Tuesday, September 3, 2019

The Quantum Physics of Finance?

Rafi Farber emails:
Hey Bob,

Rafi here. I wrote this article today. Part II Quantum Finance is the relevant part for your audience I think.

Can you see any holes in my logic here? I'd love to hear your comments on this.

Hi Rafi,

Thanks for thinking of me with regard to this.

I have many problems with what you wrote.

First, as far as Brexit, it is very difficult to understand how things will play out.

If there is a hard break, for example, what will this mean for trade between Great Britain and the EU? How will the EU react, with what kind of tariffs, other taxes or barriers, or none at all?

Thus, I would consider it high speculation to buy the UK stock market or the pound on weakness because of a hard break, unless an individual has strong insight into how the EU reaction will play out.  And I doubt many have this insight, if anyone does.

As for part II, it seems to me you are throwing in a bunch of physical science jargon that confuses the situation more than anything else. You are flying in the face of the warnings of F.A. Hayek in his book The Counter-Revolution of Science. 

There is no such thing as quantum finance. There is no equivalent of Pauli’s Exclusion Principle in finance. I hasten to add that mathematics can be employed in arbitrage-type trading but that is very different than what you are claiming.

You go on with all kinds of physical references that have no place in the science of human exchange, which includes the subset finance. These concepts which you employ are not helpful: global financial black hole, neutron star levels of financial compression. Perhaps using one of these as a metaphor may work but to use them all suggests, and the way you are using them implies, some kind of physical scientific attributes which don't exist in the world of finance.

Further, the concept of a "discount on time" makes no sense. But apparently, you think otherwise. You write:
Indeed it is. It is actually happening right now. It’s called negative interest rates.
I urge you to read Negative Interest Rate: Toward a Taxonomic Critique by Walter Block. From the abstract:
A basic principle of Austrian economics is that the originary rate of interest (the rate of discount of future goods compared to present, otherwise identical, goods) can never be negative. The reason for this arises not because capital is productive, nor out of man's psychology. Nevertheless, in spite of the foregoing, there are many benighted souls who insist upon the possibility of a negative rate of originary interest. They are continually discovering cases which "prove" their conclusion. The number of such examples has reached such proportions that it seems advisable to take account of them in a systematic way. Accordingly, this paper is devoted to classifying them in a manner that makes the most intuitive sense: in accordance with the economic errors which are necessarily committed in their very statements.
And as Murray Rothbard writes in Man, Economy and State:
 … every man’s time preference is positive, i.e., one ounce of present money will always be preferred to one ounce or less of future money. Therefore, there will never be any question of a zero or negative pure interest rate.
The "negative interest rates" we now see are the processing, storage and protection fees during a period of very low rates. The processing, storage and protection fees are not that different from the monthly maintenance fees we see banks charge on plain vanilla checking accounts, and always have existed even when interest rates, in general, were much higher.

The danger of collapsing paper currencies is very real, but this could happen if the interest rates on US dollar-denominated securities were negative or positive. Further, at some point during a period of a collapsing currency, negative rates would disappear real fast. For example, in Venezuela, where the currency is very weak on foreign exchange markets, the benchmark interest rate is 27.87 percent.

Your paper makes things much more complex and confusing and thereby misses a lot.

A much more succinct and broad-based commentary would go something like this:

Central banks, such as the Federal Reserve, create money out of thin air which distorts the capital-consumption structure of the economy. This results in the boom-bust business cycle. In addition to creating the business cycle, money printing also creates the danger of exploding price inflation. The more money printed the greater the danger including the threat of the collapse of a currency on foreign exchange markets and in terms of gold.



  1. What about the case where one is in the presence of a likely thief, such as a state, for a period of time. To avoid the outcome of loss, wouldn't one be willing to lend at a negative interest rate until the risk of theft has passed? Might one want to lend at a negative interest rate if one thought there would be a large enough risk of any sort of loss over the period of time? This is what one does when one pays for storage of gold, for example.

    So it is likely that the absence of such risk is implied in the claim about interest rates always being positive. Any other unmentioned conditions for this claim to be true?

    A related question: why do those who must roll over large holdings of bonds and facing negative interest rates not just hold cash? Do their bankers charge excessively for this, making negative interest rate bonds look more attractive?

    1. As noted in the Walter Block article referenced above, the Austrian view is that the interest rate is always positive, but there might be additional factors that a person might be willing to pay for that mask this positive interest rate. So, for instance, if the person would only lend at +2%, but is willing to pay an insurance premium or storage costs to protect against some of the risks that you mention, and the premium/cost equals 3%, then it would look like the interest rate is -1%, even though that is not actually the case.

    2. I might have known that Walter Block has already considered this.

    3. As to your final question, central banks have created a very large speculation game where traders can buy a new sovereign bond with a very low yield on the assumption that its price will get bid up, generating a nice short-term profit. Successive bids might drive the yield into negative territory, but each successive buyer assumes that the price will keep going up (no one is intending to hold the bond to maturity). As David Stockman noted recently "The Austrians issued a 100-year bond two years ago, with a coupon of 2%. That bond was recently trading at 210% of par and at a yield that is less than 1 now. The point is, if Austria survives until 2117 when the bond matures, investors are going to be paid back 100 cents on the dollar, not 210 cents. Somebody is buying the damn thing with a guaranteed 55% loss if they hang onto it over time... Why would anybody buy that Austrian bond at 210% of par? Well, the answer is that a couple months ago, it was at 160, and a few months before that, it was at 130."