An Amazing Trade is Shaping Up...

How can money have no value on the one hand, and infinite value on the other?
What I mean by this is that real interest rates are now effectively zero.  That means that money earns you nothing if you hold it, and costs you nothing if you borrow it.

And yet, food costs something.  Water costs something.  Education costs something.  All of these things of real value cost something, but money costs nothing.

Take it a step further...A movie ticket costs something.  Parking costs something.  Going to a little league baseball game costs something.  Fishing costs something.  Decorative yard mulch costs something.  But not money.  Money is free, and yet everything costs money.

So I struggle with the paradox of its pricing:  If all things cost money and are purchased with money, then, money, as a store of value and the medium of exchange, should also have a cost.  But it does not. This is an impossible arbitrage.  An oxymoron.  A mutually exclusive situation.  Money either has value, or it does not.

For instance, I am about to buy a car.  I could write a check out of my bank account, and it will cost me nothing in lost earnings power, because the bank is not paying me any interest.  I could take the "zero interest" loan the auto dealer is offering me, and because I pay no interest, there is no cost to borrowing the money.

There is no benefit to holding money, and there is no cost to borrowing money - and yet, simultaneously, money is more valuable and more difficult to earn than at any time I can remember.  How can this be?

We can look at it another way as well.  The Federal Government is broke.  I mean, like $60 trillion dollars broke.  And yet people are willing to loan it money for nothing.  How can this be?  How can an entity that is more levered than any other entity in the history of the world borrow at zero?  People are willing to GIVE money to an entity that has spent ALL of its future earnings...ALL OF THEM...FOREVER...at zero percent!

The only way this makes any sense is if some force is artificially distorting the value of money and therein manipulating other markets.  Bending values like Uri Geller bent spoons.  Money, it seems, has value in one context, but not in another.  Obviously, the force behind this alchemy is the Federal Reserve. Anyway, because I respect any reader's time, I will not go off on a diatribe about the Fed or the Government.

So, from a purely trading standpoint, we have reached a point at which we can isolate a major market distortion - there is no bid or ask for money.  We have simultaneously reached a point at which rates cannot really go lower...I mean, in theory you can have negative interest rates, but taken to an extreme, it would cause massive bank runs, so it is a state of being that cannot last.  And we are at a point where everyone recognizes the government and the country is, from a GAAP point of view, bankrupt.

So, we are there.  The price of money is so low that it distorts the pricing of all levered assets. Like in a quantum physics world a particle can be in two places at once. Or like physical properties become altered at absolute zero because all particle motion stops.  At these extremes, everything is theoretical.  But, like absolute zero is the coldest temperature possible, we can know interest rates are realistically bound by zero.  
All right...None of the above is original thought.  Here is where the original thinking starts.

I have been trading a long time...since 1989.  The vast majority of those years I was trading either for myself full time or professionally on behalf of a firm.  Here is the thing...

Interest rates have been falling now since 1981.  That is 33 years.  I am 46 years old and have been in the business since 1989, when I graduated college.  8 years prior to that I was in 8th grade.  So, for all intents and purposes, interest rates have been falling for as long as I can remember...and I am not young anymore.

How long ago was 1981?  Reagan was shot.  The Iranian Hostage Crisis ended. First case of AIDS. Princess Di got married. The first test tube baby.  1981 was a long, long time ago.

Certainly there are many people with more white hair than me, or perhaps no hair at all, who have longer memories.  But I bet in 1981, they were not sitting at the same desk at which they are sitting now.  They very likely had a lot less responsibility than they do now and had a lot less say over the capital they managed.

The point is this:  No one in the investment business, or any business, for that matter, knows what is going to happen when interest rates reverse and go higher.  And I mean this in a much deeper sense than, "If rates go up, bond prices will go down".  I mean, every business that has been successful since 1981 has done so in a rapidly falling rate environment.  By definition, if their business model was successful, their business somehow benefited from, or adapted to, falling interest rates. When I think about that, it boggles my mind.

Those who have done the best since 1981 have effectively had a massive bet on falling rates whether they knew they made that bet or not.  What has done well?  Real estate.  Financials.  Lenders.  Retailers.  IBM.  Public companies buying back their shares.  Levered Mergers.  Derivatives.  Anything that requires lending or borrowing money has done well.  Long and Levered is a business model that has worked since 1981!  Think about that.  That model has been so profitable and grown so large that it has stomped out all other business models.  GM is a lender.  GE is a lender.  Colleges are lenders.  Sears is a lender.  Target is a lender. My dry cleaner is a lender.  My airlines offers me credit cards. My eye doctor will finance lasix surgery.

And look beyond financial and business models at risk models as well.  The Investment banks survival, all of which went bankrupt in 2009, are entirely based on perpetually falling rates.  They turn their inventory over every 30 days or so...If rates go up and asset prices (bonds) fall, they cannot sell them.  Overnight their levered business models implode.  Ask Corzine. And don't even get me started on counterparty risk...And "risk free" annuities? That will be an explosion worth watching.

Anyway...Investment models, Pension models, Fed models, manufacturers models, insurance models, government borrowing, home sellers, auto dealers...all of them are skewed towards falling rates.  Not that high rates in and of themselves are disastrous...they are not.  But rising rates will act like a buy versus sell outtrade. The pain of rising rates will be more than double that which would have been caused by a free market, statically high interest rate.  All of the things we count on and take for granted rely on falling interest rates.  And rates are at zero.

So...we all know how it works...if you are the guy preaching long and levered, you look like a hero and have looked that way forever. You might even be CEO by now.  If you are the guy preaching thrift and caution, you have likely been replaced. Can you imagine walking into a Goldman executive committee meeting with a risk model that flies in the face of what has made everyone on the executive committee billions of  dollars?  You would be spit on as they threw you out of the room.  We are living through the ultimate in global groupthink.  We all take falling rates as the natural order of things because they have been falling throughout our careers.  I fail to see how that thinking does not indelibly permeate every financial model across the globe.

The implications of this are pretty mind boggling. How many assumptions do rising rates not only disprove, but actually reverse?  If the old adage, "the market's job is to fuck the most people"  is true, than the market has never done a better job.  It has ushered EVERYONE onto the same side of the interest rate trade at a time when everyone freely admits they are aware rates cannot fall forever.  And still, nobody cares.

I sold my hedge fund in 2010.  I may have to start something back up here pretty soon.  Ladies and Gentlemen, we are going to be in for a barnburner.