Allocating capital post-QE

[bofh]

Hi,

What are your asset allocation plans when the "free money" eventually runs out, interest rates climb and trigger large scale loan defaults?

Thanks

[dspp]

Hi,

What are your asset allocation plans when the "free money" eventually runs out, interest rates climb and trigger large scale loan defaults?

Thanks

I have always underestimated the ability of politicians to pursue short term benefit despite the long term consequences.

So I remain as fully invested as I reasonably can be. In my case - taking the overall view including house & pensions - that is an approx 1/3 property, 1/3 equities, and 1/3 fixed income (i.e. pseudo bonds, a DB pension).

regards, dspp

[bofh]

Same here dspp - but the free money is still flowing...
https://fred.stlouisfed.org/series/WALCL

[tjh290633]

I reckon to stay fully invested, regardless. That policy has worked for me over the last 50 years. I don't switch between investments for the sake of it.

TJH

[TheMotorcycleBoy]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

[odysseus2000]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

There is a lot of inertia to political economic policy especially if things are working and there is neither inflation or worse deflation.

It is possible that the high interest rates phenomena of the 70's have been fixed by the increased productivity such that we are no longer in a scenario where too much money is chasing too few goods.

Historically there have been very long periods of low interest rates that have ended with inflation caused by war.

Imho the status quo will only change in response to a big shock to the world's economy like a war or natural shocks that remove a substantial amount of the collective human ability to manufacture.

If robotics and Artificial Intelligence boost productivity hugely as many predict the danger will be more like deflation: too many goods chasing too little money.

However, serious developments in either of these fields will almost certainly require substantially different economic models.

Regards,

[TheMotorcycleBoy]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

There is a lot of inertia to political economic policy especially if things are working and there is neither inflation or worse deflation.

It is possible that the high interest rates phenomena of the 70's have been fixed by the increased productivity such that we are no longer in a scenario where too much money is chasing too few goods.

Historically there have been very long periods of low interest rates that have ended with inflation caused by war.

Imho the status quo will only change in response to a big shock to the world's economy like a war or natural shocks that remove a substantial amount of the collective human ability to manufacture.

Thanks for this - that's a very interesting perspective on the things.

If robotics and Artificial Intelligence boost productivity hugely as many predict the danger will be more like deflation: too many goods chasing too little money.

However, serious developments in either of these fields will almost certainly require substantially different economic models.

Indeed. It's weird trying to contemplate it. On the one hand, us working peeps being awarding more and more vacation time, on the other having many more people around and having more and more sci-fi like existences with cuboid living arrangements and GM-style food stuffs.

PS to the OP - apologies in derailing the thread. But whilst being very much aware of the Free money pumped in by QE and low interest, I've also wondered what it's removal will actually look like.

Matt

[bofh]

No worries Matt, you asked a good question. I plan to keep tracking QE from a distance but paying closer attention to credit defaults, price of gold, along with buy signals that fail on major indexes (or put it another way, when big money stops "buying the dip"). These are all things I keep an eye on anyway, since I'm heavily invested in equities and 10% gold.

But if we fast forward to the "point of recognition" - whatever that might be - the sign for you that the economic weather is materially changing - would you stay fully invested at your chosen level in equities like tjh (which with his track record, I'm certainly not going to argue against!) or would you change your asset allocation?

[scrumpyjack]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

There is a lot of inertia to political economic policy especially if things are working and there is neither inflation or worse deflation.

It is possible that the high interest rates phenomena of the 70's have been fixed by the increased productivity such that we are no longer in a scenario where too much money is chasing too few goods.

Historically there have been very long periods of low interest rates that have ended with inflation caused by war.

Imho the status quo will only change in response to a big shock to the world's economy like a war or natural shocks that remove a substantial amount of the collective human ability to manufacture.

If robotics and Artificial Intelligence boost productivity hugely as many predict the danger will be more like deflation: too many goods chasing too little money.

However, serious developments in either of these fields will almost certainly require substantially different economic models.

