The End of an Era: Jim Grant on Interest Rates
"Falling rates have been really desirable, and you can imagine that rising rates will have mirror-image consequences."
The most important price in the world is the price of money: namely, interest rates. And interest rates are suddenly on everyone’s minds, as rates shoot upward for the first time in decades. The effects or this rise will be felt in the markets, the economy at large, in households, and at the election booth. Which is why I went to Jim Grant: the investor, historian, and editor of the Grant’s Interest Rate Observer, which has been required reading on Wall Street for many years. No one has followed the rate cycles more closely or perceptively. To try to make sense of today’s new environment, the inflation problem, the likely trajectory of markets, and where one might find opportunity in the chaos to come, I spoke with Grant last week from his office in the financial district. In our conversation, he drew on his deep knowledge of financial history to explain why he believes we are likely entering a new cycle that might last decades—and how best to navigate it.
Octavian Report: Your newsletter is called Grant’s Interest Rate Observer. You’ve now been watching interest rates for nearly 40 years. For almost that entire period, the trajectory was down, down, down. Do you think we’re now going into an upswing that will be similarly long?
Jim Grant: Yes, I think so, and I have thought that prematurely at intervals going back many years. The striking thing about the bond market and interest rates is that they tend to rise and fall in generation-length intervals. No other financial security that I know of exhibits that same characteristic. But interest rates have done that going back to the Civil War period, when they fell persistently from 1865 to 1900. They then rose from 1900 to 1920, fell from 1920 or so to 1946, and then rose from 1946 to 1981—and did they ever rise in the last five or 10 years of that 35 year period. Then they fell again from 1981 to 2019-2020.
So each of these cycles was very long-lived. This current one has been, let’s say, 40 years. That’s one-and-a-half successful Wall Street careers. You could be working in this business for a long time and never have seen a bear market in bonds. And I think that that muscle memory has deadened the perception of financial forces that would conspire to lead to higher rates. Throughout 2021, the market was very skeptical about the inflation problem. Of course, the Federal Reserve was telling us it was transitory. The verdict of the bond market is expressed in the so-called breakeven rate, which is the difference between nominally denominated yields; that’s to say, yields unadjusted for inflation on the one hand and treasury inflation, protected securities known as TIPS, on the other. That breakeven inflation rate was very, very low—two percentage points. So people were very slow to come around to the idea that interest rates could rise in persistent way. In fact, theories developed explaining why that had become impossible.
Those theories still may yet have some life in them: at one point in 2020, some $18 trillion worth of bonds worldwide were priced to deliver a yield in nominal terms of less than nothing. A remarkable thing. Bloomberg just reported that German two-year notes had risen in yield to above zero, and quoted somebody saying that this was remarkable. What was remarkable was that German yields were all below zero in the first place. Of course, there are interest rates denominated in paper money that the central banks have pledged to debase. It’s on the agenda, that they want to deliver two percent inflation. That two percent comes right out of the pockets of the bondholders. They’re like Stockholm Syndrome victims: “Yes, we’re all on board for two percent inflation.”
OR: It’s not two percent right yet. What do you think is driving inflation today? Was it all that government stimulus spending? Or do you think it’s the supply-chain bottlenecks?
Grant: I think it’s the confluence of things, including record-smashing fiscal deficits, record-smashing growth in the Fed’s balance sheet, near-record growth in money supply as broadly defined, and the constraints on supply attendant on COVID at first and now the disruptions that are part and parcel of the war in Ukraine. If I had no shame about using clichés, I would use the phrase “perfect storm.” There has been a confluence of events that at once suppressed supply of the margin and stimulated demand at the margin. All this at a time when governments are running immense deficits, and central banks are printing extraordinary amounts of money. So you kind of wonder, what did they expect to happen?
OR: What do you expect the Fed will do now?
Grant: The wrong thing.
OR: Which is what?
Grant: Oh, that’s my reflexive response to any question about the Fed. I think it will deliver too little and too late, as usual. And then overdo what it was lazy in starting to do.
