The Value Of Interest Rates

Copyright© Miklos Szegedi, 2023.

There is life, love, money, and future.

Money is important, but something is more important. It is interest rates. If there are interest rates, you can get money, whenever you need it. If you do not have a job, if you see some unemployed, if you have an idea, you set an interest rate.

I came to North America more than ten years ago. The main motivation was to learn and understand the world. I can tell you know what I learnt. When you are young, you are hired into the jobs that your grandparent’s generation made for you. There were also young before, they understand. You get some stable salary, you find a spouse. We happened to have a social democrat and liberal parliament in Hungary in the 2000s, so social democracy resonates with me as love.

Later, you challenge the system. You point out and fix inefficiencies, since you also see jobless, old equipment. You want more salary, travel, etc. If you are good at it, you will do nothing else after a while but analyze and fix issues. It is a great time to have children.

Finally, you made the system so efficient, that you eliminated your job. This is what the grandparent’s, parent’s and your economy reached in efficiency. You freak out. You are out of a regular salary. This is when you need interest rates.

The economy has three parts. We have houses, jobs, offices, factories, trucks, infrastructure, government. Many of these still run on assets. Asset is something you buy, like a computer, and you use it for more than a year. Somebody from my grandparents age would say you kneel down, you work hard, and after five years you buy your equipment. Luckily, we have interest rates. You do not need to wait five years but pay an interest and earn money with it for five years. Do you want to open a registered nurse room next to a gas or recharge station? Create a business plan, show it to a professional and start it.

The economy has three parts. The first biggest one is in the middle. These are the assets working for us. Factories creating cars, data centers helping to communicate, offices that provide space for professionals. All these run on some debt, usually a portion of the revenue statement that you can see on Nasdaq. It is a fixed part of the revenue, no more. The higher the interest rate, the less you can pay to the equipment manufacturer or the construction company. If you pay more, all you will see are for lease signs all around.

Should we ignore debt, we had our economy running on hard-earned equity, with higher prices, risk, and interest rates. A running business is usually the least risky having a low interest rate. Companies in this group are the core of the economy, bigger than eighty percent, if assets amortize in five years or more. They have competition making them good B class borrowers.

These assets age, and eventually they become salvage, you need to replace them. Part of the economy is running on this regular and expected replacement of machinery. Car purchasing rates are a bit higher as a result, consumers can delay replacing equipment and opt for fixing them. Car companies need financing as a result, when demand increases, and they need space, hiring and equipment. Companies are smaller, they have fluctuation, but there is always demand for their products. These companies have the know-how to build, they paid the excise tax, licensing. They are more reliable A class borrowers as a result.

Now the way the world works, is that eventually you optimize jour job eliminating it. You are out of your job, and you have to realize, you are in a special place. You cannot find another job. This is about two to four percent of the economy. You are the growth. Companies here are the green field investments, startups, and small businesses. Finding new value for new customers is hard. This is why the borrowers here are not investment grade. They are C class, growth.

There is an easy way to reduce risks. You diversify. You find three C class players, they will likely make an A class. Conglomerates do this by using the existing company to expand overseas. This reduces profitability and increases crowding, but it works. Others do small businesses, and they pay part-time consultants, and marketing staff. The economy eventually grows, and you find new value that you can create to your customers.

Marketing has three main tools, product, place, promotion, and price. Customers get happiness, utility, ergonomics, and savings as an analogy. The value my company tries to provide is happiness reducing latency of computer systems, making them lean, fast, and cheap. Who has blood pressure issues due to annoying computer bugs?

The circle closes at this point. You hire youngsters with stable jobs, and they can care about love and nothing else. Companies in classes A and B will pay dividends and occasionally capital gains. Why? You need investors to keep costs low for customers. Investors get some money for their time. The economy gets some passive income to take care of the elderly, the children, the disabled, the underemployed. Interest rates and yields will eventually converge, so that all passive earners get their share.

This is what causes inflation and higher interest rates. Debt eventually closes the gap of missing money. Saved money can be used later, but it is not just consumers, it is the entire economy that decides the value of past money. If buildings built ten to twenty years ago are too energy intensive, rates will become higher. The labor ten years ago built less value today than the original investor anticipated. The economy has to build better houses, cheaper commute leaving less resources for elderly care and hospitals.

If the trouble is bigger the government comes into play. Higher inflation is a result of lower past values of savings. You have to provide value Now. Higher real interest rates on top of inflation are a result of higher demand for passive income like pension, or disability. If the rate hikes are too much the government steps in, and they increase taxes.

This is the way government works. Imagine two people Alice and Bob in the Ancient times. They dispute, who owns an orange. First one slaps the other, the other slaps back. This is how society starts. They realize this is how to teach children empathy, they think more.

Next, they realize, they need a judge, and arbitrator. They choose somebody, who writes down and enforces the rules. This is law. Everybody wants to be a judge. You have to learn and become meritocratic in this case. If it does not pay, people will force you by birth, making aristocracy.

Now, we are all different, so some people, notably minorities, will be unsatisfied. They want to be represented, and they want individual rights and happiness. They will insist on separating the judge as the final arbitrator, and the majority. Constitution is formed. Minorities tend to be strong in meritocratic professions as a result relying on their individual strength to protect happiness.

Some families will be conservative, and they will insist on repeating the success of their descendants. They will become patricians it becomes a republic. Others will embrace happiness, they become the majority. It is a democracy.

Money and taxes are still an issue, so they elect a president as well. They collect taxes. Taxes increase. People need to challenge them. People start learning, they become educated and solve most of their problems themselves cheaper. The state is limited to the essential services of about twenty to forty percent of the economy. The state not necessarily provides these, it may subsidize big project that pay essential workers. This is civil society.

The key there is that individuals will learn that they need to understand the world to be happy and prosper. A-type individualists will elect a judge. B type personalities will find a bigger group to protect them, and these groups will fight each other. Law only builds with the former.

Nationalism and tribalism builds with the latter. Fighting groups are a negative or zero-sum game. Destruction and extensive spending on security limits real growth.

Some will eventually yield forming a hierarchy, and an aristocrat like leader, the dictator. Each node of the hierarchy has a leader, a selected successor, and a vassal. The leader cannot control everyone, so the majority will eventually become independent A-type personality. They will embrace their individual values. Some hierarchy will always form even in an individualist society as a result of statistical events. Such a hierarchy will probably be limited to a logarithmic line of hierarchy with an accessible constant factor of admirers of four to six.

Individualist societies on the other hand will insist on the rule of law over power. This will ensure that you can take on debt. You can build growth and enjoy its results. Interest rates will grow the economy, and the prosperity sustains the civil society.

This is what will be the story for the next twenty years.

What are the boundaries of the government and what are the boundaries of the individual? You Decide.