A Point of Logic

James Mackintosh writes a generally perceptive column in the Financial Times called Short View. On March 11 he wrote:

The releveraging of America is under way. After a brief nod to the idea of cutting debt, US companies increased borrowing last year and reduced their equity. Easy money from the Federal Reserve was followed by ever-easier lending terms from investors: easier even before the credit crunch.

Perhaps the best indicator of this is the ease with which private equity houses are extracting money from lenders. Dividend recapitalisations, when a company borrows in order to pay its private equity owner, have soared ... In the first nine months last year, non-financial companies, listed and unlisted, paid out more to shareholders than they made in profits ... In other words, [the companies] took advantage of record-low interest rates to transfer money from lenders to bondholders to shareholders.

Michael Pettis is a finance professor at Peking University and a senior associate at the Carnegie Endowment. On March 15 he wrote in the same paper:

China’s breakneck economic growth was fuelled by vast transfers of household wealth, which subsidised the manufacturing and investment boom and paid for bad loans. The most important of these transfers is the very low interest rate set by the central bank, which takes at least 5-7 per cent of GDP every year from households to give to banks and borrowers.

Here is a question. Why is it – and how is it – that in China, the low interest rates – set by the central bank – result in “breakneck economic growth”, through the transfer of wealth from the households to banks? But in the U.S., the same low interest rates – set by the Fed – result in looting: companies borrowing money and paying up that borrowed money to the shareholders. They paid out more to shareholders than they made in profits – without, no doubt, uttering one word about “fiscal responsibility”, “moral obligation to reduce debt”, “the future of our children”, etc?

If you do not know the answer, you should. But I put the two stories next to each other to make a point about the identity and difference.

Nothing exists out of context. And until we know the context, we know nothing about the conditions in two countries by merely comparing the interest rates in them. (In deducing the difference from unity, Hegel says that in statement “A is A”, the first A is different from the second. That is because a relation implies at least two terms to be valid. If the two As were the same, there could be no relation. Hence his statement that “self relation is a negative relation” because it repels itself from itself. Rumi proves that in 5 words – and 500 years earlier.)

Keep that in mind next time some fool compares two countries on the basis of their GDP, or two markets on the basis of their performance. The subject is dear to me because it is the stuff that arbitrage is made of.