Crying over spilt milk or why higher interest rates are hard

Should you invest in a business? If interest rates are zero, the answer is probably yes. When money in a savings account or a bond earns nothing, any reasonable business promising a non-zero returns starts to look good. If it sells electric cars and promises a 10x payday in a decade, all the better. Sure, the business may not make money until then, but neither will the savings account. Savings accounts are also boring. People will buy you drinks to hear about an electric car company, not a zero-interest savings account. So, you invest.

But when interest rates rise, the calculation changes. Now when someone knocks on the door promising a 10x payday in a decade, you look at the cheque from your bank, which reads: “Interest: $1,000”, and think about how easy that was. Maybe you say thanks, but I’d rather receive cheques from my bank which read “Interest: $1,000”. People buy you less drinks, but you can now afford to buy your own.

In a world of zero interest rates, investors call founders. At 4% or 5% interest rates, founders call investors and sometimes the call goes to voice mail. When investors do pick up, they offer far less money, with far more strings attached. Unfortunately this happens just when businesses most need money. Higher interest rates mean fewer jobs and less spending. Bad for business.

Last week, MilkRun, an Australian business that delivers groceries by bicycle, said it would close. Here’s founder Dany Milham in an email to staff, reported by the Australian Financial Review:

“Since we announced our structural changes in February, economic and capital market conditions have continued to deteriorate, and while the business has continued to perform well, we feel strongly that this is the right decision in the current environment.”

MilkRun, which was recently losing money on each order, had spent months shopping around for more funding. Last year they raised a record haul with help from giant US fund Tiger Global Management. But investors aren’t picking up the phone anymore! Here’s one, quoted in a separate story:

Investors are wary of funding companies that don’t have a very clear commercialisation plan. We need to be clear about how that business is going to make money and generate revenue.

When the bank sends meaty interest cheques each month, investors start to ask hard questions, like: “Do you make money?”, “Will you ever make money?”, “Will you make me more money than my bank?”


Nuclear submarine roundup

Australia will host, buy, then build nuclear submarines as part of the AUKUS alliance with the United States and United Kingdom. The deal is complex: three-parts over four-decades and a 12-digit price tag (~368 billion). The biggest defence project in Australian history, it’s also a significant commitment from the US and UK towards containing China.

If you want to learn more, a few pieces I’ve enjoyed:

  1. An academic who thinks AUKUS is a good idea to counter: the military power, ambition, reach and recklessness of a hard authoritarian China. Pair this with a positive editorial from Australia’s version of the Financial Times.
  2. An academic who thinks AUKUS is a bad idea, hastily agreed on and rushed past an electorate unaware of what they were signing up to, never has so much been so meagerly explained by so few. See also a separate piece on AUKUS in the context of the 20th anniversary of the Iraq War.
  3. A balanced exploration of the questions AUKUS proponents need to answer.
  4. For a cocktail of vitriol, hyperbole and truth see former Prime Minister Paul Keating on “the worst international decision by an Australian Labor government since the former Labor leader, Billy Hughes, sought to introduce conscription to augment Australian forces in World War One.”
  5. If you’re more listener than reader – here’s a short podcast interview with a big name (and AUKUS skeptic) in Australian defence.

Happy reading.

Thoughtful exchange on China – US

The conversation about China and the US is as polarised as the conversation between China and the US. Which is a pity, because it is the international relations problem of our time and it deserve a corresponding amount of thought and care. Both were on display in a recent episode of The Economist’s Drum Tower podcast. Here’s an excerpt from a discussion about US technology controls:

Simon Cox: One of the tragedies of course is that America has confirmed d China’s world view. America has confirmed the fact that it does want to contain China which obviously China always believed and now it feel justified in that belief. It’s a very striking thing to say to a country that we’re going to try and limit your technological development in this way. I feel very ambivalent about it, I don’t particularly want China dominating the industries of the future either. But what’s very striking about the controls as they’re conceived and as far as we understand them is that they’re not merely trying to maintain America’s edge not merely trying to say there will always be a gap between America and china. they’re trying to hold china to an absolute ceiling of technological development….

David Rennie: Look the thing about a vicious circle right and of course Chia is going to try and escape these controls but to try and explain how the Americans see this which is why would we let China make the People’s Liberation Army (PLA) stronger and more capable of doing things that we don’t want like invade Taiwan using American technology or American money. Again, I think back to my time covering the Obama administration in DC, you saw them trying these really targeted export controls… we’re going to tell an American company Intel that they cant sell the most advanced chips so the PLA can make these supercomputers but what happened was that because of civil military fusion, this big Chinese government idea of blurring all the lines between the military and civilian companies and harnessing everyone to this grand national endeavor, those chips that were supposedly never meant to go near a PLA university of supercomputer, China got them anyway. What you’re seeing from the Biden administration is now you know if you’re going to make it impossible for us to only target military end users, then you leave us with no choice but to block all of this and you’re right Simon, it’s extremely aggressive but I think the alternative from the American perspective is naively continuing to allow the PLA to build weapons that can kill Americans and invade Taiwan with American chips….

And finally, Simon again in response to a question about whether the Chinese Communist Party can be trusted

I just think that if the two economies [China and the US] do decouple, especially if China were able to decouple from Taiwan, I don’t think anyone else is safer as a result.

Please do listen to the whole thing.

