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Interest rates = financial gravity

June 11, 2021

My grandfather was a great engine mechanic. He was less great at opening doors or windows when testing his engines. I'd try to learn about the gaskets and pistons from him, peering through the blue haze of exhaust, conscious that carbon monoxide was pooling around my knees. Eventually I'd make a break for it, running to open the garage doors, making a play for optionality so we could both repair things another day.

It didn't matter if the engine sputtered a little, or hummed in perfect form, if the oxygen had been chased from the room.

In investing, you have to put appropriate weight on the big, influential variables. One of those variables is interest rates. Warren Buffett recently used an excellent analogy when he described interest rates as "financial gravity." If interest rates, like gravity, are high, they pull the value of other assets down. If interest rates, like gravity, are low, other values float up (and away sometimes).

The risk-free rate defines the baseline for investing. If you are going to get paid X without taking risk, something that contains risk needs to return X+B for it to attract capital. The more risk, the larger B has to be.

Here is the daily update to the yield of various U.S. Treasuries bonds:

On Tuesday, November 13, 1990, the oldest known web page was constructed. On that same day, U.S. Treasury yields looked this this, matching columns with the graph above:

Relative to previous decades, you can see that today gravity has been removed from the financial system. Gravity, like oxygen, is not a small variable. Because of its, shall we say, gravitas, much of the financial system has inflated upward.

Much, but not all. Returns tied directly to this rate are not inflating. For example, banking deposits. On top of the low rates, American banks are swimming in money as the government floods the system. This has led to an explosion in banking deposits:

With cash deposits just below the value of the entire American GDP, banks have no incentive to pay more interest. This impacts a wide swath of Americans who use banks to save.

To invest well in today's world, you have to accept that a major variable operates differently than it did 30 years ago. That acceptance, that realization, will keep you out of the blue haze.

Dan Cunningham

1. Here is the web's oldest page, If you are curious.
2. Commercial bank deposit source: Federal Reserve Bank of St. Louis
3. Treasury daily yield curve rates



School Bus Jenga. Plus Bitcoin.

May 21, 2021

I had never heard of School Bus Jenga.

My daughter explained it to me this winter. When her teammates and she travel on a school bus to Nordic ski meets, they start a game of Jenga on the floor, in the aisle, stacking the little blocks, hoping not to be the person that triggers a fall. The bus bouncing and turning adds a significant unknown to the game. Potentially random, if you believe in randomness.

Whether or not a school bus is involved, Jenga provokes anxiety because you know what's coming. You know what, but not when.

Stock market participants don't know what, and they don't know when. Many participants perceive that they know one or both, but the reality is the school bus could hit a pothole at any moment. It's the perception of control that changes. The uncertainty remains.

With the Covid stock market plunge fading from memory, anxiety has receded as people perceive the future to be more predictable. It's not, but mapping the recent past onto the recent future is a common, and large, investment mistake.


I feel compelled to talk about crypto.

Charlie Munger's description of crypto as "rat poison squared" remains memorable, but it has had little effect on coin prices. Regardless, let's go over a few things we've learned:

- Economically, Bitcoin and inflation seem to want to be related.

- Socially, if anyone questions you as to the value of Bitcoin, you bring up the blockchain and pretend you know something about software and distributed systems. When the price of Bitcoin plunges, the value is in the 'chain!

- Educationally, you might feel curious about the blockchain. When you read the foundational paper on Bitcoin, you realize this is complex stuff and wonder how anyone whose body mass is less than 70% Red Bull can understand it.

- Politically, the Swiss may be miffed that they have stable currency competition. Especially when the "stable value" argument of Bitcoin's resume seems shaky, unless you consider 30% daily swings stable.

- Linguistically, a language that celebrates misspellings is sprouting. HOLDR? BUIDL?

- Environmentally, it appears we will bake the planet mining the last remaining million blocks of the Bitcoin ledger.

- Finally, you can now create a new coin type in under 10 minutes.1

This is fascinating on so many levels! As you can see above, it's a financial movement wrapped in a cultural one. Let's look at the basic scenarios:

Outside of the criminal underground, the usage argument of crypto is pretty weak. At least in America, it's hard to argue with the liquidity, availably, and acceptability of U.S dollars.

