Jim Grant (Interest Rate Cycles, Are Today's Events Unprecedented? Price Signals, Economic History)

High corporate and government debt in today's economy means that even modest nominal increases in interest rate yields would put pressure on companies carrying debt, forcing them to cut costs, fire workers, reduce production, and sell assets in order to service that debt.

“there's a lot of there's a lot of leverage or debt in corporate america uh families are better financed than there were in 2006 and seven but corporations and the government itself leave the government itself aside for a second but there's a lot of debt in the corporate world a lot of private equity transactions that have entailed a whole lot of leverage leverage being a wall street term for encumbrance or debt so the question is as we look at interest rates now beginning to rise and the yield curve began to flatten by some measures and you say well what what does that mean well it might mean that the economy has so much debt that even a a measured or nominal rise in yields would put pressure on companies that home money and they would have to take steps to repay debt you know they'd have to fire people cut back production do things to hunker down and uh kind of cell division”

The current monetary regime, which Grant calls the 'PhD standard' (unbridled management of monetary affairs by former 10-year faculty members at leading universities), has never been seen before in its particular combination of raging inflation with zero percent federal funds rates and continuing quantitative easing.

“so-called quantitative easing qe is still going it's kind of winding down but in the face of a pretty severe inflation the fed has set its little tiny policy interest rate at nil and continues to buy securities with money that didn't exist before the fed tap keys on a computer pad to call those dollar bills into existence so in the monetary regime you know we called it here at grass a phd standard which is the more or less unbridled management of our monetary affairs by former 10-year faculty members at our leading universities it's um it's kind of a new thing”

John Bull (the symbol of Britain) cannot tolerate interest rates as low as two percent because such low rates incite speculation and cause harm through boom-bust cycles, as observed during Walter Bagehot's era and continuing today.

“you said uh you're alluding to the national symbol of britain he said that john bull can stand many things but he can't stand two percent meaning that a rate of interest as low as two percent would incite a lot of speculation and get a lot of people hurt because they would uh start uh you know buying the bonds of these emerging markets you know in south america and elsewhere”

Suppressed interest rates lead to wasted capital and malinvestment because people undertake projects for which there is no real demand, and while this waste has entertainment value and psychological reward, it has real-world economic consequences including white elephants and inefficient allocation of resources.

“when interest rates are are manipulated especially when they are suppressed and pressed down to uh kind of long level there's a lot of wasted uh capital or people undertake projects for which there you said no real demand a fanciful imagine one the imagination could run rampant in this world in science a moment ago was kind of level in zero gravity and there's a lot of waste a lot it's you know a lot of it's fun people have taken up speculation not just because they hope to have a sound and sensible early retirement because it's fun and lights dance and and uh you get a little splash of confetti on your robin hood account”

The 1920-1921 depression was the last governmentally unmediciated (uninterrupted by policy intervention) business cycle downturn in U.S. history, lasting only about 18 months with severe but relatively rapid adjustment.

“so there was there was no federal response beyond that and uh the depression was relatively short wide over over and done within 18 months but it was very severe the stock market was down uh basically saw it in half commodity prices down this half or more unemployment not then measured was must have been in the teens profits corporate profitabilities certainly plunged initially um but uh i it was the last as i put the last governmentally unmedicated business cycle downturn and so to date in our history”

The Great Depression of the 1930s did not actually end in the 1930s but persisted like a chronic low-level illness through the 1940s, with recovery only arriving with World War II and subsequent postwar expansion.

“and so you compare that with what happened in 1929 through 1946 others say i say that the depression did not end in the 1930s it it persisted like a low-level chronic virus you know you can't get out of bed in the morning without really wanting to”

When Herbert Hoover convened leading industrialists to Washington in spring 1930 in response to a worsening business cycle, he explicitly instructed them to maintain wages above all else, a policy intended to prevent a repeat of 1920-21 but which actually prolonged the depression by preventing wage-price adjustment.

“the first thing that hoover herbert hoover did when confronted with um a business cycle downturn that was not going to be as mild as some thought it would be in the spring of 1930 he called all the industrialists leading industrials to washington and said that um that he was not prepared to lead this country to uh repeat episode of 19 2021 it fell so disastrously and this time he said to these people including henry ford and other than that caliber let us maintain wages above all things”

Cathy Wood's investment strategy of concentrating in high-growth, disruptive technology companies is not unique to the current era but has parallels in past boom periods (railroad booms of 1800s, canal booms, interwar speculation, Bretton Woods era speculation), though suppressed rates certainly amplify and extend such trends.

“kathy woods i think there have been kathy woods's during the pure gold standard during the interwar fake gold standard called the gold exchange standard there were kathy woods's during the bretton woods twilight fake gold standard and there is the real kathy was during our phd study yes so we can't we can't say that um artificially low interest rates are the total cause”

The depression of 1920-1921 was caused by the monetary inflation that financed World War I, followed by a sharp credit contraction and writeoff of investment errors through very high nominal and real interest rates, not by the Spanish Flu pandemic.

