In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Capital Spectator’s – 700-Year Decline In Interest Rates. Here’s an excerpt from the episode:
Tobias Carlisle:
Well, I like those points. I think we’ve got to move on just for time. My topic, Capital Spectator has come out with this argument that if you’re expecting high interest rates, there’s this 700-year history of interest rates that beg to differ. And I’ve got this chart that shows, and on this chart, you can see things like Simon van Halen lending to Edward III in, it looks to me like maybe 1335, something like that. He was getting 35% interest rates. Amadi/Rommel loaned to King Sigismund 18% in about like 1380 over with estimate.
Bill Brewster:
[crosstalk 00:28:37] my time.
Tobias Carlisle:
They’ve got always dots on this chart and then-
Jake Taylor:
Are those BBB, or what’s that?
Bill Brewster:
This is Buffett terms right there.
Tobias Carlisle:
Lacy Hunt would have been all over this thread 700 years ago. So basically, the thing has … Over time, they’ve got this chart that purports to show that, I fitted a line to it, and it points to basically zero interest rates in 2018. I hit a couple of problems with this. One, I don’t think we really have enough data 700 years ago, 500 years ago, 200 years ago to draw any really strong conclusions about where the market was back then. I think maybe capital is a little bit harder to come by and we didn’t have quite the same. But maybe that’s the argument. Maybe that’s the argument that they’re making that it should be close to zero.
Tobias Carlisle:
But within sort of living memory, not my own but other people’s, we had zero interest rates in 1937. And in the ’86, we had like 16% interest rates. We had stagflation in the ’70s with very high interest rates. And now through the intervention of central banks, we’ve come back to like virtually 0% interest rates. I don’t see that that’s directionally down. I think that that’s the bottom of the cycle. I don’t necessarily know that we go back to higher interest rates to the other side. But I think that what that shows is in a cycle rather than it’s directionally down. Anyway, clearly, I’ve got no idea what I’m talking about because we’re at zero, and the arrow points down to zero.
Jake Taylor:
So just for fun, I’ll take the other side of the argument. And I was thinking about this that one of the biggest things that is a marker of how successful an economy will be is the level of trust between all of the participants. And I think you could make the pretty strong argument that we have probably more trust than they did 500 years ago. I think if you look at like … They’ve looked at different hunter gatherers societies and measured their level of trust and it correlates really well with productivity and even just trading, all those kinds of things require a higher level of trust.
Jake Taylor:
I think we’ve also seen a centralization of power on a lot of different fronts that we might be peak centralization right now. And that doesn’t mean necessarily that it’s something that can keep going on because I think eventually that sort of thing fragments and we get more decentralization again. But one of the things I think would correlate with the centralization would be higher trust rates. Therefore, it doesn’t surprise me that maybe lower interest rates are part of that.
Tobias Carlisle:
Yeah. I liked that argument. I can also see looking at that chart, data is better now than it was and it’s maybe just reinforcing your point but data is so much better now than it was. And I think that we all sort of know we’ve got a rough idea where the market is, you know what the market is for different credits. You can work out what sort of credit somebody is, so maybe we are just getting better at lending to them.
Tobias Carlisle:
But I think that absent that central bank’s pinning interest rates is negative or zero, I don’t think that they come down to negative or zero. I just don’t see why you would lend to someone without getting some return on your lending.
Bill Brewster:
Well, fundamentally, you’re getting paid for risk, right? I mean, that is what an interest rate is. So you’re giving out money today to get money tomorrow. It’s just very hard for me to think that in a world where the central bank has turned rates negative, that isn’t incenting behavior that is more risk-seeking and therefore compressing spreads. It’s just very, very hard for me to believe that when you have all of Europe seeking for yield, that that doesn’t have some impact on the overall rate market.
Bill Brewster:
And I don’t know how to quantify it. I don’t know how to put it into numbers. It’s just sort of like a common sense thing to me that may not be common. I might be wrong but my brain says, with this many people are looking for some yield, it’s down to compressed yields.
Jake Taylor:
Bye, bye, bye.
Bill Brewster:
Yeah.
Jake Taylor:
I’ve only heard one argument for negative interest rates that makes any sense to me. And it’s, if you think about a bond as more of like a piece of art, because there’s no yield to a piece of art. However, you can speculate that someone will pay you more for it later. And maybe there’s even storage cost of a piece of art. A bond that is being speculated on could also be bought at a negative interest rate if you believe someone is going to come and pay you more for it. So it’s a giant greater fool theory. There’s only speculation. It’s the only reason you’d ever take a negative interest rate on a bond.
Bill Brewster:
Or if you think the world is going to shit and you want some guaranteed return and you think it will be less bad-
Jake Taylor:
What return?
Tobias Carlisle:
Aren’t you guaranteeing your loss?
