Abnormal Normalisation Obscures a Better Future

Interest rates are to asset prices like gravity is to the apple. When interest rates are low, there is a very low gravitational pull on asset prices.  Warren Buffet

The Price of Time

The financial world is going through a period described as monetary policy “normalisation”, taking us back to more normal interest rates. This commendable objective re-establishes a positive time value of money lost during an extended period of near-zero rates. It restores our “normal” ability to assess the future and rationalise savings and investment decisions.

First Derivative

However, the way we have got here has been anything but normal. The above chart shows the rolling 12-month rate of change LIBOR over the last forty years. From this perspective, it is clear that 2022 is abnormal. This abnormal normalisation represents the most aggressive tightening of global financial conditions in living memory. It illustrates the critical difference between absolute levels of interest rates (still relatively low in a historical context) and their rate of change. The gravitational pull of rising interest rates on asset prices has wreaked havoc in bond markets and on share prices. Higher rates force market actors to focus more on today and less on the future. Longer duration growth shares have declined in value, and the prices of energy and commodities to satisfy today’s needs have risen.

Future Now

The dip, on the chart above, from 2020 to 2021 was when things went wrong. Emergency lockdown measures compounded upon a prior decade of loose money. Money was so widely available interest rates trended to zero, and the future hurtled towards us at a rate not seen since the late 1990s. As a consequence, E-commerce exploded, and Amazon, Shopify and others witnessed a decade of market share gains in two years. Just Eat and Deliveroo kept us fed as we bought digital assets to equip us for our imminent new life in the metaverse. Securely locked away, we saved money, and the future was the place to be, according to Cathy Wood, among others.

Pessimism Preference

Eighteen months later, things are very different. Today risk profiles have radically changed. The future is no longer as obvious or inevitable. We have a war on our doorstep, rapidly rising prices and the looming prospect of disrupted energy supplies. In 2020 we didn’t worry about companies failing. Going bust was outlawed, a critical element of the lockdown regime. But today, Europe faces the prospect of de-industrialisation as rising energy and borrowing costs undermine corporate liquidity and solvency. We are bombarded by relentlessly bearish media on our well-honed risk aversion bias, or what Morgan Housel calls our propensity to be seduced by pessimism. In short, we can find little to be positive about.

A Better Future

While we become overly focused on our immediate problems, it is worth reminding ourselves that a better future is ahead. The problem is the increasing price of time has made it more expensive to consider. Naturally, the media and most political opinions want to see a plan for our better future. Indeed human instinct expects a plan everyone can get behind. But we also understand this is not an easy task.

No Plan Required

However, a plan is unnecessary if you listen to AI specialist and author Kenneth Stanley. In fact, the existence of a plan will likely make things worse. Prof Stanley’s counterintuitive thesis is that when it comes to big life-changing innovation, the less we plan for it, the more chance we have of achieving it. In Greatness Cannot be Planned, the Myth of the Objective, Stanley reaches a similar conclusion to economist John Kay’s Obliquity, Why Our Golas are Best Achieved Indirectly and risk analyst Nassim Nicolas Taleb’s Fooled by Randomness, The Hidden Role of Chance in Life and Markets.

Stepping Stones

There is no a priori objective route to success regarding the great unknowns. Think of the evolution of the PC or the internet. After the event, the route to success is obvious, but it is far from the case while on the journey. Stanley likens it to taking stepping stones across a lake shrouded in fog. Real game-changing innovation evolves from serendipity between disparate groups of people who find various things interesting over a long time combined with much trial and error. It doesn’t require an objective plan.

Weirdness Rules

Our long-term economic fate is due to a complex adaptive system, unpredictable, prone to extreme tail events, but ultimately positive if you can stomach the ride. Evolution does not suffer from risk aversion and will try anything to survive and reproduce. As Taleb points out in Skin in the Game, The Hidden Asymmetries of Everyday Life, evolution operates at its best in the moment of near extinction. As the saying goes, the gene pool doesn’t have a lifeguard, and weirdness (mutation) is a necessary but insufficient prerequisite for success. It is still even in the realm of possibility that the Truss, Kwarteng think-tank simulation they have subjected us to is successful. Albeit, this should be regarded as a tail event outcome. The organism that will deliver a better future remains operative. We are just not currently paying attention.

The Case for Optimism

Famously grumpy Winston Churchill said that he was an optimist as it didn’t seem much point being anything else. He said pessimists saw problems in every opportunity, while optimists saw opportunity in every problem. In The Rational Optimist, How Prosperity Evolves, Matt Ridley wrote, “exchange is to cultural evolution as sex is to biological evolution. At some point in human history, ideas began to meet and mate, to have sex with each other. Sex is what makes biological evolution cumulative because it brings together the genes of different individuals. A mutation that occurs in one creature can therefore join forces with a mutation that occurs in another.” Evolutionary biologist Richard Dawkins coined the term meme to describe the evolution of ideas in our cultural development.

Ridley, Stanley, Churchill, Taleb, Dawkins and Kay are all right. Human progress is both spontaneous and relentless. Our cultural and economic development has survived far bigger setbacks than we currently face it is just that the rising price of time is obscuring our view.

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