“the depression of 1920 was a began in the aftermath of uh america's participation in world war one and it was a consequence i believe of the economic policies that uh uh with which we fought world war one so it's a huge inflation the federal reserve just got into business in 1914 1915 and uh so it got right down to work with uh facilitating the uh monetization of debt and expanding the money supply to finance the inflation that was part and parcel of almost every war yeah world war one so the country emerged from this war uh with the pandemic and with an inflation pandemic you know died down died down actually all too at the description of the uh mortality uh this was was uh was brutal much worse than colbit um but you know you go back and look at uh at the covering the journalistic coverage and the official commentary on the pandemic it was played down um there wasn't anything like the universal um uh hysteria yeah hysteria uh so i don't i don't think that i the shortened my i don't think the spanish flu was responsible for the depression”

Because the Federal Reserve has suppressed interest rates through quantitative easing and near-zero policy rates, interest rates are no longer discovered in the marketplace but rather imposed from on high, creating a 'financial dream world' or 'hall of mirrors' where things are not what they seem.

“i have contended george that that because our interest rates are not discovered in the marketplace these days but rather imposed from on high uh or if not imposed heavily influenced from on high that to that extent we are living in a kind of financial dream world we are living in a hall of mirrors because things are not what they seem”

The combination of visible debt in the corporate and government sectors, yield curve flattening, and very high inflation rates (around three percent) are creating conditions for stagflation (stagnation plus inflation), which was thought impossible by some Keynesian economists but did occur in the 1970s and could happen again.

“the fear i think is that uh the combination of the visible debt in the economy the combination of that plus the visible flattening at some portions of the yield code and the intrusion of very high rates of inflation at least three things are setting up for what we used to call stagflation in the 70s speculation being of course the state of recession overlaid on inflation keynesian once said that was unlikely or impossible but it did happen way back when i guess it could happen again”

Grant does not know whether these long interest rate cycles follow a 'law' (in the sense of a law of physics) or can be explained by monetary regime changes; he views them as a mystery worthy of caution—people who claim to know what interest rates 'should' do are likely overconfident.

“you know interest rates are so funny that that respect you know they i don't think i can't think of any other uh department of finance that exhibits these long cycles but i'm not sure that they're a matter of physics i'm not sure it's hard and fast [32:43] it's a law capital l... but uh you know i leave it as a mystery but something to know has happened and to be and to be wary of those who contend now that oh yes interest rates fall that's what they do for a living yeah”

The 10-cent beer night incident at Cleveland's Municipal Stadium in 1974 perfectly illustrates how mispricing a substance (beer) leads to harmful outcomes (riots, arrests, emergency room visits), and this metaphor applies directly to the mispricing of credit and money caused by suppressed interest rates.

“so this is announced and 25 000 self-selected individuals push their way through the turnstiles this old cavernous ball yard and the game progresses and the cheering gets a little bit uh rowdy and uh before you know it fans are down the field introducing themselves to players and uh and uh the score is uh nine to nothing that's a forfeit george cleveland lost again with the tying run on third base at the bottom of the ninth wouldn't you know it so um it turns and and so you know there was a full moon but that wasn't the problem that wasn't the reason for the emergency room visits the streakers or the arrests the problem was the mispricing of a substance even more potent than credit”

Gold's value is conceptually 'the reciprocal of the world's faith in central banks'—expressed as one divided by trust—making gold a hedge against loss of confidence in monetary institutions and central bank credibility.

“i think conceptually you know present gold is the reciprocal of the world's faith and in central banks and and matters one divided by trust”

The truth about financial markets lies between the Efficient Markets Hypothesis (too hygienic, too rational) and the opposite extreme (market chaos). Markets exhibit long periods of normal behavior interrupted by speculative extremes, and monetary regimes influence where on this spectrum the market operates.

“i would say that the truth falls somewhere between the efficient markets hypothesis the soft form and my somewhat exaggerated hyperbolic riff on it but um but kathy woods i think there have been kathy woods's during the pure gold standard during the interwar fake gold standard called the gold exchange standard there were kathy woods's during the bretton woods twilight fake gold standard and there is”

Despite the apparent weakness and vulnerability of the 'PhD standard' monetary regime, it has proven remarkably durable because people believe in it, and as long as people believe in the narrative of Fed competence, they will dismiss gold as foolish and continue supporting fiat currency.

“so as as as seemingly um feeble and as as as vulnerable as the phd standard might seem to be it is in some respects as hard as steel you know people do believe it and believing it they are prepared to turn your back on gold because you're silly because they know that there are better things in the world”

Gold has no traditional valuation metrics (P/E ratio, book value, earnings yield), but recently there was a large amount of government bonds (approximately $18 trillion) yielding less than zero percent in nominal terms, making gold's zero yield competitive with negative-yielding bonds.

“there's no pe price earnings ratio there's no book value there's no earnings yield although gold does out yield only recently there were like 18 trillion dollars worth of bonds in the world price to yield less than nothing in nominal terms so gold was out yielding uh at zero without yielding that cohort of so-called fixed income securities”

A successful Wall Street career typically lasts about 25 years, meaning someone could have 1.5-2 Wall Street careers within the 41-year bond bull market (1981-present) without ever experiencing a bond bear market, which removes market participants' lived experience with rising rates.

“so that's 40 41 years and you have to be even older than i am george that's if that's conceivable wall street a successful wall street career is like 25 years if you're if you're any good at all you're playing golf in boca raton so you could have one and a half wall street careers and never have seen the bond bear market right right”

The typical yield curve shape reflects 'the impatience of the ordinary human being'—people prefer something available now over waiting, creating a preference for earlier-maturing securities that typically have lower yields than later-maturing ones.

“so what is a yield curve it's this [20:44] is simply the spectrum of interest rates over time so it stretches from zero which is like this instant to 30 years and typically bonds maturing later longer dated securities have a higher yield because of the typical human preference for something available now rather than having to wait so the impatience of the ordinary human being accounts for conventional shape of [21:16] the yield curve”