Do nudges wear off or why Robert Moses’ beaches may be dirtier today

Once on a university tour in Berlin, I slipped off to the bathroom. Washing my hands, I looked about for paper towels to dry them. Pasted over the dispenser was a glossy sign that read: “Most people take two towels.” I yanked out eight.

The sign was “nudge theory” 101. Popularised by books like Nudge, the aim is to get people to behave a particular way without using force or limiting choices. How? By formulating information, questions or choices in a certain way, designers can make people more likely to make a particular choice. Take organ donation. Lots of people want to donate organs, few bother to register. By making organ donation the default, few people bother to opt out and more people donate. A small change in how a decision is presented leads to a big jump in organ donations. Policymakers get the outcome they want, people remain free to say no.

But I’ve always wondered if the power of nudges would fade once people realised they were being poked in the ribs. In that bathroom in Berlin, I knew what was going on and I resented it. In that vein, here’s a scene from the Power Broker, the story of Robert Moses, describing a then-new strategy to keep a beach clean in the 1930s:

“The lines of wire trash receptacles on the clean white sand were only a symbol of the emphasis on cleanliness there also. At intervals, loudspeakers sounded a bugle call, and then an announcer, in a carefully modulated tone, “thanked” the visitors for their cooperation in keeping the beach clean. “The effect,” as one observer wrote, “is magical. In no time at all, every guilty culprit is doing KP in his immediate area.”

Being thanked for your cooperation is a rudimentary nudge. However, it’s one that usually elicits eyerolls, not “KP of the immediately area” today. So maybe nudges do wear off.

Silicon Valley Bank or why bank regulators should ban WhatsApp

Apologies about the delay. We’re back

Silicon Valley Bank collapsed last week. The bank lost money on a bunch of investments that looked safe (they always do) but turned out to be very risky. When it announced the loss, some of the people who had money with the bank got worried. What if the bank didn’t have enough money to pay back its depositors, they asked? Unfortunately, they asked these questions in group chats with other depositors. And it turns out that the start-up founders and venture capitalists who made up most of Silicon Valley Bank’s customers like group chats. Worried people saw other people worry on Whatsapp, pulled out their money and the bank failed. A classic bank run but where everyone listens to Tim Ferriss and has a friend who works at Google. For the record, I like Tim Ferriss.

Much ink has been spilt on why SVB blew up, whether the government should have rescued depositors (it did) and if the collapse will trigger more bank runs. Here are some venture capitalists predicting Armageddon without government intervention, some traders downplaying the risk of a wider banking collapse and finally Matt Levine wrapping up the debate around moral hazards and bailouts beautifully. Highly recommended.

I’ll add one thing: Crises rumble on for years.  Lehman Brothers blew up in September 2008, a year after the run on Northern Rock bank. The US Federal Reserve started raising interest rates roughly a year ago. Since then there have been cryptocurrency bankruptcies, a meltdown in the UK pension fund sector (remember LDIs) and the collapse of two Silicon Valley banks. All unique, all unlikely without higher rates. Expect more to go wrong as rates barrel through through the economy’s creaking pipes.

Inflation (re)targeting

Central banks by and large try to pin inflation to 2%. When prices rise above that, central banks lift rates, people lose jobs, the economy slows and prices slink back down. The higher inflation, the harder it is to muscle back down. Going from 8% to 4% will be tough and take time. Going from 4% to 2% will be even tougher, especially because by then, many will have lost jobs and the economy will be stalling. Why not make it a little easier and raise the target slightly?

Two great pieces in the FT over the past week on the issue.

Ethan Wu in the FT lays out the temptation for central banks succinctly:

It’s no large leap to imagine a scenario where inflation is falling but still above target, while unemployment is rising but not yet recessionary. The political pressure to loosen policy would be immense. The Fed might conclude raising its inflation target, or at least acting chill about enforcing it, is the best of a bad set of options.

Well, people might not believe the new target, goes the counter argument. If people suspect the central bank will goes easy on inflation today, they’ll expect the same again tomorrow. The result is inflation tends to stick around.

Still, the idea of lifting the inflation target slightly to 3% or 4% is gaining traction. In an opinion piece last November Olivier Blanchard, an economist who has banged this drum since at least 2010, dusted off the idea. He spoke to the FT again about whether changing the target will make people distrust central banks:

I think, in the right environment, a one-time goalpost move would be credible. There is no slippery slope here. It is clear that the earlier conclusions and computations that 2 per cent was the right target, and the probability of hitting the ZLB was small, were wrong. I think any reasonable economist, including [Harvard’s Kenneth Rogoff and Gramercy’s Mohamed El-Erian], agree about that. I think there is zero risk of moving the target further and further. I heard the same argument about credibility when central banks started QE.

I share Blanchard’s skepticism about slippery slope arguments. Trust does not grow in a vacuum. I treat differently the friend who repeatedly borrows and fails to repay money, to the one who faithfully repays me, but one day comes in tears, to say they lost their job, and need more time. Context matters, history matters.

Andy Haldane, former Bank of England chief economist argues for a third way. Central banks should fudge the issue and promise to get back to 2% eventually. He sees the 2% target as a relic of an era where inflation was kept low by globalization (cheap transport / cheap labour, predominantly in China). That’s over he says, and we’re now in an era where inflation will be buoyed up (trade wars make transport expensive and Chinese workers want higher wages). The 2% target should be shelved until this passes.

But the line is thin between a permanent change and a pause for an undefined amount of time. If they’re both likely to undermine credibility, better to make the change and be done with it.