OR: All of a sudden, there are rumblings that we’re going to have a recession if the Fed raises rates too quickly.
Grant: We might. Back when I went to Stanford, there was a professor there named John Taylor. A formidable academic and a very respected public servant. John Taylor’s name is among the most frequently mentioned in the transcripts of the Federal Open Market Committee. Why? Because Taylor is the author of the eponymous rule that sets the framework for setting federal funds rates. Right now, the Taylor Rule would have a funds rate of about 9.5 percent. But what is the actual funds rate? Just a little bit more than zero. So, it would take 30-odd quarter-point turns in the rate to get to the Taylor Rule, and we’re currently talking about many fewer. So the Fed has still not confronted the inflation problem, and people are hoping that it’s just going to go away, that the supply chain problems will cure themselves, that the Biden Treasury is going to rein in spending, and so on. But I think that inflation will prove less tractable and altogether more troublesome than most people realize.
OR: If we are in an inflationary environment for a long period of time and if rates continue to march upward, what will that mean for the different markets? When rates were going down, everything went up, other than cash. What happens when you go in the other direction?
Grant: Well, it’s not good for financial assets. Interest rates do all sorts of things. They measure investment-hurdle rates, they discount the value of projected future cash flows, and they measure credit risk. So when interest rates fall, more projects are greenlit by corporate strategic planners.
Falling rates entice borrowing and lending. They are gentle on companies that are over-leveraged, since they allow them to refinance their debts at lower costs. Falling interest rates are also immensely helpful for the housing business, a very important sector. Falling rates allow homeowners to refinance their mortgages and pocket or spend more of their income. Over the last 40 years, falling rates have done wonders for the net worth of the average American household and for the balance sheet of your average American corporation.
Of course, falling rates also have their drawbacks. For example, they have worked to the detriment of companies carrying large cash balances. And from time to time, they have steered people in the wrong direction, leading them to take risks they should not have taken. We saw this in the financial crisis of 2007-2009, for instance. But on the whole, falling rates have been really desirable, and you can imagine that rising rates will have mirror-image consequences.
OR: What do you think will happen with commodities?
Grant: What is driving commodity prices is not so much the Russian invasion of Ukraine, and before that the lockdowns due to COVID, but rather 10 years of underinvestment in new commodity production.
That’s especially been true in the realm of oil and gas. The world is facing a hydrocarbon first in which it will be consuming more than the producers are pumping. The market is very tight. I think people are focusing too much on the Russian-Ukrainian peace talks and not enough on the underlying cause of high commodity prices, which is a very widespread case of underinvestment in energy. And that’s also true of a number of other industries: metals, oil and gas and the like. So, yes, we’re bullish on commodities.
OR: Do you think agricultural commodities will do well also?
Grant: I think so.
OR: One dramatic thing about the sanctions regime on Russia is how thoroughly the West has cut Russia off from the global economy. Do you think that will impact the U.S. dollar’s future as the global reserve currency? And do you think we’re going to see a reordering of the financial system in general?
Grant: Reserve currencies have a very long shelf life. I think that the dollar deserves the benefit of the doubt. The reserve currency franchise takes a long time to earn, and it takes a long time to dissipate. But this idea of weaponizing the dollar is a term that is pregnant with long-term meaning.
Not every country in the world agrees with the West. And countries like India and China, which have lined up with Russia in this very ugly business in Ukraine, will think again about the composition of their own reserve assets. I also think that the world in general has had its fill of the United States Treasury handing down protocols, instructions, and strictures about how you can and can’t use the dollar. “You must know your customer. You must be sure you’re not dealing with terrorists. You must conform to this and check that. You must not miss any of the boxes, lest you be kicked off the relevant digital payment system.” So I think America has to watch its assumption that the dollar will retain its position for all time.
OR: Do you think gold will go up?
