Wimpy’s World

By: Michael Ashton | Tue, Feb 23, 2016
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Would you rather have a bar of chocolate today, or one year from today?

Most of us, if we like chocolate, would prefer to have a bar of chocolate today rather than at some point in the future. If you don't care for chocolate, how about money? Would you rather have $100 today, or $100 next year?

The reason that Wimpy's "I'll gladly pay you Tuesday for a hamburger today" ploy doesn't work is that we would prefer to have the money today compared to the money on Tuesday. If Wimpy wants his burger today, but doesn't have the money for it, then he must borrow the money and pay that money back on Tuesday. Because of our time preference for money, this will cost Wimpy something extra, as he needs to incentivize us to part with the money today so that he can get his burger now.

This is where it gets weird.

We are now in a Wimpy world. Not only can Wimpy get his burger today, it costs him less if he borrows the money because interest rates are negative. That is, "I'll gladly pay you less money than the burger costs, and not until Tuesday, for the burger today." And we are enthusiastically answering, "Sure! Sounds like a great deal!"

This is one weird implication of negative interest rates. If the yield curve was flat at a negative interest rate, it would imply that the further in the future something is, the more valuable it is. A dollar next week is worth more than a dollar today. With negative discount rates, a chocolate bar next year is preferable to a chocolate bar today. And poor Wimpy...being forced to have a hamburger today when a hamburger on Tuesday would be so much better!

It gets even weirder if the yield curve is initially negative but slopes upwards and eventually becomes positive. That implies that discount rates (time preferences) are negative at first, but then flip around and become normal at some point in the future. So there is one day in the future where value is maximized, and it's less valuable to get money after that date or before that date.

You think this is mere theory, but this is happening internally to derivatives books even as we speak. The models are implying that money later is worth more than money now, because money now costs money to have. And from the standpoint of bank funding, that is absolutely true.

Another strange implication: in general, stocks that do not pay dividends should trade at lower multiples (relative to the firm's growth) because, being valued only on some terminal cash flow date (when a dividend is paid or when the company is bought out), they're worth less. But now it is better for a stock to not pay dividends; those dividends have negative value. Technically speaking, this means that companies which cut their dividends should trade at higher prices after the cut.

I can think of more! Ordinarily, if your child enters college the institution will offer you an incentive to pay four years' tuition at a reduced rate, up front (or at a frozen rate). But, if interest rates are negative, the college should demand a premium if you want to pay up front. Similarly, car companies should insist that you take out a zero-interest-rate loan or else pay a premium if you feel you must pay cash.

In this topsy-turvy world, it is good to be in debt and bad to have a nest egg.

Neighbors appreciate you borrowing a cup of sugar and frown at you when you return it.

Burglars put off burglaries. Baseball teams sign the worst players to the longest deals. Insurance companies pay out life insurance before you die.

And all thanks to negative interest rate policies from your friendly neighborhood central bank. I will thank them tomorrow, when they'll appreciate it more.

 


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Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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