Regards,

Of course it depends what you define by inflation. Obviously humanity gets better and better at making things so the relative price of 'products' tends to decline. But the price of employing people and the price of land (they've stopped making it!) tend to increase. So conveniently governments
like to measure inflation based on manufactured products ('retail' or 'consumer' prices) and not on the totality of what people spend their money on.

[TheMotorcycleBoy]

No worries Matt, you asked a good question. I plan to keep tracking QE from a distance but paying closer attention to credit defaults, price of gold, along with buy signals that fail on major indexes (or put it another way, when big money stops "buying the dip"). These are all things I keep an eye on anyway, since I'm heavily invested in equities and 10% gold.

Many thanks, Bofh,

What did mean by when big money stops "buying the dip". Sorry if I appear ignorant. Since I'm a relative newcomer my only experience of "buying the dip" is that it's something I currently do a lot of - if I can. E.g. November-December 2018 we piled into UK equities in the small dip back back then, and very recently we bought "JP Morgan Chinese Investment Trust" when the first big corona dip happened.

But if we fast forward to the "point of recognition" - whatever that might be - the sign for you that the economic weather is materially changing

So what do you think that will look like to an occasional Radio Four listener/online news reader? (I know you've not got a crystal ball!!). But is it likely to be things like interest rates (and inflation) rising....since they stop using QE to suppress gilt yields etc.

- would you stay fully invested at your chosen level in equities like tjh (which with his track record, I'm certainly not going to argue against!) or would you change your asset allocation?

I have to say it will be new ground for me. We are currently heavily in UK equities with some exposure to US and RoW (straight stocks or ITs). (We initially had some bond allocation but have recently cashed in the odd one, and will let the remaining three PMO1-2021, TSCO-2020, IPF1-2020 expire on maturity and probably not maintain anymore FI assets. My naive view is that while fixed income yields are so low to "risk all" over a diversified (hopefully!) mix of straights stocks and ITs (e.g. for Asia and renewables). We have no gold allocation, but fortunately own our property and don't have any credit cards/HP etc.

Matt

[tjh290633]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

Good question, Matt. The current situation differs from any which we have seen before. Usually it has been runaway inflation, or a government financial crisis, occasionally a conflict somewhere.

Study your fairly recent history, like the Israel and Egypt 5 days war, the various oil shocks, the 1987 hurricane and the Gulf Wars. You might see a pattern there.

QE only works up to a point. It needs a failure of a gilt issue to attract buyers to force interest rates up. The alternative is hyperinflation, like Germany after the two world wars, or Argentina periodically.

TJH

[TheMotorcycleBoy]

Sorry to repeat myself so to speak,

price of gold, along with buy signals that fail on major indexes (or put it another way, when big money stops "buying the dip"). These are all things I keep an eye on anyway, since I'm heavily invested in equities and 10% gold.

But if we fast forward to the "point of recognition" - whatever that might be - the sign for you that the economic weather is materially changing

So I guess part of the visible signs of the "economic weather materially changing" is gold price rise and major stock indexes falling as big money shifts into "safer assets".

Is that right?

Matt

[TheMotorcycleBoy]

Out of interest, how exactly does/will free money end?

Is it when i) governments stop doing QE or if ii) interest rates go too negative or something.

Since I've only been investing since 2018 I'm curious as how (if at all) the current status quo will eventually wind down.

Matt

Good question, Matt. The current situation differs from any which we have seen before. Usually it has been runaway inflation, or a government financial crisis, occasionally a conflict somewhere.

Study your fairly recent history, like the Israel and Egypt 5 days war, the various oil shocks, the 1987 hurricane and the Gulf Wars. You might see a pattern there.

QE only works up to a point. It needs a failure of a gilt issue to attract buyers to force interest rates up. The alternative is hyperinflation, like Germany after the two world wars, or Argentina periodically.

TJH

Thanks for this TJH. Sorry my last post crossed with yours slightly! I'll parse these replies better in a day or so. Work is very busy these days.....I need to get my head down for now!

