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Welcome back. Today’s letter consists of a draconian (but I think correct) suggestion about monetary policy, followed by a little light bitcoin scepticism. Food for thought, I hope, for a sunny autumn weekend. Email me: firstname.lastname@example.org
The Fed is still conflicted
It is good that senior Federal Reserve officials will no longer be allowed to own individual investment securities or derivatives, or to trade their portfolios actively. Here is what the Fed said about this on Thursday:
The new restrictions will apply to both Reserve Bank and board policymakers and senior staff and prohibit them from purchasing individual stocks, holding investments in individual bonds, holding investments in agency securities (directly or indirectly), or entering into derivatives.
Policymakers and senior staff generally will be required to provide 45 days’ advance notice for purchases and sales of securities, obtain prior approval for purchases and sales of securities, and hold investments for at least one year. Further, no purchases or sales will be allowed during periods of heightened financial market stress.
Not letting people who know about Fed rate policy deliberations trade actively is a good idea because stocks and bonds are sensitive to rate policy, and if officials started front-running Fed policy decisions, that would be acutely embarrassing. It is odd that rules like this were not in place until now.
The reason things have changed is that the heads of the Dallas and Boston Fed banks were trading individual stocks quite actively last year. Eric Rosengren, the Boston president, had significant investments in mortgage real estate investment trusts. This is especially bad because the Fed, as part of quantitative easing, buys the very mortgage-backed securities that mortgage Reits invest in. More broadly, mortgage Reits are very sensitive to interest rates, which the Fed influences. Worse, Rosengren likes to jawbone about the real estate market. Both he and Dallas’ Robert Kaplan have resigned. All of this looks like hell.
But the new rule does not go nearly far enough. Both investors and the Fed itself need to think more seriously about the fact that the top brass at the Fed are mostly rich people who own a lot of assets. That fact, and which kinds of assets they own, must influence their policy decisions.
Ownership of certain specific securities — like mortgage Reits — might cause particularly egregious conflicts, but as every investor knows, it is one’s overall asset mix that determines the policy one would most like to see enacted.
In this context, there are four asset classes that matter: cash, bonds, stocks and real estate (or other real assets). Liabilities, specifically mortgage debt, might matter too. Making sure that two of these asset classes, stocks and bonds, are held through diversified indices and not traded actively does nothing to change the fact that the composition of the officials’ portfolios is going to change how they think. Like most people, they will strongly prefer getting richer to getting poorer.
To spell this out: the Federal Open Market Committee sits down to discuss when to taper asset purchases, or when to increase interest rates. It is perfectly obvious that a committee member whose wealth is mostly in cash, bonds and real estate will have different biases than one who is mostly in stocks (as, for example, Jay Powell is). Officials overweight bonds and cash will fear inflation more than those who are mostly in stocks or real assets, or who have big houses and fixed-rate mortgages. The latter officials, inevitably, are going to lean into the employment side of the mandate.
The public deserves to know, in real time, exactly what the senior officials’ asset mixes are. Further, the asset mixes of all the FOMC members should be the same, and they should be chosen to align over the long term with the Fed’s twin mandate of price stability and maximum employment. The officials’ portfolios should reflect our national priorities.
I’m not sure what mix I’d mandate if I were in charge. But I am dead certain we would get a very hawkish Fed if you had the FOMC members 100 per cent invested in nominally-priced fixed income, and forced all of them to finance their houses with floating-rate mortgages. Similarly, I think if every FOMC member was fully invested in the S&P 500, you would see a very cautious approach to rate increases, no matter how the inflation data looked.
Now, you might take the view that — unlike, for example, every single person I’ve ever known — Fed officials’ decision making is not very strongly influenced by what is likely to make them richer and what is likely to make them poorer. But I don’t think that is so. And if it isn’t, and we all agree that Fed policy is of great importance, the fact that we leave these people’s portfolio composition up to their personal discretion is pretty demented.
Blind trusts wouldn’t help. The Fed officials will be able to make a pretty accurate guess as to what is in the trust, because most trusts look alike. They are highly diversified 70/30 equity/bond portfolios, with some minor tilts. But do we want 70/30 monetary policy? I don’t know, but I think we’d better talk about it. Transparency and predictability would both be better served if everyone knew exactly where the monetary policy mandarins’ interests lay.
How the liquid assets of senior Fed officials are invested should be a policy decision, not a personal one. The only alternative I can see is making monetary policy a rule-based, non-discretionary matter. Otherwise, we are allowing our national monetary policy to be made, to a significant degree, by FOMC members’ financial advisers, which seems like a very bad idea.
Bitcoin, gold and inflation
From the FT on Thursday:
Investors are dumping gold for cryptocurrencies as inflation picks up, fleeing a metal historically touted as a store of value to buy digital assets little more than a decade old.
More than $10bn has been pulled from the biggest gold exchange traded fund this year and funds’ physical gold hoards have also been selling down, according to Bloomberg data. The price of gold has declined 6.1 per cent this year to $1,782 a troy ounce on Wednesday.
Bitcoin has meanwhile doubled in price to a record high of more than $67,000 this week . . .
Veteran gold traders acknowledged times are changing. “There is zero interest in our strategy right now,” said John Hathaway, senior portfolio manager at Sprott Asset Management, a precious metals investment group. He added: “The bitcoin crowd see the same things I see in terms of money printing risks of inflation.”
I’m sure this article is accurately describing how many investors are thinking right now. But both sides of the argument — that gold was once, but is no longer a good inflation hedge, and that bitcoin is a good inflation hedge — are wrong. This is worth emphasising, because we are likely to hear a fair amount of this sort of drivel in the months to come. So:
Point 1. The gold price tracks CPI inflation, if at all, in a slow, irregular way. They both rise over time, but the relationship is uneven. Gold is a real asset, and there is a fixed quantity of it, and people have liked it for millennia, and so it has held its value. It’s probably not a reliable inflation hedge over most investors’ time horizons, though.
Point 2. What the gold price tracks closely lately is real rates, that is, the opportunity cost of owning a yieldless, inedible shiny metal with limited industrial uses:
Point 3. Bitcoin, in its short life, has shown no apparent relationship to inflation (except that they both go up), which is what you might expect for something that might be a currency at some point in the future, but at present is mostly a vehicle for speculation:
Point 4. That said, bitcoin is a real asset, and there is a fixed quantity of it, and people have liked it for a few years, and so it might hold its value, for all we know. But there is no particular reason to describe it as an inflation hedge. If it correlates to anything, it correlates broadly to speculative appetite, of the sort we see in meme stocks like AMC. AMC is probably not going to be a good inflation hedge, either:
Talking about gold as an inflation hedge is sloppy. Talking about bitcoin as an inflation hedge is inane.
One good read
The NBA has a tricky business problem on its hands as it tries to grow its audience in China. Its owners and players have opinions, and don’t always keep their mouths shut. This story, I predict, will run and run.