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Happy to see you again. Today’s letter consists of a draconian (but I think correct) suggestion on monetary policy, followed by a bit of bitcoin skepticism. Food for thought, I hope for a sunny fall weekend. Email me: [email protected]
The Fed is still in conflict
It is good that senior Federal Reserve officials are no longer allowed to hold individual investment securities or derivatives, or actively trade their portfolios. This is what the Fed said about it Thursday:
The new restrictions will apply to both Reserve Bank and board policy makers and senior executives and prohibit them from buying individual stocks, holding investments in individual bonds, holding investments in agency securities (directly or indirectly) or to enter into derivative products.
Policymakers and senior managers will generally be required to provide 45 days’ notice for purchases and sales of securities, obtain pre-authorization for purchases and sales of securities, and to hold investments for at least one year. In addition, no buying or selling will be allowed during times of heightened financial market stress.
Not letting people who are familiar with the Fed’s rate policy deliberations actively negotiate is a good idea because stocks and bonds are sensitive to rate policy, and if officials start to direct policy decisions. the Fed, that would be extremely embarrassing. It is strange that such rules were not in place until now.
The reason things have changed is that the executives of the Dallas and Boston Fed banks traded fairly actively in individual stocks last year. Eric Rosengren, the president of Boston, had significant investments in mortgage real estate investment trusts. This is especially bad because the Fed, as part of quantitative easing, is buying the mortgage-backed securities that mortgage REITs invest in. More generally, mortgage REITs are very sensitive to interest rates, which the Fed influences. Worse yet, Rosengren likes to poke fun at the real estate market. He and Robert Kaplan of Dallas have resigned. It all looks like hell.
But the new rule does not go far enough. Investors and the Fed itself need to think more seriously about the fact that senior Fed officials are mostly wealthy people who own a lot of assets. This fact and the types of assets they own must influence their political decisions.
Ownership of certain specific securities – such as mortgage trusts – can cause particularly serious conflicts, but as any investor knows, it’s the overall asset mix that determines which policy one wants most to see.
In this context, four asset classes matter: cash, bonds, stocks and real estate (or other real assets). Liabilities, especially mortgage debts, can also matter. Ensuring that two of these asset classes, stocks and bonds, are held through diversified indices and are not actively traded doesn’t change the fact that the makeup of managers’ portfolios will change the way they think. Like most people, they will much prefer to get rich rather than impoverish.
To make it clear: The Federal Open Market Committee is meeting to discuss when to reduce asset purchases or raise interest rates. It is perfectly obvious that a committee member whose wealth is primarily in cash, bonds, and real estate will have different biases than one who is primarily in stocks (such as, for example, Example, Jay Powell is). Officials overweight bonds and cash will fear inflation more than those who are primarily stocks or real assets, or who have large homes and fixed-rate mortgages. These latter officials will inevitably focus on the employment aspect of the mandate.
The public deserves to know, in real time, what exactly is the asset mix of senior civil servants. Additionally, the asset mixes of all FOMC members should be the same, and they should be chosen to align over the long term with the Fed’s dual mandate of price stability and maximum employment. The portfolios of public servants should reflect our national priorities.
I don’t know what mix I would order if I was in charge. But I’m sure we would get a very hawkish Fed if the FOMC members invested 100% in nominal-priced fixed income securities and forced them all to finance their homes with adjustable rate mortgages. Likewise, I think if every member of the FOMC were fully invested in the S&P 500, you would see a very cautious approach to rate hikes no matter how the inflation data looked.
Now you might consider that – unlike, say, anyone I have ever known – the decision-making of Fed officials is not very heavily influenced by what is likely to make them richer and which is likely to make them poorer. But I don’t think it is. And if not, and we all agree that Fed policy is of great importance, the fact that we leave the composition of the portfolios of these people to their personal discretion is pretty insane.
Blind trusts would not help. Fed officials will be able to make a fairly accurate estimate of what’s in the trust, since most trusts look the same. These are very diverse 70/30 equity / bond portfolios, with some minor skews. But do we want a 70/30 monetary policy? I don’t know, but I think we better talk about it. Both transparency and predictability would be better served if everyone knew exactly where the interests of monetary policy mandarins lie.
How the liquid assets of senior Fed officials are invested should be a political decision, not a personal one. The only alternative I see is to make monetary policy a rules-based, non-discretionary issue. Otherwise, we allow our national monetary policy to be done, to a large extent, by the financial advisers of the FOMC members, which seems like a very bad idea.
Bitcoin, gold and inflation
From FT Thursday:
Investors are throwing gold against cryptocurrencies as inflation rises, fleeing a metal historically touted as a store of value to buy digital assets just over ten years old.
More than $ 10 billion has been withdrawn from the largest gold exchange-traded fund this year and the funds’ physical gold reserves have also sold lower, according to Bloomberg data. The price of gold fell 6.1% this year to $ 1,782 per troy ounce on Wednesday.
Bitcoin’s price doubled to a record high of over $ 67,000 this week. . .
Veteran gold traders have recognized that times are changing. “There is no interest in our strategy at this time,” said John Hathaway, senior portfolio manager at Sprott Asset Management, a precious metals investment group. He added, “The bitcoin crowd sees the same things I see in terms of the inflation risks associated with printing money.”
. . . Paul Tudor Jones, the hedge fund manager, said CNBC Wednesday that he prefers cryptocurrencies to gold as a hedge against inflation.
I’m sure this article accurately describes how many investors are thinking right now. But both sides of the argument – that gold was once, but is no longer a good hedge against inflation, and that bitcoin is a good hedge against inflation – are wrong. This deserves to be highlighted, as we are likely to hear a good deal of this kind of drivel in the months to come. So:
Point 1. The price of gold follows CPI inflation, if at all, slowly and irregularly. They both increase over time, but the relationship is uneven. Gold is a real asset, and there is a fixed amount of it, and people have loved it for millennia, so it has held its value. However, this is probably not a reliable hedge against inflation over the time horizons of most investors.
Point 2. What the price of gold has been following closely lately are the actual rates i.e. the opportunity cost of owning a shiny, inedible, inefficient metal with industrial uses. limited:
Point 3. Bitcoin, in its short lifespan, has shown no apparent relationship to inflation (except that they both increase), which you would expect for something that could be a currency at some point. in the future, but at present it is mostly a vehicle for speculation:
Point 4. That said, bitcoin is a real asset, and there’s a fixed amount of it, and people have loved it for a few years, and so it might hold its value, as far as we know. But there is no particular reason to describe it as a hedge against inflation. While it correlates with anything, it largely correlates with speculative appetite, the kind we see in meme stocks like AMC. AMC probably won’t be a good inflation hedge either:
Talking about gold as a hedge against inflation is sloppy. Talking about bitcoin as an inflation hedge is nonsense.
A good read
The NBA has a delicate business problem as it tries to increase its audience in China. Its owners and players have opinions and are not always silent. This story, I predict, will run and run.