Matt

[GoSeigen]

Hi,

What are your asset allocation plans when the "free money" eventually runs out, interest rates climb and trigger large scale loan defaults?

Thanks

I hope you don't mind my pointing out that it's not free money or even "free money". In that sense it is no different to any other financial security. If anyone is relying on it being free money, than I think they need to adjust their calculations!

Similarly it will not "run out", especially as it is perpetual!! The money is issued now and remains in existence in perpetuity.

As for interest rates rising, of course that is always a possibility but bear in mind that a decade ago or more there were plenty of people claiming investment yields and interest rates could only go up and they have been proved completely wrong...


GS

[GoSeigen]

Matt,

In the UK QE ended long ago. Same FAIAP in the US. Whether that means the end of free money as defined by the OP is for him to say -- so far he has been reticent!

GS

[TheMotorcycleBoy]

Matt,

In the UK QE ended long ago. Same FAIAP in the US. Whether that means the end of free money as defined by the OP is for him to say -- so far he has been reticent!

GS

Hi GS,

Personally I see the term "Free Money" as being just another way of saying "Cheap Debt". IOW the long-lived era of hyper low interest rates we've seen *possibly* engendered by QE.

But I'm still just as curious as to see how (if at all) the current state of affairs will wind down as it were.

Matt

[SalvorHardin]

Are today's low interest rates abnormal? Or do they instead represent the "new normal"?

Bear in mind that until the 2007-08 financial crisis it was "normal" for equities to yield less than gilts (the reverse-yield gap). Since the financial crisis the "new normal" is that equities yield more than gilts, as they did throughout history until the 1950s (the yield gap).

If inflation stays low, and as mentioned earlier there are plenty of factors which are driving down costs (e.g. robots, AI), then interest rates IMHO will stay low for the foreseeable future. Especially the real base interest rate, which I believe will remain negative for a long time. Remember that "interest rate = real interest rate + inflation rate".

Also as pointed out earlier in this thread, the British and American QE taps were largely turned off a few years ago (the last major injection I recall was after the Brexit vote in June 2016). So we're already in a post-QE environment. Though I appreciate that the taps could (and probably would) be turned back on in a crisis, which is influencing people's behaviour. There's political pressure to consider; borrowers have a lot more political clout than savers nowadays - this IMHO is a major factor in keeping the base rate low.

Strong academic backing for low real interest rates comes from Paul Schmelzing, a PhD student working at the Bank of England, who argues that real interest rates have steadily declined since the 14th century (I'd argue that the main reasons for this are the steady growth of the rule of law and property rights, combined with vastly more efficient markets and communications technology).

"He found that real rates have declined by 0.006-0.016 percentage points a year since the late Middle Ages (see chart). That may not seem much, but it means real interest rates have fallen from an average of around 10% in the 15th century to just 0.4% in 2018."

https://www.bankofengland.co.uk/working ... -1311-2018

https://www.economist.com/finance-and-e ... turies-old

The world is awash with capital, which also depresses interest rates. If inflation does take off, then I'd much rather be holding real assets (and no fixed interest). My shareholdings are already biased towards commercial property and infrastructure, which are real assets. And I've never owned any fixed interest (except for some in investment trust portfolios). Nowadays my portfolio is large enough that I'm fairly relaxed about when the inevitable 20% to 30% fall occurs in the future.

[odysseus2000]

Matt,

In the UK QE ended long ago. Same FAIAP in the US. Whether that means the end of free money as defined by the OP is for him to say -- so far he has been reticent!

GS

Hi GS,

Personally I see the term "Free Money" as being just another way of saying "Cheap Debt". IOW the long-lived era of hyper low interest rates we've seen *possibly* engendered by QE.

But I'm still just as curious as to see how (if at all) the current state of affairs will wind down as it were.

Matt

One way to think of the QE technique is what it was called in the second war: Interest rate pegging.

Long lived in financial speak usually means times scales of multiple generations, nx20 years, where n is the number of generations. Low interest rates have persisted for centuries. This is no guide to what will come, but it is a context to weigh when thinking about interest rates.

