December 22, 2017

Ex ante expected real rates of return and ex post real rates of return are apples and oranges

Gillian Tett referring to “The Rate of Return on Everything, 1870-2015” authored by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan Taylor writes: “real rates are very low today compared with the peacetime years in the 20th century. But real returns on bonds and bills were much lower during the first and second world wars, tumbling to about minus 4 per cent (compared with 3 per cent for bonds in 2015, and zero for bills).” "Take the very long view on asset prices", December 22.

Sir, we cannot know the ex post real rates of return for bonds yet, and it must be very hard to gauge the ex ante expected real rates of return during the first and second world. Therefore it is not clear to me whether Ms. Tett refers in both cases to ex ante expected real rates or to ex post finally obtained real rates? If not she is comparing apples to oranges. Frankly, no matter how high patriotic willingness to contribute with war efforts could stimulate lending to it, I truly doubt investors accepted ex ante a minus 4 per cent real rate offer… so they must have expected a much lower inflation rate.

Sir, there is a lot of confusing ex post with ex ante going on. For instance, the Basel Committee regulators, when setting their risk weighted capital requirements for banks, used the ex ante perceived risk of bank assets as proxies for the ex post risks to banks… a horrible mistake that distorted the allocation of bank credit and that has not been corrected during soon 30 years.

PS. And now having read the paper I must also observe that risk free rates, and rates of returns on what is considered by regulators a safe assets, like houses, must be separated into those before the risk weighted capital requirement for banks and those thereafter, since the regulatory subsidy to the “safe” again makes apples and oranges of these.