Can you Imagine 3% Mortgages?
One of my favorite essays by William Bernstein is called Too Much Capital. In it, Bernstein makes that argument that interest rates - or the “cost of capital” - have been steadily falling around the world for centuries. He attributes this phenomenon to a few sources:
- Lowering “friction” of borrowing money and comparing options. Obviously the Internet is the most recent example, driving down everything from the cost of stock transactions to mortgages.
- As people (and institutions) rise above subsistence level, they have the luxury of being more picky and waiting for better investment options.
If the second point appears a bit odd, consider Bernstein’s example:
How to understand it all? A simple paradigm is useful. Begin with a subsistence level society in which everyone is balanced on the knife-edge of starvation. By definition, there is no excess capital—every last bushel of wheat and barley and every last coin goes entirely towards the purchase of food and shelter. But even subsistence societies need capital for seed corn, tools, and housing. In such a world, the cost of capital is thus infinite—the first fortunate person with an excess shekel or drachma can name his interest rate. As the countryside becomes more productive, fabulous wealth rapidly accumulates in the hands of the fortunate few with money to spare.
What does this mean for us? Borrowing money is going to get much cheaper and earning money with money is going to get much harder. In other words, long-term stock returns may never hit 10% again, but our mortgages are likely to be much smaller than our parents would ever imagine.
If you’ve been reading my posts for some time, you’ll know I view everything through an optimistic lens. Bernstein summarizes the future quite well.
I, for one, do not despair our low-return world. Who in their right mind would trade the standard of living today, at almost any point on the map, for that of fifty or a hundred years ago? Who would prefer to deal with the horrors of the widespread rural poverty of 1900 or the specter of Hitler and Stalin in the 1940s than with jihadi terrorism or identity theft? The price we pay for this sanguine state of affairs is derisory expected returns. An agreeable piper indeed, and one well worth paying.
Consider low, long-term returns with the inevitable increase in human life expectancy. Those of you in (or contemplating) retirement may live years or decades longer than you expect. At the same time, your returns from your life savings will be lower. The net result is that you’ll probably run out of money while you’re still alive or be forced to re-join the labor market in one fashion or another.
Before you despair on this point, ask yourself whether you’d rather be rich and dead or (relatively) poor and alive? “An agreeable piper indeed.”
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