The unbearable pain of 0.01%

By Felix Salmon
November 19, 2009
Bill Gross isn't earning much interest on his cash: in fact, he's only earning 0.01%. Tell us, Bill, what's an appropriate metaphor to explain how it feels to earn such a low interest rate?

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Bill Gross isn’t earning much interest on his cash: in fact, he’s only earning 0.01%. Tell us, Bill, what’s an appropriate metaphor to explain how it feels to earn such a low interest rate?

My point is to recognize, and to hope that you recognize, that an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive. Like the American doughboys near France’s Maginot line in WWII – slumping day after day in a muddy, rat-infested pit – when the battalion commander finally blew his whistle to charge the enemy lines, it probably was accompanied by some sense of relief; anything, anything but this! Anything but .01%!

I’m not sure this is entirely fair. Think of the camraderie in those muddy foxholes! Think of all those meaningful religious conversions! Frankly, earning 0.01% interest on your money-market funds is much worse than that!

Or, you know, it could be a sign of how incredibly short memories are. A year ago — even six months ago — people thought that losing 30% or 40% or 50% of your money constituted something extremely painful. Now, it seems, making a small amount of money is analogous to fighting in the bloodiest war of all time.

Kid Dynamite today translates Gross’s column into Sensible, explaining that opportunities paying say 5% annualized become a lot more attractive when rates are at zero than they are when you can get 5% just by investing in Treasury bills. Hence assets yielding anything at all — even stocks — have become pretty popular of late, accounting for the impressive price rise since March. Still, he concludes, “this can only end one way… badly”. People aren’t asking that yields compensate for risk any more, they’re just asking that they pay more than nothing. Which is probably not the smartest manner of allocating capital ever invented.

As for Gross, his best advice is to buy utility stocks:

Pricewise, they’re only halfway between their 2007 peaks and 2008 lows – 25% off the top, 25% from the bottom.

Is that the new Goldilocks Scenario, I wonder?

Update: The quote above — which mangles history in unspeakable ways, as many commenters noted — has been changed on the Pimco website, which now talks about “the American doughboys near France’s future Maginot line in WWI”.

15 comments

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Something smells fishy here. Felix doesn’t get it. An interest rate of effectively zero translates to a LOSS of whatever percentage the inflation rate happens to be.

I am reminded of Martin Mayer’s long-ago quip, “Many a villa in Gstaad was acquired with the proceeds of 2 cents per trade.”

Posted by Observer | Report as abusive

Interest rates aside…”Like the American doughboys near France’s Maginot line in WWII – slumping day after day in a muddy, rat-infested pit – when the battalion commander finally blew his whistle to charge the enemy lines, it probably was accompanied by some sense of relief”…Mr. Gross might want to enroll in a basic history class at his local community college.Sheesh..

For QE to work, you want short term interest rates low, longer term higher. You are trying to defeat deflation.

If Bill Gross is forced into risk, that’s wonderful. He is a brilliant man who ought to be made to earn his (gargantuan) keep in ways that improve the world, not just coast on treasuries and pseudo-treasuries. He admits in this December commentary that he gets paid way too much.Bill Gross is a model for financial managers worldwide, who must now go out and earn their keep. They must search high and low to allocate capital well, giving us a more efficient world economy and leading us out of this mess.Government debtholders have for too long earned a terrific low-risk return while adding not much value to the economy. This has been the worst misallocation of capital of all, because it has occurred on such a large scale. And for what, wars?If government debtholders can’t earn a decent return, terrific! It’s about time. If you can’t find a useful return anywhere, go forth and spend. This means you, China. You guys earned it!

Posted by Dan Hess | Report as abusive

He also insists on using nominal interest rates, even when CPI is or has been negative.