Bill Brewster:
Yeah, you are. But if your bet is that others will lose more, you could lose a little on paper but gain wealth.
Tobias Carlisle:
But then why wouldn’t you direct it to another asset? If it’s a negative interest rate, for a bond-
Jake Taylor:
The world is insane, what do you want?
Tobias Carlisle:
Why didn’t you then go and buy some … Doesn’t that make you want to buy gold?
Bill Brewster:
No, it makes you want to buy Visa.
Tobias Carlisle:
That’s fair. But Visa-
Bill Brewster:
Because I think the way you get out of this problem is destroying the value of currency. I think gold bugs are probably right on that. And if that’s the case, more currency flows through Visa’s pipes and they combine shares and they can grow.
Tobias Carlisle:
And so does Bitcoin, right? Bitcoin benefits in that world.
Bill Brewster:
Yeah. That’s why I just don’t understand why people are buying bonds right now. I get if you have some mandate. Fine, that’s your job. But if you are actually trying to build wealth, it’s just very, very hard for me to understand, not financial advice.
Tobias Carlisle:
The argument for gold is that there’s no counterparty risk, right? If you hold the actual physical, you don’t have to worry about. Visa still it’s very good credit but there’s still counterparty risk there.
Bill Brewster:
Not really. I mean, they’re just skimming. I mean, it’s-
Tobias Carlisle:
[crosstalk 00:32:20] no risk.
Bill Brewster:
It’s not no-risk but the world that Visa doesn’t get –
Jake Taylor:
Technological risk, but that’s kind of probably about it.
Tobias Carlisle:
In a sense that they could just go and put a whole lot of gold, somebody can figure that out at some stage.
Bill Brewster:
Well, in a world where Visa’s counterparty risk is a problem, I don’t think we’re discussing Visa’s counterparty risk. I think we’re trying to figure out how to eat. So the thing about gold is you got a thousand years of history and I guess in theory, like Bitcoin can’t come destabilize the network.
Tobias Carlisle:
[crosstalk 00:32:52] got a great joke where he says, “If you’re just holding gold looking for the end of the world,” basically he’s like, “The biggest guy in the block is just going to come and turn you upside down and hit you until your gold coins fall out on the ground.”
Bill Brewster:
It’s 100% what I said to my buddy who’s a huge gold bug. I’m like, “Paul, you want all this gold, somebody’s going to come and kick your ass. You better invest in bullets too.”
Tobias Carlisle:
It might be a prison economy. It might cigarettes the currency in the next go around.
Bill Brewster:
That’s right. [crosstalk 00:33:23] But in that world, the bet on Visa is not your biggest problem, like you got much bigger issues.
Jake Taylor:
So Visa is your Noah’s ark bet then. If it rains for 40 years, you want to own Visa?
Bill Brewster:
And I don’t own it.
Jake Taylor:
Other than that, great advice. I have no skin in that game.
Tobias Carlisle:
What’s your free cash flow yield on Visa at the moment?
Bill Brewster:
It’s not high. I mean that’s the issue. It’s probably 2.5, I mean, I don’t know, maybe 2. It might be under 2. I mean that’s the issue.
Tobias Carlisle:
But at the rate that it’s growing, if you buy it now, it will be like 2.8% in like five years’ time. So that’s great.
Bill Brewster:
Well, and you’re going to be able to [crosstalk 00:34:04]. The terminal value is not going to zero on that in all probabilities. I don’t know. That’s one of those that I would understand buying despite valuation and just saying like I think it’s probably okay over the long-term.
Jake Taylor:
The terminal value of everything is zero over a long enough timeframe.
Bill Brewster:
It might be. I mean famous last words.
Tobias Carlisle:
I’m trying to find that mailbag questions for the week.
Bill Brewster:
I’ll tell you what it doesn’t satisfy, the precondition of low expectations.
Jake Taylor:
That is not peak pessimism that you’re buying into right now.
Bill Brewster:
Yeah. So they’ve got to deliver on some pretty high expectations.
Jake Taylor:
Yeah, they probably will though, that’s the problem.
Bill Brewster:
Yeah. I mean, it’s a hell of a business. And it’s like a tax on global payment. I mean, if you’re going to make a bet, I’d rather bet on that than a freaking bond.
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One Comment on “What Can We Learn From Capital Spectator’s – 700-Year Decline In Interest Rates”
As to declining interest rates you & everyone else is looking at the demand not supply. The supply of capital increases unless it is destroyed by war, famine & epidemic. The increased capital stock chasing a relatively fixed number of opportunities investment leads to a lower price. What you see in the history is fluctuations in capital supply. If we view capital as a commodity its price is set by supply & not demand. The price of capital will approach its cost to store (negative interest rate = storage cost). This IMO is what the market is showing.