PE, VC industries vulnerable in rising interest-rate scenario: James Grant

Interest rates act as financial gravity, without them you have a fantasy world. (Photo by Karolina Grabowska/Pexels)

In a rising interest-rate world, many financial sectors and products including private equity and cryptocurrencies will face an existential crisis, according to James Grant.

Grant is the founder and editor of Grant’s Interest Rate Observer, a “contrary minded” journal, which is widely considered an authority on interest rates.

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“Entire industries have been built on phoney interest rates,” he said, and named the private-equity business as one of them. He was talking to Moneycontrol on products and sectors that can be vulnerable when the US Fed Funds rate climbs above 3 percent. As of now, the Fed’s benchmark rates are at 2.25-2.5 percent, and a 50-75 bps hike is expected in the September meeting.

“The private equity business–which is a great force in this country, both for financial speculation and in politics– is a product to a no small degree of these tiny, little teensy interest rates, or insect-sized and unwholesome interest rates,” he said.

He named other pockets of vulnerability too “in no particular order” and they included non-fungible tokens (NFTs), cryptocurrencies, venture-capital industry and real-estate sector.

“Interest rates are kind of a universal price and they are, as it were, financial gravity. Without interest rates set at reasonable and logically acceptable levels, we kind of live in a zero-gravity financial world where you get crazy things such as great explosions in venture capital, non-fungible tokens and cryptocurrencies by the trillions, you get a fantasy world with speculations,” he said.

“Without meaning to sound like a killjoy, an ageing baby boomer... these (assets and industries) are not normal, they are cyclical sightings. They are cited at moments of the greatest financial abandon and recklessness that are often the products of monetary profligacy. What we have had is nothing if not monetary profligacy, and we have had it for so long that it has come to seem normal,” he said.

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Grant pointed out that these pockets of vulnerability may be hidden from public view because of the nature of their financial reporting, which are not marked to market.

“If interest rates persistently rise, if price earnings ratios contract, if the revenue growth slows, if it becomes more difficult to service one’s debts out of cash flow, then the consequences will ripple through the economy in a more deliberate fashion… those consequences roared through on the NASDAQ stock market earlier this year,” he said.