2 februarie 2009

My time will come: interest rate will raise and die...eventually

Few years ago I was taking a finance class, within a Risk management program in USA and I had one particular question for my teacher at that time: why do we still need interest rate? Since the moment of Bretton Woods when gold became a different "commodity" than money is it still wise to rely on something so conventional defined with such a "strict precision" as the value of one piece of paper?

My question raised interest in professor's mind and a fierce reaction especially  from my colleagues (most of them bankers in Eastern Europe at that time:). They jumped on me trying to explain everything that was told during their own studies back home: Money is a commodity and as a consequence it has a price. Therefore if you ask for money you have to pay for bla bla... Needless to say that even here the price is not the mathematical result of the demand and supply law. (those who don't think so, could give a try repeating the experiments of Dan Ariely that concluded sharp: price is mostly triggered by supply side).

In fact you don't pay the price of the commodity but the expectation of what this price would be. Based on that derivatives emerged hedging became a temptation and in the end as we all see, speculation won the battle. 

This question I had back in 2002, came back to my attention while reading another challenge raised by someone else here:

"What assumptions are we making that we do not know we're making?

And the root cause could be what? Allow me to posit that it is:

Double Entry Book Keeping."

and I would dare to bring another assumtion more: concept of interest rate or what it became out of it. Time will prove if the major change will start from basics or from ashes (VAR, and other nice maps as professor Kanheman says.

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