On AI and Interest Rates
Note, To say it up front: None of this, or anything ever on this blog, is investment advice.
This post on the EA form, highlighted by Tyler Cowen, points out that
Transformative aligned AI would increase real interest rates. A lot.
Transformative unaligned AI would increase real interest rates. A lot.
Markets continue to have low interest rates not pricing this in.
Therefore, either (A) AI not only isn’t about to end the world it also is not about to do anything economically that powerful or (B) the Efficient Market Hypothesis (EMH) is false.
There is no one in the market to price this in. Beyond avoiding wrong-way investments and locking in low-interest loans, the few who buy the hypothesis have better trades to make than betting on future interest rates.
Nor is the market meaningfully considering and then rejecting the hypothesis.
The pre-Covid-pandemic market did not peak until February 20, 2020.
Thank you for coming to my TED Talk.
The OP claims that option B implies there is treasure everywhere.
No. A lot of comments attempt to explain.
Even the OP’s proposed trade would, under favorable assumptions, only return about 10%. That’s at best a highly mediocre trade, in its full context.
At a minimum, again assuming you buy the hypothesis, buying a portfolio of companies that would profit from transformative AI is a superior play. So is shorting a portfolio of assets that would not profit from this scenario but do depend on low interest rates to justify their valuations, if you want that level of risk. If you’re so sure interest rates will go up, why settle for ~10% returns when there are Bitcoins (and many other assets including stocks) you can short?
Don’t forget to consider the marginal utility of capital in various scenarios.
Many traders at Jane Street Capital are aware of the potential of AI, or at least have considered strong arguments for it. On the time horizon of almost all their trades, this makes almost zero difference.
Eliezer Yudkowsky points out that taking advantage of knowing that the world will be ending is difficult. How do you collect? If you did collect, how would you spend it?
That does not mean none of your financial choices change in such a world.
While there are not amazing winning moves, there are plenty of losing moves you can avoid if you are sufficiently confident in doom. For example:
You can spend down capital and other resources.
You don’t have to save for retirement.
You can avoid making long term or illiquid investments.
You can borrow money rather than loaning out money, especially locking in low long term interest rates. This is more like a win. You still can’t that win big this way, even if you’re fully confident you never have to pay it back, because there is a limit to how much money you can borrow over a 10-year horizon.
You can also alter other life choices, including whether to have children. Unless your certainty level is far higher than I believe is justified, I think this is almost always a mistake. Children and ordinary life well lived are great joys, keep you sane and grounded, give you something to protect, improve how you are treated. Often they teach you something. The more extremely you modify your choices, the more you really will be doomed even in relatively ‘normal’ futures, and dread of this will impact your experience and life now.
Yes, there are perhaps exceptions to this where your focus really is that important, but if you are not mentioned in this post by name you probably don’t count for that.
Expecting abundance via AI, or a mix of abundance and death, is less obviously unexploitable beyond not doing stupid things. It is still, at best, highly difficult.
Whether or not to spend down or to accumulate capital in general is not so clear. When things are changing rapidly, not being solvency or liquidity constrained can be a huge deal. There are plausible scenarios where having liquid capital at the right time becomes absurdly valuable. Real interest rates going way up suggests you want to be holding a lot of capital when that happens. A coming pivotal time when action is most valuable suggests this as well (among other things).
Once again, avoiding stupid mistakes is easy and a big win. Don’t lock away assets or make non-strategic medium-to-long-term illiquid investments.
There is good potential low hanging fruit for what wealth you do have, again if you buy such a scenario. You can perhaps use it to lock in loans at low interest rates. You can can make investments that are liquid, while paying off in the worlds you expect. The upsides are there.
If you only bet on this outcome on its own, it is difficult to anticipate how the market will respond, or the timing thereof, and the real returns available are modest. If you use it as part of a combined strategy, and it is justified, it can do quite a lot of good.
There are a lot of things in the world.
When you notice one of them likely to be remarkably important, like AI, some people will also think about whether that thing is important. They will reach a variety of conclusions. Mostly, if it is not already obviously important, they will not think much about this. Of those that continue to think about it, they will reach a variety of conclusions.
Those who think the most about it can reasonably be expected to include those most taken in by the idea and the hype, who will tend to overestimate its impact. They are the ones who speculatively invest. That can cause the corresponding speculative asset to be overpriced, especially when there is no reasonable way to be short the asset, and no reason for regular people to trade it.
The asset here is interest rates.
It is very very easy and cheap to get short interest rates.
It is very very common to be trading interest rates.
The amount of money trading interest rates is, basically, all of it.
People betting on or against AI are trading, of all the money, almost none of it.
People betting on or against AI have very little impact on real interest rates.
This market does not think about you at all.
It is not putting a probability on transformative AI. It doesn’t have one.
That may eventually change, but it will be slow and late to the party.
It would be a huge surprise, and violation of my model of markets and people, if this got seriously priced in this early. It would be a huge surprise and violation of my model of markets if, at the end of 2023 or even 2024, I look at the market and think ‘yes, they have priced in a huge impact from AI and they have priced it in enough.’ If they do price in a huge impact, it won’t be anything close to enough. Every step of the way I expect the market will be slow to react. For there to be time.
