James Grant founded Grant’s Interest Rate Observer in 1983 following a stint at Barron’s, where he originated the “Current Yield” column. His books include many works of financial history, finance and include “Mr. Market Miscalculates” (Axios Press, 2008); and “John Adams: Party of One” (Farrar, Straus & Giroux, 2005). Grant answers questions on savings, debt, and growth.
What is the difference between real savings and money injected into the system?
Real savings is consumption deferred. Money is work. It is the residue of work. Credit is a promise to pay money. It’s different than [money] itself. These days, the distinction is somewhat blurred because paper money is called notes. A note is a promise to pay and yet money also goes by the name of note. If you look at a Federal Reserve note, our greenbacks in America say, “This note is a promise to pay.” Pay what exactly? There is nothing behind it.
The age-old distinction between money and credit has been blurred certainly since the early 1970s with the disappearance of the last vestiges of the gold standard. But there still remains a clear intellectual distinction between what central banks do when they create new credit that is, promises to pay on the one hand and what someone does when he or she puts aside money that he or she has earned.
People talk about a savings glut. That’s a phrase you hear a lot. But it’s not so much a glut of savings as it is a glut of central bank created scrip.
What is the economic impact of real savings?
One is wholesome and one is not in my judgment. Over the last couple of years, central banks have created trillions of dollars worth of new scrip, of new fiat currency. Typically, such emissions do both good and harm, they do good in that they seem to infuse some with a spirit of speculation and adventure. That’s a good thing. More business at the margin, I guess this is good.
But there is a strong residue of mischief in the creation of all the central bank credit. It destroys value; it introduces inflation if not at the checkout counter at your local grocery store, than in the financial markets. On Wall Street we call this “a bull market.” But when values get out of kilter, as they did in this country with respect to housing in the mid-2000s, there is typically a price to be paid later when values are restored to a reasonable level.
What about productive activity?
The United States is a fountain of productive activity, the government can’t seem to suppress it, try as it might with regulation and money printing. We Americans are enterprising people and there is a lot of that in this country. The trouble is that to my mind at least, a lot of enterprise is being thwarted and misdirected through the activities of government in regulation and in central banking.
Ultra low rates, invisible interest rates discourage savings and encourage speculation. In the short run that doesn’t seem to bother too many people. There is a great silence with regard to the removal of interest rates on savings. The silence is the silence of people who ought to be protesting, but don’t seem to be doing so.
You would suppose there would be a great protest by the victims of zero percent interest rates. Anyone who has dutifully saved for retirement. The cost of retirement is through the roof because the yield on savings has plummeted. Once upon a time $1,000,000 would yield a saver about $60,000 a year in a relatively secure credit instrument.
Bank deposits paid 4–5 percent. You could get high quality bonds for 6 percent, so $60,000 a year. These days no such yields are available and you need $10 million to achieve the level of income that $1 million would have yielded you not so many years back.
One isn’t necessarily entitled to a rate of 6 percent. But the authorities ought to do a better job at explaining why it is just for banks to be paying the depositors zero percent as those banks were maybe not the causes of our difficulties in 2007–2008, but certainly played a big part in them as they return to something like health.
It’s an ethical question as much as a financial one. The Federal Reserve protests that zero percent rates are good for everyone because they encourage economic activity, which I dispute.
What can a saver do?
There are so called businessman’s risks. These are investments in real estate investment trusts, mortgage backed real estate investment trusts, and business development companies. In other finance companies that trough a relatively small amount and prudently managed amount of leverage can generate returns upward of 5 or 6 or 7 percent for savers. But those yields come with a risk.
What it means for savers is: To generate a living level of income comes with a certain amount of apprehension.
What about stocks?
Well stocks don’t yield very much. They have been on the upswing since March 2009; it has been a lovely bull market. But the consequence of all these years of appreciation means that valuations are relatively high. They are relatively high with respect to revenues with respect to earnings, with respect to book value and with respect to dividends.
So stocks may or may not be near a top—I have learned in the fullness of years not to say that. In any case they are no longer cheap.
It’s hard to say because we have never seen this kind of monetary policy before.
We certainly have experience with ultra-low interest rates in this country and others. Interest rates were very low in the 1930s and 1940s into the ’50s. They were very low in the Victorian age in Europe. But never before in financial history that I know of have these ultra-low interest rates coincided with muscular attempts by the monetary authority to lift asset prices: both stock prices and bond prices.
So in the 1940s in America interest rates were almost as low as they are now. What was different was that the Fed was imposing higher margin requirements to stifle speculation. Now the Federal Reserve is fanning speculation. There is a very big difference and a difference that very few people understand or appreciate.
What about currency speculation?
The idea of a strong currency is like the old maid in a card game, nobody wants the old maid; everyone wants a weak currency.
Imports would seem to be the pay-off for foreign trade. People talk about exports. But isn’t the way you get paid through imports and a strong currency makes imports cheaper.
Germany seems to have done well since the late 1940s with a relatively strong currency. Argentina, which has chronically had a very weak currency seems to have done less well. Still, most intellectuals in the policymaking realm these days prefer a weak currency. Hence central banks are in competition to lower their currency values.
The Germans thrived with the Deutsche mark, which was rather strong. I am not sure if Germany’s relative economic success has to do with the currency in principle or with the idea that one should work and save. There seems to be a laudable work ethic in Germany. Maybe that explains it more than does currency value.
Can you explain the famous wealth effect?
This is a very fancy concept. As posited by the scholars at the Fed, the portfolio balance channel is a technique by which people are led to consume more by way of owning more. If the stock market goes up, they will feel richer and they go out to dinner and a movie.
Isn’t this circular and backward?
Right. I think the idea is that you feel so smart and so wealthy because of appreciating asset prices that you are led to consume more. I think the empirical evidence for this wealth effect is very, very slight. And I read some very persuasive arguments saying it doesn’t exist.
Inasmuch as it has contributed to this country’s well-being it has helped the people who didn’t really need the contribution. It has done very well for the rich.
Please explain the connection between low rates and economic potential.
It speaks to a sterility of capital. If capital yields nothing, which is what it does these days, what does that say about commercial opportunities and returns to investment capital?
So why are these returns so low?
I suspect it has to do with the policies of the central bank but also with the psychology these policies have instilled: All this talk about deflation and near-depression and crisis.
It’s been six years and it seems to me the Fed has done us no favor by keeping alive this idea we are in a perennial crisis, “a new normal.” I dispute that.
James Grant is the founder of Grant’s Interest Observer, a New York-based provider of investment research. He is the author of numerous books on finance as well as several biographies.
The interview has been edited for brevity and clarity.