Posted by steve | Report as abusive

Just to elaborate on spork’s well-taken point:-American doughboys in rat-infested French trenches, following the whistle over the top were a feature of the FIRST World War.-The misery of that conflict led France to construct the Maginot Line after the war was over. It had no muddy trenches – that was sorta the point. Instead, it had obstacles and concrete strongpoints. Americans never manned the Maginot Line because the Germans simply drove around it, and then conquered France before America entered the war.There’s a lesson here. It’s not merely that Bill Gross lacks perspective, because that would imply that he has an accurate view of two objects but not of the relationship between them. It’s that people who are incredibly smart and well-informed about one topic are often stunningly ignorant about others. I’m not going to pit my ability to pick bonds against that of Bill Gross – instead, I hold shares of a PIMCO fund. And it would behoove Gross to avoid sweeping pronouncements about history, culture, or even political economy. His views on the relationship between government and markets, for example, don’t often make much sense. His ability to figure out spreads on bonds is a narrow and immensely valuable talent. But it didn’t shield him from stupid, blind panic when he withdrew funds from his FDIC-insured bank account.When he talks about finance, though, Gross comes closer to the mark. Money quote: “The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until.”That’s just about right. And it’s why Kid Dynamite’s concerns are largely misplaced. Equity is re-inflating, but it’s still well off of its pre-recession highs. Some of that difference is appropriate – valuations were undoubtedly overblown. But it’s not at all clear to me that we’re seeing a new bubble, or that capital is entering these markets indiscriminately. Indeed, there’s still vastly more money in cash and MMFs than before the panic, and not all sectors of the market are re-inflating at the same pace. I think Gross’ prime point is probably correct – it makes more sense, at this point, to reinvest in the equity of companies that can promise a stable and steady return, albeit a modest one, than to move back to industries in a state of flux where historical returns may not be a guide to future profits.

Posted by Cynic | Report as abusive

“People aren’t asking that yields compensate for risk any more, they’re just asking that they pay more than nothing. Which is probably not the smartest manner of allocating capital ever invented.”This may be a heresy against the Sacred Market, where the investments that people choose to make are, by definition, the best possible allocation of the capital.That aside, does anyone think that we may be looking at a long period where average rates of return are more in the 1% range than in the 10% range, and where it will take a lot of actual work to find the rare opportunities that net you that extra half-percentage point?

Posted by Ken | Report as abusive

I think by and large the runup in commodities and stocks is a good thing for prosperity.If energy prices are high now, there is great incentive to find energy or alternatives. If commodities are being stockpiled all over the world, the future risk for scarcity or war goes way down.If companies have higher capitalizations, there is a stronger motivation to start new companies and get a piece of that action.The big bridge to the future is rising prosperity in Asia, enabling companies of all types to grow into their valuations. Apparently, the younger generation in China are more geared toward spending.If China revalues the RMB, their suddenly boosted spending power will start to heal the world economy and Fed policy can start to normalize. If China keeps its peg, US joblessness will remain very high and Bernanke will keep rates at zero.As long as China holds its peg, it remains captive to Fed policy.

Posted by Dan Hess | Report as abusive

The fact that you did not bring up two other issues makes me think you and Bill Gross both have terrible understanding of history, even if your short term memory is far better.American “doughboys” fighting in trenches were a feature of WWI, not WWII. The Maginot line was constructed in the years prior to WWII, but saw basically no use throughout that war because the Germans (twice) and the Allies attacked through the Ardennes forest (north of the northernmost major Maginot line forts) or through Belgium and Holland.

Posted by OmerosPeanut | Report as abusive

Bill Gross’ commentary presently reads”Like the American doughboys near France’s future Maginot line in WWI”Did Bill just quietly change it?

Posted by Daniel Hess | Report as abusive

Great catch, Daniel. That’s not the version up this afternoon; apparently, someone brought it to his attention. But what I really love about the correction is that it kept the reference to the Maginot Line, even though it makes no sense whatsoever. And, contrary to the practice of most people who post their material online, Gross didn’t bother noting the correction. I guess being that rich means never having to say you were wrong.

Posted by Cynic | Report as abusive

Perhaps the “Siegfried Line” would have been a more defensible choice? Although, yeah, officers with whistles and going over the top and all that is pretty World War I. ‘Course, there was a Siegfried Line in WWI as well…@Robomarkov–”An interest rate of effectively zero translates to a LOSS of whatever percentage the inflation rate happens to be.”And the inflation rate, at the moment, is…?

