The Money is the Message
Distorting the cost of money messes up all economic and social communication. But it also conveys an important truth.
The global economy is a biological system, and money is its nervous system. This is more than a mere analogy. Money is not just important; it is a system that conveys complex information that enables billions of actors to do what the world needs them to do in order to get what they want from the world.
As I wrote in Visible Capital, "At their core, economics and biology are the same science. And the actions observed by economists are, in essence, biological processes — organisms interacting selfishly with their environment in order to survive." Money helps coordinate the actions of these organisms. It has always done so, but more forcefully and efficiently over the past few hundred years.
But money's role is under question from several directions. Some question money's ability to serve its original function. And some question the social cost of allowing money to continue to serve that same function — to serve as the preeminent driver of human action.
Today, we'll focus on the first question. Earlier this week, my friend Dylan Grice tweeted that "money is the channel through which we communicate with distant strangers, the original social media... distorting media distorts the way society talks to itself."
Grice was referring to two important ideas. The first is money's role in coordinating human activity. A single person (or government) can never have all the information required to efficiently allocate the world's resources. Most relevant information is held by disparate individuals who value different things. Money "flattens" their different desires and helps them communicate with each other.
I am not saying that money's role is a good thing, only that it is a thing. The worker at a Nike factory in China does not know what kind of shoes I would like to buy next week, but the price I am willing to pay for a specific type of shoe nonetheless guides that worker to produce more of the shoes that I want. Likewise, the investors who set up the shoe factory evaluated that investment based on how much money they would earn. Specifically, they evaluated that investment compared to other things their money could do instead — sitting in the bank or flowing into a different project.
Hence, prices expressed in money and the price of money itself are the lifeblood of the economy (I mean "the nervous system". Both metaphors work!). By "the price of money," I am referring to the interest rate money earned by doing nothing. Or, more accurately, the interest money can earn from being deposited in a bank. Interest rates indicate the supply and demand for money.
In theory, when savings are high and many people put their money in the bank, interest rates go down. This, in turn, means that investors have a stronger incentive to invest in new projects rather than put their money in the bank. Let's say investing in a new Nike factory would earn you 3% a year and, alternatively, your bank would pay you 0.5% a year to keep the money in a saving account. In such a situation, investing in a new Nike factory seems attractive. But what if the bank pays you 3% or even 2%? Then, investing in a new factory is not worth the effort and the risk.
Hence, the price of money helps investors discriminate between good and bad investments and between opportune and inopportune times to invest. That's the theory. In reality, the price of money is not determined by supply and demand.
Governments and central banks actively intervene in markets to influence interest rates. They do in order to achieve different policy outcomes that they deem desirable, such as reducing unemployment (by encouraging the construction of new factories), increasing home-ownership (by giving cheaper loans to less-qualified candidates), and increasing college attendance (you get the idea...).
When done in moderation, "guiding" interest rates provides a useful way for the government to serve the people. For example, it is legitimate for a government to choose to have a less efficient economy but one in which more people have a job and can afford a home. The problem is that once you give politicians (and, worse, bankers) such power, it ultimately gets abused. Further, even with the best intentions, there is no scientific way to determine how much intervention is too much.
Ultimately, interest rates become meaningless. They no longer tell investors anything. This is what Grice was referring to in his tweet. Intervention by governments and central banks makes it impossible for investors to allocate capital. Nothing is known. Productive investments seem risky or not worthwhile. Alternatively, useless things seem worthwhile. The rational (in the most limited sense) allocation of resources grinds to a halt. Society becomes poorer. Or it becomes richer, but through complete coincidence — through people's investment in things that don't seem to make economic sense.
In light of the above, it is common to say that intervention from governments and central banks "distort" money and makes it impossible for investors to get accurate information from the economy.
But there's another way to look at it. These interventions are themselves market signals. To influence interest rates, banks and government conduct large-scale buying operations in open markets, and they use technology to create new money and to communicate messages that impact the decisions of billions of people. Because these interventions happen within the market system, the information they generate is valuable.
The distortion itself is the message. It conveys the fact that technology now enables banks and governments to do what they do with unprecedented scale and speed. It tells us that interest rates cannot be trusted to guide investment decisions because they should not be trusted. By "not making sense," interest rates tell investors not to rely on them.
When a demented parent (or friend) is mumbling something incoherent, they are still telling us something. They are telling us that they should not be trusted or listened to. They are telling us that our relationship with them is now uncertain and we should prepare for the worse. When a weather forecaster tells us it's sunny while a look outside the window tells us there's a massive storm — the forecaster is still telling us something. He tells us that things are changing too quickly for forecasters to discern, that the environment is too complex and that the old linear relationships between cause and effect no longer work as they once did.
The economy is telling us something similar. It is an unpleasant message. But it is clear. And we should listen to it.
Have a wonderful weekend. Uncertainty does not mean things will get worse. It only means we know less and have less control.