Lots of the comments here are pointing at details of the markets and whether it's possible to profit off of knowing that transformative AI is coming. Which is all fine and good, but I think there's a simple way to look at it that's very illuminating.
The stock market is good at predicting company success because there are a lot of people trading in it who think hard about which companies will succeed, doing things like writing documents about those companies' target markets, products, and leadership. Traders who do a good job at this sort of analysis get more funds to trade with, which makes their trading activity have a larger impact on the prices.
Now, when you say that: “the market is decisively rejecting – i.e., putting very low probability on – the development of transformative AI in the very near term, say within the next ten years.”
I think what you're claiming is that market prices are substantially controlled by traders who have a probability like that in their heads. Or traders who are following an algorithm which had a probability like that in the spreadsheet. Or something thing like that. Some sort of serious cognition, serious in the way that traders treat company revenue forecasts.
And I think that this is false. I think their heads don't contain any probability for transformative AI at all. I think that if you could peer into the internal communications of trading firms, and you went looking for their thoughts about AI timelines affecting interest rates, you wouldn't find thoughts like that. And if you did find an occasional trader who had such thoughts, and quantified how much impact they would have on the prices if they went all-in on trading based on that theory, you would find their impact was infinitesimal.
Market prices aren't mystical, they're aggregations of traders' cognition. If the cognition isn't there, then the market price can't tell you anything. If the cognition is there but it doesn't control enough of the capital to move the price, then the price can't tell you anything.
I think this post is a trap for people who think of market prices as a slightly mystical source of information, who don't have much of a model of what cognition is behind those prices.
What to Do?
I think that is all slightly too strong. Some traders who do consider the situation have shifted their portfolios to take advantage of expected higher interest rates, mostly by finding otherwise solid investments that have upside in scenarios with impactful AI. This has had some very small impact.
That includes me. Did I bet on low interest rates in 2021 by locking in a 2.5% 30-year (!?!) fixed rate mortgage, thereby making more money off that than I have made from all other income combined since then? Yes. Yes I did.
That mostly wasn’t about AI. The trade was absurd anyway. AI simply made me more excited to pursue it, get it done and size it larger. That is core to my betting and trading strategy (not investment advice!). Look for plays that have multiple reasons to do them (often below the threshold that is worthwhile on its own) and that avoid similar reasons not to do them.
It is good to recognize that the market has not priced AI (or fusion power, or the kind of climate change people often warn about, or many other things) into market prices or real interest rates. This tells us that the common knowledge economic impact of such things is, as of yet, not so large. It does not constitute ‘market has well-considered the impact, and rejects it as tiny.’
It is also good to generalize this observation. There are lots and lots of things that are not fully factored in by the market, because the market is made up of people who mostly don’t know most details and have plenty of other places to focus their time and money, especially for long term plays. That includes you. If you know something, that usually does not mean that it is a big enough impact for you to make a play on that basis. Nor do you want to spend too much time and effort and stress on your portfolio.
What I have found one can often do in the general case is avoid wrong-way actions. Finding very good investments is hard. Finding lousy investments to avoid is easy. We all do it all the time. You avoid investing in penny stocks and Nigerian princes and bot-marketed Ponzi crypto offerings. You could simply extend that principle to avoid paying high management fees and to not buy stocks with high borrow costs or horrible tax implications or products you know to be lousy or that are non-obviously lacking in a future, or other things like that. Addition by subtraction. If all you are doing beyond that is choosing at random, that’s a much better pool than the one you started with.
The housing market has plenty of really bad places for rent or sale. Places you would not want to live. Places that you would want to live but that are overpriced by huge amounts, sometimes 50% or more. You want to find a mispriced briefly available hidden gem. What is most important is avoiding the huge number of really bad places, and finding a way to at least choose among the reasonable ones, and find one that offers the features you care about without offering expensive things you don’t want.
This is entirely consistent with the weaker and more reasonable EMH model that says ‘it is mostly impossible to easily beat the market by a large amount quickly.’
No one would disagree that it is very easy to predictably underperform the market by a very large amount quickly!
Or that people do that.
So, don’t do that.
(And no, none of that is investing advice.)
The same is true outside of investing, in non-financial circumstances.
Especially in places that no one was pretending were efficient in the first place.
Extend that, in turn, to anything where you are offered options (or could find additional options by searching more), one of which has something important that you think is an important downside, while others don’t see it that way. Even in an efficient market, that helps a lot.
Similarly, flip it. If you can find something with a feature that others think is a downside, but which you don’t mind, and this is getting you a discount or opportunity? That’s pretty great.
How far you let the impact of AI alter your investments and other actions depends on how likely, and how large, you believe such impacts to be, while keeping in mind that predicting the way things are impacted is often not so easy.
What I am not going to do is assume that the market and world, most of which is completely asleep at the wheel on this, has taken care of the problem and everything is priced efficiently.