Posted by Craig | Report as abusive

It looks to me as if you are all missing the point. You are coming at it from the growth perspective of the younger investor, not the retiree or near retiree who is looking at that pot of money in a very different way.If you are retired or nearing retirement (probably about 70 MM people), you are looking at a pot of prudently selected fixed-income investments. That’s what you are told to do so you can avoid the ups-and-downs of equities. Of course, you might have the common goal of wanting to preserve the principal for your heirs, and are planning to live off the interest income from those investments to supplement Social Security. My expectation formed over my entire life is that I can find very safe investments that cover the rate of inflation and pay 2-3 % on top of that for the right to use my money. Unlike you, I don’t care too much about maximizing the interest rate or the rate of return per se, only that it stay within a range that allows me to achieve my retirement expectations.If I have accumulated $1 million for that purpose, at the 5% I came to expect as a minimum rate for safe fixed-income investments – far from what anyone would have ever said was the product of an “asset bubble,” I can generate $50,000 per year for as long as I live without depleting principal. Maybe I will have $70,000 total income combined with Social Security, which could be a reasonably comfortable retirement income.If the interest rate is 1%, my annual interest income is $10,000, so my combined annual income has been more than cut in half.The stock market and housing market are not the only asset classes where there has been a massive depletion of wealth. For those in and near retirement, the fixed income investments they prudently have been shifting towards have been virtually destroyed in the terms they were thinking of.Imagine the trillions of dollars in demand that pulls out of the system. Meanwhile, we effectively take that demand money from seniors and make it available for businesses to borrow at the extremely low rates. In other words, it’s a supply-side strategy. But the businesses are not borrowing it, partly because the banks don’t want to lend it in a more risk-averse climate, but more fundamentally because there aren’t that many businesses that want to borrow it. This, of course, the banks see, too, so that poor demand partly explains their reluctance to lend – i.e., to buyers who seem to over-estimate their likelihood of success with the money).So we have both a reluctance to borrow with poor business prospects, and a reluctance to lend for the same reason as well as more careful attention to lending fundamentals. Why? Because there is not enough demand, and a significant part of that loss of demand is loss of wealth on fixed-income investments for the retired and those planning to retire soon.Is tending to the supply-side as the Fed typically does to boost the economy — by making it less costly for businesses to borrow — worth the trade-off in massive loss of perceived wealth among a high-consuming part of the population? Normally, when you are talking about the kinds of fluctuations in interest rates we have seen over the years, it probably is. But when overall demand for many reasons has been damaged so badly, not the least of which is the loss of wealth that seemed to make that demand reasonable, I have my doubts.

Posted by urban legend | Report as abusive

“If I have accumulated $1 million for that purpose, at the 5% I came to expect as a minimum rate for safe fixed-income investments – far from what anyone would have ever said was the product of an “asset bubble,” I can generate $50,000 per year for as long as I live without depleting principal. Maybe I will have $70,000 total income combined with Social Security, which could be a reasonably comfortable retirement income.”@Urban Legend:If you think it is reasonable to get a 5% return on top of inflation without taking risk, I have some oceanfront property in Nevada to sell you. That may have been possible in the past, but we are in a new world now.Investing is not about loaning your funds out to a government, completely abdicating responsibility for finding meaningful uses for the capital and then expecting a substantial return above inflation. Our governments are nearly bankrupt.If you lend to a nearly bankrupt and profligate entity, you deserve to lose a lot of money. You are like a bartender serving a drunk who is drinking himself to death. You are not innocent. You are part of the problem, and your investments are making the world worse. You don’t deserve a good return for that.How to invest? If you really want risk fee, go for TIPs, but don’t expect much beyond inflation. Better yet, learn basics of business and investing and carefully loan out to local small businesses. Or be a landlord, watching your profit and dividends every month. Or invest in important and useful companies via the stockmarket. Or invest in making your house energy efficient. Or invest in your childrens’ and grandchildrens’ educations. Or donate it for research to invest in everyone’s future.Whine about the Fed if you want. Your treasury buys make all these games possible.

Posted by Dan | Report as abusive