The idolatry of interest rates | CFA UK

Friday 4 December 2015

The obsession with interest rates as a cure-all rests on some dubious views about the way the world works, says James Montier.

Not many professional investors can compare themselves to Morpheus from the cult film The Matrix and get away with it, but James Montier isn’t like most investors.

Mr Montier, a value investment specialist within GMO’s asset allocation team, spoke on the “idolatry of interest rates” at a well-attended CFA UK lunch event on Thursday 3 December.

He told attendees, that like the film character, he would be taking his listeners on a mind-altering tour of ideas about interest rates, central banks and much else.

“We are going down the rabbit hole and I’m going to quote Karl Marx,” he began.

He was introduced by CFA UK Chief Executive, Will Goodhart, who described him as an enjoyable and interesting if irreverent speaker.

“I know he is going to tear lumps out of the theory on which we depend,” he predicted somewhat anxiously.

First up was the concept of the equilibrium real interest rate.

“The idea that interest rates are the key driving force really does seem very suspect,” said Mr Montier, arguing the theory does not fit the way the world works and is unsupported by data.

“Central bankers are spending all their time chasing this natural rate of interest and it just doesn’t exist,” he added.

Linked to seeing interest rates as a panacea to all economic ills is a mistaken belief that monetary policy is the best economic tool available Mr Montier continued.

Expanding on an essay he wrote earlier this year, he said fiscal policy had fallen out of favour for political reasons but offers a potential way out of the low growth we face. For fiscal policy to be properly utilised, however, central bankers’ groupthink on monetary policy would need to be punctured he said.

Groupthink on interest rates also affects the wider investment field he argued, citing the widespread use of the equity risk premium (ERP) as an asset valuation tool. Uncertainty over real cash rates in the long term means investors are better off ignoring rates and valuing equities independently he suggested.

In an interview with CFA UK before his talk, Mr Montier gave further detail on what he believes may combat groupthink within the economics and investment fields.

“I think groupthink generally only fails when you get a cataclysmic event that shows that there was groupthink,” he said.

Nevertheless, seeking out markets professionals rather than academics to run central banks would help he believes although it would be important to ensure this didn’t become “regulatory capture” he said.

Training investment professionals to think critically is vital he added. But he acknowledged investment training bodies face demand side pressures and practical difficulties in switching to essay-based assessment methods.

“Exams that encourage people to rote learn are pretty poor as they tend to generate groupthink and clone behaviour,” he said.

“I’ve been interacting and working with the CFA for more than a decade now. We’ve talked a lot about the importance of teaching history and teaching across a broad spectrum – not just very narrow skills. Although, the problem is, there’s a demand for those very narrow skills.”