With western birthrates falling the pressure on property and land prices is all about immigration. If that is curtailed property inflation can go negative. A global pandemic would crash property prices as happened with the black death

The arguments about gold are often based on the times when the world operated on the Gold Standard and that was abolished by President Nixon. Making comparisons to early ages with a very different financial system and predicting forwards is likely to lead to errors. Everything in economics is in flux and one has to invest based on now, not on the past or predictions of the future.

As things now are we have a huge world wide bull market, stronger than I have ever before seen with a raft of secular developments that can sustain it for a long time or lead to its collapse in very short measure.

Now IMHO is the time to be making large equity profits in secular growth and if not to adjust styles to capture money while these conditions exist and most importantly to stop reading anyone who is not in tune with the market and has been advocating defensive positions or being short for a long time while this bull market has run.

My inbox is full of bears all telling me the market is going to crash. I tolerate these wrongsters to see if they are seeing things I am missing but for now all their arguments are lame and indicative of trying to panic folk to line the doomsayers pockets. E.g. several prominent US media folk have been saying to short high beta tech for years and been wrong for years. It is very unlikely they are putting their money where their mouth is as otherwise they would be bankrupt, but the US media keeps putting them on because they know a lot of their audience is pessimistic and loves to be told that things are terrible and about to get much worse.

I have no idea when things will change or what the cause will be, but for the markets to come down, prices have to fall and that is the only tell I have found to be worth studying.

Regards,

[dealtn]

Strong academic backing for low real interest rates comes from Paul Schmelzing, a PhD student working at the Bank of England, who argues that real interest rates have steadily declined since the 14th century (I'd argue that the main reasons for this are the steady growth of the rule of law and property rights, combined with vastly more efficient markets and communications technology).

"He found that real rates have declined by 0.006-0.016 percentage points a year since the late Middle Ages (see chart). That may not seem much, but it means real interest rates have fallen from an average of around 10% in the 15th century to just 0.4% in 2018."

https://www.bankofengland.co.uk/working ... -1311-2018

https://www.economist.com/finance-and-e ... turies-old

I wouldn't call the work of one PhD student, regardless of who his employer is, "strong academic backing". Having read his piece it is "long" of the "what" but woefully "short" of the "why". In essence he produces a very long term falling trend and extrapolates that into the future, in theory in perpetuity. Were one to make prediction on world records for the mile, or marathon, for instance you would be predicting some kind of times scientists of physiology would be amused by for instance. Indeed looking at horse racing, where many multiple millions of pounds have been spent on breeding, race times are barely lower, if at all.

There are several reasons, such as institutional false demand for fixed interest products, that will fade in time (as pension liabilities unwind with the slow death of defined benefit product, as an example), behind the current period of negative real interest rates. To argue, as his implied extrapolation does, that such issues will not just remain but reinforce, going forward is simply wrong.

[SalvorHardin]

I wouldn't call the work of one PhD student, regardless of who his employer is, "strong academic backing". Having read his piece it is "long" of the "what" but woefully "short" of the "why". In essence he produces a very long term falling trend and extrapolates that into the future, in theory in perpetuity. Were one to make prediction on world records for the mile, or marathon, for instance you would be predicting some kind of times scientists of physiology would be amused by for instance. Indeed looking at horse racing, where many multiple millions of pounds have been spent on breeding, race times are barely lower, if at all.

There are several reasons, such as institutional false demand for fixed interest products, that will fade in time (as pension liabilities unwind with the slow death of defined benefit product, as an example), behind the current period of negative real interest rates. To argue, as his implied extrapolation does, that such issues will not just remain but reinforce, going forward is simply wrong.

All he's done is show what has happened. He's done the work in digging out the data and demonstrated that there has been a substantial fall in real interest rates.

I'm not interested in extrapolating further, just whether the general state of affairs will remain (real interest rates below zero, low inflation), or change.

If I was looking to do an academic paper as to why real rates have fallen, I'd start with my suggestions regarding rule of law, property rights, better communications, etc. But I'm not