Grant: I do. I’m eternally bullish on gold. Gold competes against other brands of money. It competes against fiat currencies. It competes against credit, which is the promise to pay money. And with interest rates at zero, the competition was very easy. As interest rates rise, the competition will become more intense. I think the real test will be when rising rates impinge on the Federal Reserve’s determination to not only manage the economy, not only provide for a stable dollar, but act as a force for equity and for a labor market that is strong for all parties
OR: What’s your position on crypto?
Grant: If you’re a gold guy, it’s awfully frustrating because people are buying crypto when they ought to be buying gold. The other day I got an elevator and Kenny G was playing. And I was thinking, what does Kenny G play? He’s anodyne, it’s annoying. And then I got to thinking that Kenny G is like BitCoin. Here’s what Brandon Marsalis had to say about the criticism that jazz musicians have heaped on Kenny G. He said, “Hey, leave Kenny G alone. It’s not as if people listen to John Coltrane and Ornette Coleman and then listen to Kenny G and say, ‘Wow, I’m going to stop listening to Coltrane.’” So I think that people who are buying Bitcoin are actually not buying Bitcoin to express a monetary point. They are buying the Kenny G version of a monetary alternative. It’s not a substitute for the real, substantive thing. And they can have it. Me? I’m going to buy Coltrane and Ornette. And Newmont Corporation.
OR: You have a really broad view of financial history.
Grant: I am 100 years old.
OR: Does this period of time remind you of any other?
Grant: Well, there are elements that evoke different times. For example, the manipulation of interest rates evokes the fixing of Treasury bond yields between 1942 and 1951. It reminds me, to a degree, of the late 1960s. And it reminds me of the late 1990s, but what is new and different is the overlay of basically free money, zero percent interest rates, and a never-seen-before program of debt monetization by the Fed, which is a fancy phrase for buying the Treasury’s debt with dollar bills that didn’t exist before the Fed conjured them into being.
The combination of immense Treasury borrowing in a time of peace and of gargantuan money-creating operations by the Fed, that’s a new thing. These things are not unique in the history of finance, but the clustering of them and their intensity introduces a new, if not unique, element.
OR: Because negative interest rates are a new phenomenon?
Grant: Yes. Irving Fisher, who was often ranked as among the top American economists of all time wrote about negative interest rates. He thought that they could possibly materialize, but not for long. But the idea that $18 trillion worth of bonds will be priced to yield less than nothing, that’s unheard of in thousands of years of interest rates. Negative Treasury bill yields were a feature of the late 1930s and early 1940s. We’ve seen them periodically at rare intervals since then, but nothing like $18 trillion. And it’s not just Treasury bills; junk bonds were also yielding less than nothing at one point in the past couple of years. Remarkable.
OR: Can we get out of it the debt mess, or are we stuck?
Grant: We always get out of it. But there’s no guarantee that we’re going to get out with as much money as we had when we started to adjust.
OR: So if you were going to summarize your advice for navigating the current environment, it would be, number one, to subscribe to Grant’s, right?
Grant: Stop right there.
OR: And the other thing is to invest in gold?
Grant: As the value investors have said since time immemorial, “There’s always something to do.” I believe that there’s always opportunity, not just on the short side. Japan, for instance, has more public companies than does the United States, I think, and in Japan, they’re starting to get the hang of a new idea: of making money for their stockholders and investing with an eye to a return on capital rather than just growing market share. A whole new generation of younger managers are coming into positions of leadership in Japan, and they share this view, and I think it’s very promising, because stocks there are cheap and nobody follows them.
Instead, a lot of big U.S. investors have been all about China for a long time. And now what do we see? We see China lining up on the wrong side in Ukraine. And what would happen if we had an explicit parting of the ways with China? What would happen to all of these hundreds of billions of dollars of private equity invested there? BlackRock’s view is that the main China political risk involves carbon emissions. But I think it might have more to do with the conquest of Taiwan than with smog. So I’m thinking that Japan might be a thing. That’s what we try to do at Grant’s. We try to imagine how a hardened consensuses of opinion could change—how people think that there’s no alternative but the way things are, and how that could change. So yes, there will be trouble ahead, but also a lot of interesting things to do.
This interview has been edited for length and clarity.