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Macro Musings - I dont always dabble in it but when I do.....


doughishere
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You have things like annuities and perpetuity which are so heavily dependent on interest rates. Huge chunks of the markets are based on assumptions of greater than 0% interest rates. If youre an old guy who's lived for so long managing funds and stuff then you have most likely not even considered if rates could ever have gotten to 0. so you just get schwacked by it.

 

For instance, you have all these Universities out there that have all these scholarship funds(the old guys managing them) based on interest rates at say like 4%, assuming tuition costs stay the same, you need some sort of present value to establish the fund....present value of a perpetuity is 1/ DiscountRate times amounts per year...nothing exciting. So if you need to increase your amounts you need per year get 1/(DiscountRate - GrowthRate in CashFlows)...again nothing exciting well....whats that growth rate needed if that DiscountRate goes to  zero or negative?

 

Its generally assumed that people are pretty shitty at estimating the growth rate. So you throw in a negative or zero DiscountRate....suddenly you need a lot larger amount to establish that fund to get just the same tuition cost. Where do you get that?

 

 

To me thats all you need to know about ZIRP. Its almost a self sustaining deflationary(is it deflationary?) policy. And now its not even just the Universities...Social security, pension plans..yadda yadda yadda.

 

Is the logic wrong? 

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I just pulled out my accounting text book.

 

 

the value of of (DiscountRate - GrowthRate) turns negative and results in a meaningless negative number. The analyst who encounters such a situation should reconsider whether a firm can generate growth at a higher rat than its discount rate forever. Perhaps the growth rate assumption is too large or the discount rate is too low or the growth will stop at some future time.

 

 

Is it meaningless any more because now you have a negative number with a 0% discount rate? Surprise! That means something now.

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Jim grant calls this a bull market in liabilities, for this reason.

 

From a psychological standpoint, negative rates are deflationary because people start saving more, spending less..., and then Incomes decline because someone's spending is another's income. Debt as percent of income increases and then that reduces ability to spend and ability to borrow..and the cycle continues.

 

 

Increase this off sets the Increase in M2 everyone loves to point at.

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