Philadelphia Reflections

The Place of Interest Rates in All This

We regularly used 7% interest rates in this discussion for the convenience of doing math in your head. Periodically, we warn the average investor probably won't achieve 7% consistently, although average results are not far from it. We are not on any gold or other monetary standard, where in the past the prevailing interest rate could emerge from the ratio of gold supply to population as a surrogate for the current economy. It must be mentioned, however, that America holds seven or eight thousand tons of gold in Fort Knox, as a sort of unofficial gold standard in reserve. Officially, our Federal Reserve adjusts the money supply to a 3% annual growth target, which is an expedient which works most of the time. Right now is not one of those times, and the Fed is plainly unable to achieve a stated 2% inflation target. The reason for this is not entirely clear, although many suspects we have issued so much debt the interest-rate "price" was depressed. So it is somewhat unclear what our normal interest rate should be, or even when rates will level off. All of our assumptions of 7% must eventually be adjusted to the real rate, but we aren't entirely clear what that should be. Like the Federal Reserve, we must operate on the assumption that present relative values will persist in the economy. They may not.

The upheavals of Greece, Brexit, and the 2016 Presidential elections are a hint others see this untethered interest rate as an opportunity to change it to their advantage. Generally, debtors favor lower interest rates, and all governments are debtors. Conservatives generally adopt the posture that absolute rates do not matter, what matters is to maintain stable interest rates for the present duration of your main assets. However, this pressures a shortening of the duration of loans, which have gone from a formerly typical thirty years to ten. Carried too far, this makes capitalism impossible and picks up supporters who favor that inclination.

Based on these two paragraphs, we favor the purchase of common stock in some form, over debt in some form, as an investment for Health Savings and Retirement Funds. The bond market is so much larger than the stock market, this situation probably will not change much. Even if the economy is destroyed, and the stock market will then be destroyed, stocks are likely to be destroyed last. Cowboys and bandits may dabble in derivatives or active investing, but the ordinary investor is urged to consider total market index funds without high fees as their safest long-term haven. Buy and hold, but don't buy and forget. Two or four times in a lifetime, you may have to be prepared to do something else.

Originally published: Wednesday, August 10, 2016; most-recently modified: Friday, June 07, 2019