers-inflation-predictions-biden-stimulus-american-rescue-plan-federal-reserve-treasury
You're right that not everyone got this wrong, but I think it's an open question whether they were correct because they were lucky or correct because of better analysis. And if it's the latter, then what is the analysis and is it repeatable?
There are always a few people who correctly predict some big change whether it is inflation in 2021-2022, or the financial crisis in 2007-2008, but it's not often clear if they arrived at the correct conclusion via objective and repeatable analysis.
"There are lots of places where more application of software and hardware engineering could do good, but where you’d be trying to hit singles rather than swinging for the fences."
Jay Powell is banning the shift!