"Interest Rates Should Be Discovered, Not Made"
By Bill Bonner
YOUGHAL, IRELAND – "With nothing in the news to distract us, we get right to work. And we begin by turning to G.K. Chesterton, who described a crazy person as one who had nothing left other than his power of reason. If you’ve ever spoken at length to a lunatic, you see how reason runs amok:
“The two-headed aliens come all the time. I kill them with my zapper gun.”
“Oh… I’ve never seen any aliens.”
“Of course not, I kill them all.”
“I’ve never seen any dead aliens either.”
“They disappear when I zap them.”
Insane people have an answer for everything. Like Ms. Elizabeth Warren, they’ve “got a plan for that.” It is those plans… and where they come from… that we begin looking at today.
Great Leap: We saw last week that being able to produce vast quantities of steel and oil didn’t make the Soviets rich. We saw too that being able to buy cheap steel (along with 49 other “foundational” commodities) doesn’t make the average American rich either.
Economists Gale Pooley and Marian Tupy claim that innovation and invention over the last 40 years have reduced the cost of 50 foundational commodities, in terms of the time needed on the job to pay for them, by 64%. This they hail as a great leap forward for humankind. But they base their calculations on “planetary” averages. The biggest gains have come in China, where in 1980, the economy was still communist, with real wages of only a couple hundred dollars per year. Now, the average Chinese fellow makes about $15,000 per year – the most spectacular economic growth story in biped history.
In the U.S., alas, wages have been stagnant. As we saw on Friday, the U.S. working stiff is in many ways worse off than he was in the 1970s. He spends twice as much time to put a roof over his head and wheels under his feet. His medical care is 28 times more expensive in cash, and four times more in terms of his time.
Real Wealth: Stocks represent real wealth. In 1969, an average person could work 225 hours and earn enough to buy shares in all 30 Dow companies. Today, he has to work 1,125 hours. The only wealth that matters is relative, not absolute. And, compared to much of the rest of the world abroad… and to his own elites at home… he has gotten poorer.
Nevertheless, Pooley and Tupy insist that the American proletarian is better off. He has less capital. He has less time. But he has an iPhone! Gale Pooley: When Apple introduced the first version in 2007 at $500, the blue-collar hourly compensation was $25.07. That would put the iPhone time price at 19.94 hours or 1,196 minutes.
The iPhone 11 is $1,000 and is 120 times more powerful, [by my rough metric of the increase in the number of transistors in its CPU, gg], which would mean the comparable price is really $8.33 ($1,000 ÷ 120). Blue-collar hourly compensation today is around $32.06. The time-price today is 0.26 hours or around 16 minutes. The time price has decreased by 98.7%. The time required to buy one iPhone in 2007 will buy almost 75 today.
In 1980, iPhones didn’t exist. Now, we all have phone calls, trivia, distractions, and porn right at our fingertips – 24/7. And each model is more powerful than the last. We also have Facebook… and (money-losing) Tesla… and (money-losing) Uber… and (money-losing) WeWork. But that is not the only thing that is new… and, judged by consumer preferences… better. Instead of bell-bottom jeans, we have skinny jeans. And instead of listening to Sinatra, we now listen to Justin Bieber.
Hapless Academics: Are we better off? Pooley, Tupy, and the Bureau of Labor Statistics think so. Here at the Diary? Uh-uh. Not only that, but Pooley, Tupy et al. go on to make an extraordinary assertion. In view of all this pullulating progress, they say, savers should be happy to lend at negative rates of interest.
When we first saw this, we were staggered by it. What pit of darkness have these hapless academics wandered into, we wondered. Here is what Mr. Pooley actually said: One of the first equations we learn in Economics is: Nominal Interest Rate = Real Interest Rate + Inflation
If we assume the real interest rate is 3% and we have 3% inflation, then the nominal rate should be 6%. But what if we have negative inflation or deflation? If the real rate is 3% and we have 3% deflation, then the nominal rate could be zero. If the real rate is 3% and we have 6% deflation, then the nominal rate would be negative 3%.
The problem is people are mis-measuring inflation. People are trying to use money to measure money. They should be using time prices. Since 1980, on the average, time prices for our 50 foundational commodities have been falling around 3.4% a year. So if the real rate is 3.4%, then the nominal rate should be zero. Negative nominal interest rates could be perfectly rational.
Oh my… reason runs amok. According to Pooley/Tupy, their signal prices have been coming down by 3.4% per year since the Reagan administration. And we presume – since growth rates are lower today than they were in the past – that prices of these foundational commodities must have been dropping even faster in the past… ever since the debut of the Industrial Revolution.
You can imagine, for example, how fast the price of wheat declined when Kansas farmers replaced horses with tractors and mechanical harvesters. You can guess, too, that the price of steel must have taken a big slide after Andrew Carnegie put in the first Bessemer converter on the banks of the Monongahela River in Pennsylvania in the 1880s.
But not once during that time – more than 150 years – did lenders lend at negative rates. Why not? The obvious answer: There is no necessary connection between interest rates and the planetary averages of prices for 50 foundational commodities.
Never Rational: Interest rates show where lenders and borrowers come together. They are never “rational.” They are evolutionary… discovered, not made. You can no more reason your way to a correct interest rate than you can reason your way into love… or into appendicitis. It just happens, no matter what you think.
There was a time when economists realized this. They spent their time observing the economy, the way a naturalist might watch a beehive, just to see how it worked. But then, the lure of power and money got the better of them. And so, they began to imagine that they could not merely observe, but control. After all, an economy was a rational thing, they argued. They could use the left sides of their brains to make the economy work, well, more rationally. The results so far? Always harmful… sometimes amusing… occasionally disastrous. Stay tuned…"