How Artificially Low Rates Alter Your Behavior By Changing Your Incentives

This article explains what the Fed is trying to reverse. Were you forwarded this email? [Sign-up to Rude Awakening here.]( [The Rude Awakening] September 08, 2022 [WEBSITE]( | [UNSUBSCRIBE]( How Artificially Low Rates Alter Your Behavior By Changing Your Incentives - Time preference is simply a question of “sooner or later.” - In the ordinal sense, marginal utility is just a listing of your preferences. - How artificially low rates change your incentives and alter your behavior. Recommended Link [Sad Because You Missed Out On The Crypto Boom? Your Timing Might Be PERFECT]( Because of the crash, super-valuable cryptocurrencies are trading for pennies on the dollar. Now is your chance to scoop them up… sit back… and let your fortune build. As I’m sure you can imagine, you need a different strategy to make money with cryptocurrencies today… … and that’s exactly what you’ll find here. [Click Here To Learn More]( Sean Ring Editor, Rude Awakening Happy Hump Day! A quick note: I originally wrote this piece in May 2021. It’s a good time to review it. Central banks are raising rates, and all sorts of projects look shaky now. But time preference and marginal utility are critical concepts we need to internalize to make good decisions and understand what’s going on. I hope this article goes a long way to help you out. Quick Warm-Up Everything I write in today’s essay you already know subconsciously. Some of you may have studied economics and consciously understood it. But I love economics - especially the microeconomics of the Austrian School - because, to me, it’s inherently inborn knowledge pulled into the front of one’s mind. It’s almost as if you’ve always known it but were never aware of it. The enormous benefit of becoming aware of it is that you can wield it to your advantage. Step by step, I will walk you through my ideas of what’s going on today. I didn’t originate any of this. It’s knowledge brighter people than I have discovered, but I’ve been lucky enough to come into contact with and piece together. Time Preference I want it all, I want it all, I want it all, and I want it now. -Queen Allegedly, Queen guitarist and astrophysicist (really) Brian May wrote this song. His wife, Anita Dobson, an English television actress, inspired him by constantly saying, "I want it all, and I want it now." That’s a believable explanation for any married man. What is “time preference,” and why is it so important? Let’s start with the axiom that everyone wants more satisfaction rather than less. And we want that satisfaction earlier rather than later. That’s the practical way to think about time preference. We’ll get more definitive in a bit. We know big goals take more time to accomplish. If we’re willing to invest more time to achieve these goals, we demonstrate a low-time preference. Someone who wants their flatscreen TV and new car RIGHT NOW reveals a high time preference. (Sometimes, the terminology gets confusing. Just remember, lower time preference means longer. Lower, longer. Lower, longer. Now, you’ve got it.) Why does time preference matter? It matters because people who save and invest, rather than consume, build civilization. To forgo your immediate desires to build resources for increased future consumption is how we move forward as a civilization. Prudence. Long-term planning. Ah, the days of yesteryear. We can thank our lately besmirched forefathers for setting up all this for us. If they didn’t save and invest, putting off consumption until later, we’d still be hunting daily for food. (The enviroMENTALists overtly desire this with gardening rather than hunting.) Essentially, our civilization is not the privileges our forefathers bequeathed us so much as the consumption they forewent. Frederic Bastiat distinguished between the seen and unseen. I encourage you to do the same. And that leads us to our next step: marginal utility. Marginal Utility Understanding this concept changed my life. It changed the way I view objects, people, and goals. “Utility” in economics means pleasure or satisfaction, not “usefulness.” “Marginal” means “additional.” When economics professors teach this, they use cardinal numbers (number of units at a price level). And if you’re Apple, you can gauge demand for iPhones. But ordinary people have neither the resources nor the know-how to do that. So, thinking of utility in an ordinal way makes much more sense. That is, we just list our preferences from most desirable to least desirable. For instance, our list at this moment may look like this: - Eat a good breakfast. - Talk to the boss about a promotion. - Pick up kids at 3 pm from school. - Move into a McMansion. You may look at this list and say, “Geez, surely the promotion is more important than picking up the kids!” Or “Why is having a good breakfast even on this list?” Good questions, both. But this is my list, not yours. And that’s the beauty of economics. Understand that everyone has different ways of thinking about our priorities. Why does my list look like this? Perhaps I forgot to pick up my son last time, and he thinks I don’t love him as much as I used to. Or I need a good breakfast because my health isn’t that great. My promotion matters, for sure, and I need that before moving into my McMansion. Crucially, this list may change in the next 5 seconds. Things come up all the time. Of course, my time preference matters. I have to pick up my kids at 3 pm. That’s when they get out of school. I have no choice there. But I’ve been working for years on my promotion, so I think the time to talk about it is today. But I’ve got leeway if my desire to discuss my promotion may not be high on my boss’s marginal utility list. Ok, say I ate a good breakfast. Yum! My list now looks like this: - Talk to the boss about a promotion. - Pick up kids at 3 pm from school. - Move into a McMansion. Now, I have just talked to my boss about my promotion. It’s not happening. Ugh. Here’s my new list: - Pout and surf the net all day at work because I’m pissed off. - Pick up kids at 3 pm from school. - Look for a new job. - Tell my wife the McMansion is on hold. - Check my wife’s phone to make sure she doesn’t have a Tinder account. See? The list radically changed. The Powers That Be (TPTB) know this. They mess with it all day, every day. They have two primary ways to do this: monetary policy and fiscal policy. Monetary policy has been king for quite a while, so let’s show how artificially lowering interest rates distorts incentives. How Artificially Low Rates Leads to Malinvestments It’s 2008. The stock markets follow real estate and credit markets down the toilet. The Fed (duh! duh! daaaa!) shows up in a red cape to save the day. It lowers interest rates to zero. We’re thrilled they “stepped in” to “rescue” the economy. The markets rally. We feel better. But what really happened there? Recommended Link [Trump’s Secret Legacy]( [Click here for more...]