The inflation argument is next. There is logic in owning real assets if the currency depreciates, though an entry in a distributed ledger being considered "real" might be a stretch, particularly one that has a habit of disappearing.2

This leaves the gambling argument. That's hard to contest with Vegas shut down.

Dan Cunningham

1. Tools now exist to create a new coin in minutes, where the naming and promotion are the differentiators. More...
2. Roughly 20% of Bitcoin is lost forever due to passwords being lost or chains broken. There is irony here: if Bitcoin were valued like a business, it would produce something for its owners, and a password would not be needed. But value by Bitcoin owners is measured in U.S. dollars (Bitcoin is almost always quoted in dollars), and they perceive loss when they cannot convert back to U.S. dollars. Dollars, and businesses, do not need to be converted to anything to be valuable. More...



Taxes. Fun.

April 29, 2021

When it comes to taxes, societally we're probably under-discussing Newton's Third Law of Motion.

As a refresher, that's the one that says "for every action, there is an equal and opposite reaction." When you tax something, there is going to be a reaction. It might not be equal, but it will exist.

This is important, because policy-makers love to pretend that this is not the case. There is always some reaction, and in economics, these reactions tend to work on curves. Here is one way to think about it. If a tax rate is at 30% today, and that rate is raised to 100%, there would be no reason to work unless you love your boss as much as the employees at One Day In July. People do not wait until the last percentage change, from 99% to 100%, to alter their behavior. Unlike activation energy in chemistry, or static friction in physics, in economics, human behavior tends to work on curves.

So that is base point #1. Base point #2 is that no one really knows how to measure the unknown, or opportunity cost, or "value of doing something else relative to what you are doing." When I read an academic economics paper, I first try to convince myself that I can skip all those mathematical summations, that I can always go back and figure them out. By the end of the paper I'm skipping most of the paper, but console myself that it's probably wrong anyway because of the difficulty of measuring opportunity costs.


Taxes fire up lots of people! Instead of the classical arguments, let's look at two effects that rarely see media discussion.

1. Tax Rates on Corporations. The 14th Amendment, intended to abolish slavery, by way of a court reporter's footnote in Santa Clary County vs Southern Pacific Railroad Co led to the concept of personhood for the U.S. Corporation. From an accounting perspective corporations get interesting. If you raise a tax rate on a corporation, you are not applying an equal standard. Many expenses are paid by certain types of companies after taxes. For example, all that inventory in retail stores? That is bought, initially, with after tax-dollars. Most expenses in a law firm? Before tax.

If you raise the rate on this corporation-who-before-the-court-reporter-was-not-a-person, and if the business happens to be in an industry that underfunded its lobbyists, it now needs to find funding somewhere else to expand. It may not be able to do so on its own, now-reduced cash flows. The financial industry does not complain about this opportunity, as it creates a new customer for lending, and control transfers from the business to the financiers.

2. Silos of Capital. When the private equity folks are not making lots of money on the new business channel in #1 above, they can use their spare time to complain that the higher tax rates on capital gains will harm their hundred-million-dollar take-home pay. This pitch has not sold well with the American public so they have rebranded it as "harming investment in startups." Here it gets interesting, because they're not entirely wrong.

Remember the first point of this email. Behavior works on curves. Here, the investors needed for the startup have to move the capital from somewhere else, and in many cases, when the tax is higher, they are reluctant to move it. The startup would have to have an even higher expected return, and most startups fail. So inefficiency is created in the economy, as capital is now trapped in assets that may not create innovation, and may not be optimal. Transaction friction silos capital into non-optimal positions, and there it sits.

A prominent counter-argument is that Red-Bull fueled entrepreneurs do not think about capital gains when they form a business. Red-Bull fueled entrepreneurs think about code and crypto, not boring things like taxes! Again, things tend to work on curves. And Isaac Newton has a funny habit of showing up.

We have this capital friction problem every day at One Day In July. As new clients join, often in securities that we don't favor, we have to decide whether to leave the position or sell it and recognize a tax hit. Because the tax is rarely zero in a brokerage account, many times capital gets siloed in places that enrich the financial industry even more.


It's a minefield out there when you bring up taxes! The opinion writers on the pages of the NY Times and the Wall St Journal have found perfect clarity on the topic. For the rest of us, in practice this is more like whack-a-mole.

Dan Cunningham

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