An Observation Regarding Keynesian Economics
Debt and business cycles happen, boom and bust phases exist in most economies throughout history. It really is not predictable when the booms or busts happen, but it is a cycle. Deflation is generally considered to be more destructive than inflation, and so most central reserve banks target a small amount of inflation.
During economic decline governments essentially have three "levers" they can use to soften the landing:
1. They can decrease interest rates
2. They can increase the money supply directly (printing of money basically)
3. They can increase government spending
However, just as the stock market is quite volatile, but generally trends upward in value and returns over long time periods, most governments see their currency valuation and interest rates trend downwards over long time scales. I think there is a reason for this.
The Birth of a Nation and National Economy
Most nations are "born" and typically have their first currency pegged either to gold or another currency until they eventually float it to a purely Fiat currency. Most small or young nations also pay large interest rates because their bonds are inherently more risky. The US in the civil war and before the civil war paid much larger interest rates, loaning to young government is, well, risky. Common sense nothing new here.
However, eventually governments realized that lowering interest rates and quantitative easing can reduce the severity and duration of an economic crash, and so they do so. Gradually over the long term we see the interest rates and currency valuation gradually creep downwards for most economies because this is used to soften the busts that happen during the debt and business cycles. Government spending is also usually rather high. Unfortunately for Bond traders this observation is quite useless because while the trend may be downward on average over the very long term, in the short term interest rates and currency valuations can be very volatile.
The Economic Arrow of Time
Entropy tends to trend upwards in any closed system, we may see probabilistic local random dips in entropy, but the whole trend line always points up. In national economies their currency valuations and interest rates, when controlled by a central banking system, or similar body, tend to always trend down. Any administration is very hesitant to raise interest rates (or currency valuations), and keep them raised for too long, as poor economic performance is often the result. Thus it tends to always trend downward in systems where inflation and deflation are well understood. This trend usually continues until a restructuring of debts and currencies, and then the process starts all over again. To investors this means very little, as in the short term it has very little utility.
The Economic Event Horizon
When a national bank lowers interest rates to zero, or worse negative interest rates, they have begun to reach the limits of what they can do with that level, they have essentially broken it off, it has reached its logical extreme. When currency then inflates to a certain point, there really is very little benefit to printing or otherwise making more. When a nation reaches these extremes there is a very low probability of ever revaluing the currency, or re-raising the interest rates substantially over zero again, without causing a recession or depression. In short the only real way out is likely some kind of restructuring of debt, changing of laws, or even changing of governmental structure. The old order has, at that point crossed the economic event horizon, their central reserve bank will have simply used up most of its ability to stimulate the economy.
Concluding Remarks
This is a look at economies through the lens of Keynesian economics, and is a little oversimplified. Hopefully it was somewhat entertaining and or informative. It really doesn't tell us anything that useful, just because QEs effectiveness eventually drops off does not mean there are not other governmental measures to help economic growth. It is not something that allows us to really time the market in any way, so its useless for traders. Most changes in currency do not result in a total destruction of investible assets, just a more severe crash in the short term, so it really does not impact us long term indexers either. It is interesting, and it explains why, in the long term, we are unlikely to see an end to inflation, and it kind of tells us how close we are to greater levels of volatility. If the central banks cannot soften economic landings the falls will be deeper and sharper, but they will ultimately still recover. The central banks are not the only piece of the puzzle, there are still more policy measures that can be taken to stimulate an economy, public works projects, subsistence payments, and the like. It will be very interesting, from a theoretical perspective to see what the three nations that reached negative interest rates do over the next few decades.
Debt and business cycles happen, boom and bust phases exist in most economies throughout history. It really is not predictable when the booms or busts happen, but it is a cycle. Deflation is generally considered to be more destructive than inflation, and so most central reserve banks target a small amount of inflation.
During economic decline governments essentially have three "levers" they can use to soften the landing:
1. They can decrease interest rates
2. They can increase the money supply directly (printing of money basically)
3. They can increase government spending
However, just as the stock market is quite volatile, but generally trends upward in value and returns over long time periods, most governments see their currency valuation and interest rates trend downwards over long time scales. I think there is a reason for this.
The Birth of a Nation and National Economy
Most nations are "born" and typically have their first currency pegged either to gold or another currency until they eventually float it to a purely Fiat currency. Most small or young nations also pay large interest rates because their bonds are inherently more risky. The US in the civil war and before the civil war paid much larger interest rates, loaning to young government is, well, risky. Common sense nothing new here.
However, eventually governments realized that lowering interest rates and quantitative easing can reduce the severity and duration of an economic crash, and so they do so. Gradually over the long term we see the interest rates and currency valuation gradually creep downwards for most economies because this is used to soften the busts that happen during the debt and business cycles. Government spending is also usually rather high. Unfortunately for Bond traders this observation is quite useless because while the trend may be downward on average over the very long term, in the short term interest rates and currency valuations can be very volatile.
The Economic Arrow of Time
Entropy tends to trend upwards in any closed system, we may see probabilistic local random dips in entropy, but the whole trend line always points up. In national economies their currency valuations and interest rates, when controlled by a central banking system, or similar body, tend to always trend down. Any administration is very hesitant to raise interest rates (or currency valuations), and keep them raised for too long, as poor economic performance is often the result. Thus it tends to always trend downward in systems where inflation and deflation are well understood. This trend usually continues until a restructuring of debts and currencies, and then the process starts all over again. To investors this means very little, as in the short term it has very little utility.
The Economic Event Horizon
When a national bank lowers interest rates to zero, or worse negative interest rates, they have begun to reach the limits of what they can do with that level, they have essentially broken it off, it has reached its logical extreme. When currency then inflates to a certain point, there really is very little benefit to printing or otherwise making more. When a nation reaches these extremes there is a very low probability of ever revaluing the currency, or re-raising the interest rates substantially over zero again, without causing a recession or depression. In short the only real way out is likely some kind of restructuring of debt, changing of laws, or even changing of governmental structure. The old order has, at that point crossed the economic event horizon, their central reserve bank will have simply used up most of its ability to stimulate the economy.
Concluding Remarks
This is a look at economies through the lens of Keynesian economics, and is a little oversimplified. Hopefully it was somewhat entertaining and or informative. It really doesn't tell us anything that useful, just because QEs effectiveness eventually drops off does not mean there are not other governmental measures to help economic growth. It is not something that allows us to really time the market in any way, so its useless for traders. Most changes in currency do not result in a total destruction of investible assets, just a more severe crash in the short term, so it really does not impact us long term indexers either. It is interesting, and it explains why, in the long term, we are unlikely to see an end to inflation, and it kind of tells us how close we are to greater levels of volatility. If the central banks cannot soften economic landings the falls will be deeper and sharper, but they will ultimately still recover. The central banks are not the only piece of the puzzle, there are still more policy measures that can be taken to stimulate an economy, public works projects, subsistence payments, and the like. It will be very interesting, from a theoretical perspective to see what the three nations that reached negative interest rates do over the next few decades.
Statistics: Posted by Benjamin Buffett — Sat Nov 30, 2024 3:19 am — Replies 0 — Views 71