“Money Being Held in Stock Form Is Massively Overpriced Today. Lots of People Want to Move Their Money From Stocks to More Appealing Asset Classes. There Are Political Reasons Why the Fed Does Not Want to See That Happen. So the Cost of Money Is Temporarily Being Kept Artificially Low. But the Value of the Money Obtained at Today’s Low Prices Will Be Revealed As Very Great Once the Crash Hits and the Long-Term Return on Stocks Skyrockets.”

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

interest rates establish THE COST OF MONEY.

I’ll add a few more words on this particular point because I find your overall question fresh and interesting.

I understand why you say that interest rates establish the cost of money. That is the conventional take.

Shiller’s revolutionary finding of 1981 will be changing the conventional understanding as we all begin to explore the IMPLICATIONS of his Nobel-Prize-winning work. Shiller’s research suggests that establishing the cost of money is not so simple a matter as we once imagined.

An interest rate of x in 2015 is not the same as an interest rate of x in 2000. In 2015, we are probably one or two or perhaps three years away from a stock crash that will pull the most likely 10-year annualized return on stocks up to 15 percent real. In 2000, we were 16 or 17 or perhaps 18 years away from that crash. Do you see the difference?

People who share my doubts about the wisdom of buying stocks today have a hard time lowering their stock allocations because they HATE the idea of accepting the low returns offered today by the super-safe asset classes. They believe that they cannot finance their retirements on such returns. In a surface sense, they are of course correct. Today’s returns are horrible in a surface sense.

But long-term investors need to look deeper. Over a 10-year basis, investors who earn 2 percent real for the next two years and then 15 percent real for the following 8 years will be earning a return far in excess of the 6.5 percent real return that is the average return for stocks. That’s AMAZING. Today’s returns on super-safe asset classes are great. They look bad. But the story is very different when you take the implications of Shiller’s revolutionary finding of 1981 into consideration.

To understand this better, it helps to take into consideration the REASON why interest rates are so low today.

Interest rates are low because the Fed is trying to hold off the coming price crash. I don’t believe that they can do this because the primary cause of the coming crash is that investor psychology needs to change for market to be able to continue to function. But the next crash is going to cause a deepening of the economic crisis and that has huge political implications and so the Fed naturally is motivated to do what it can to hold back that crash. And keeping interest rates low certainly has delayed the crash for a good amount of time.

In a surface sense, interest rates can be said to reveal the cost of money. But that’s not really true in a deep sense and in a long-term sense. Money being held in stock form is massively overpriced today. Lots of people want to move their money from stocks to more appealing asset classes. There are political reasons why the Fed does not want to see that happen. So the cost of money is temporarily being kept artificially low. But the value of the money obtained at today’s low prices will be revealed as very great once the crash hits and the long-term return on stocks skyrockets. The long-term value of the money that can be obtained at today’s low interest rates is off the charts.

The core problem of all analyses done under the Buy-and-Hold Model is the root assumption of that model that economic transactions are rational transactions. Rationally, the price of money should reflect its value. But this just isn’t so! That’s what Shiller showed! He showed that investors are NOT rational. All overvaluation is irrational and all undervaluation is irrational and both are 100 percent real phenomena that investors need to take into consideration when developing their strategies. Money is artificially and irrationally priced today.

The material in this post probably doesn’t matter much for the average investor. He just needs to keep his head down, keep it simple and lock in that 6.5 percent real long-term return. But it doesn’t hurt to think through the theory that explains how things are playing out.

I think this question is a helpful one. I am grateful for it. I wish we saw more questions of this nature being brought up on a daily basis in all sorts of venues. We need to launch a national debate re this stuff and to thereby launch a massive learning experience.

Please take good care.

Rob