( In July 2020, the Trump administration oversaw a RADICAL change to the tech world… one that could unleash a huge wave of disruption… prosperity… and wealth creation in the near future. Chances are, you haven’t heard about it until today. But according to one of America’s most respected tech forecasters, it’s set to create small fortunes right here in this country. He recently went on camera to explain why... [Click Here To Watch]( What The Fed did was mess up everyone’s incentives. By lowering interest rates, they reduced the discount on all future cash flows in the economy. Take a look at these tables. They are the same project. The only difference is the rate at which we discount the future cash flows is lower in the left table. I’ll walk you through it. When it comes to project finance or financial modeling, we use the NPV method. NPV stands for net present value. Essentially, we estimate a project's cash flows and its interest rate. Then we discount all the cash flows by that rate back to the present. If the NPV is positive, we accept the project. If it’s negative, we reject it. So let’s look at our project with two different discount rates. First, we have an initial investment, or outflow, of $50,000. The next five years’ cash flows are all positive: $10,000, $10,500, $11,025, $11,576.25, and $12,155.66, respectively. The DF column represents the discount factor applied to each cash flow. That formula is 1/(1+r)^t. So for Year 1, at a 2% discount rate, the discount factor is 1/(1+0.02)^1, or 0.98039. The present value of that future cash flow (PVCF) is $10,000 x 0.98039 = $9,803.92. We apply that formula to each cash flow. If the project has a 2% interest rate or cost of capital, the net present value (NPV) is a positive $1,989.18. As it’s positive, we would take on the project. That is, we’d spend the $50,000 and start the work. But notice the NPV when rates are at 5%. We’d reject this project outright, even though it has the same cash flows. In fact, we’d reject this project for any rate above 3.315%, the project’s internal rate of return (IRR). That means rates must be pretty low to make this project attractive to investors. Here’s the project at various discount rates: Now imagine this happening for millions of projects around the world. That’s the power central banks wield. We’re not exaggerating when we say they alter incentives worldwide. Marginally profitable projects at lower interest rates would be woefully unprofitable at historically normal rates like 5%. At a more retail level, think how much more likely one is to buy that flatscreen TV on credit at zero interest rates rather than, say, 5%. Because you can’t earn any money in your savings account anymore. This has enormous repercussions for society. It may be the main reason why women are Instagram addicts and sometimes promote themselves to OnlyFans. It’s why many men have given up on ever owning a home or getting married. It also explains the rampant gambling in the stock market via RobinHood and cryptocurrency markets. Why not, right? It’s just too hard to do things the old-fashioned way. Economists blame women’s literacy rates for the decrease in birth rates. What if we suppose it’s not reading but mathematics skills that lower birth rates? After all, if a woman knows she and her husband can’t support a kid, why would they have one? Everything is more expensive when rates are on the floor. In summary, central banks incentivize companies to create malinvestments by artificially lowering rates. This makes projects look more profitable than they are once rates get back to normal. Congratulations, you’ve just quantified time preference! To Wrap It Up Central banks bring investments forward in time that may not have happened at all. And perhaps should not have happened at all. And now you know why we’ve been messed about since 2008. We won’t get out of this mess until The Fed takes its foot off the yield curve and lets the market find its clearing rate. But if you understand time preference, marginal utility, and how central banks manipulate our preferences with rates, then you’re better prepared than most to face the upcoming reckoning. Until tomorrow. All the best, Sean Ring Editor, Rude Awakening P.S. Jeff Tucker, a Paradigm Press contributor, wrote the [best article on marginal utility]( I’ve ever read. And thanks to Jeff’s [article on shaving]( I have a babyface at age 47. For more on time preference, Hans-Hermann Hoppe’s first essay in his excellent book, [Democracy: The God That Failed]( is a perfect start. Enjoy the reading! [ARCHIVE]( | [ABOUT]( | [CONTACT US]( Rude Awakening is committed to protecting and respecting your privacy. We do not rent or share your email address. By submitting your email address, you consent to Paradigm Press delivering daily email issues and advertisements. To end your Rude Awakening e-mail subscription and associated external offers sent from Rude Awakening, feel free to [unsubscribe](. Please read our [Privacy Statement.]( If you are you having trouble receiving your Rude Awakening subscription, you can ensure its arrival in your mailbox by [whitelisting us.]( © 2022 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. 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