The Superclass: A Rational (Investor’s) Perspective

It’s that time of the election cycle again. Many frequent musings I overhear include:

“This is one of the most important Presidential elections.”

“The market is going to sink by 30% and the U.S. is entering a recession.”

“The Fed shouldn’t be doing this or that, and the Fed should be abolished.”

This is all random noise, and ultimately a waste of time. It doesn’t matter what you or I think. It only matters what Fed Chairman Bernanke, the ECB, IMF, Angela Merkel, and the new Chinese government think. Unless you are Bill Gross or Larry Fink and have a direct line to Treasury, I won’t care about what you have to say unless you are better at getting inside their heads–as well as the heads of large institutional investors–than I am. If you failed to time the last two major peaks of the global stock market (i.e. early 2000 and late 2007), then you have failed your clients–and should get and stay out of the investment industry.

To quote French dramatist, Jean Anouilh:

“God is on everyone’s side … and in the last analysis, he is on the side with plenty of money and large armies.”

To gauge the sentiment of global policy makers and large financial institutions, you need to at least read Bernanke’s two major publications (“Inflation Targeting” and “Essays on the Great Depression”) and to get inside his head regarding what the Fed will do today. If you had read both books before the late 2007 to early 2009 crisis (which we did), you’d have had a much better idea on Bernanke’s next steps on a real-time basis during and after the financial crisis. It is unacceptable to be learning and reading about things after the fact.

It is also unacceptable to write a long commentary when one could be brief. So here goes.

Today, we know that:

1) US Treasury rates remain at historic lows; therefore, the US government will not cut Federal spending
2) Using the same logic, neither would they increase US taxes
3) And yes, the Fed will inflate–the Fed is already doing this through QE3 with $40 billion of MBS purchases on a monthly basis

A currency regime is only sustainable if the underlying currency is allowed to be debased on a small and consistent basis. It is laughable to hear young Americans advocating for the return of the Gold Standard, when these same Americans (especially the so-called Jeffersonian “yeomen farmers”) were advocating for a bimetallic standard and rallying behind William Jennings Bryan’s “Cross of Gold” speech in 1896. It also did not occur to these same individuals that a true gold standard never existed in the United States. Chaos reigned after President Andrew Jackson killed the Second Bank of the United States. Banks issued their own bank notes and inflated the economy through the normal credit cycle, in spite of the so-called gold standard. The “gold standard” subsequently became a strait jacket on credit creation once the down cycle hits–thus accentuating the busts. For example, at the peak of the Panic of 1873, the NYSE closed for 10 days, and 36% of all corporate bonds defaulted from 1873 to 1876. The latest financial crisis pales in comparison.

With regards to U.S. interest/Treasury rates, we also know that there exists a shortage of global risk-free assets. According to numerous studies, there will at least be a shortage of $9 trillion worth of risk-free assets in the next five years due to the destruction of risk-free assets during the European sovereign debt crisis; as well as the implementation of Base III requiring higher capital standards of global banks.

That means there will be a rush to purchase more US Treasuries, no matter where US domestic inflation lies. By the way, there is no hard rule that nominal interest rates have to track inflation; nor any hard rule that nominal interest rates have to be positive. In fact, my base case scenario is for the U.S. Treasury Bill rate to decline below 0% sometime in the next several years.

Besides, we also know that inflation is nowhere near as “sticky” as it was in the last inflationary cycle during the late 1970s (culiminating in the peak of the gold price at $850 in January 1980). A comparison to the late 1970s to 1980 is thus erroneous. Inflation was very sticky in the 1970s given the rigidity of wage increases due to the power of unions and the fact that US labor was mostly domestic in nature. Today, unions no longer hold any power; and US labor wages are tied to global wages due to outsourcing.

So in a nutshell, yes, the Fed will continue to ease. And no, the government will not spend less; nor will it increase taxes. And yes, interest rates will remain low until at least the next Presidential election. And yes, what you say does not really concern me, unless you happened to be in a “Top 50 list” of global policymakers or a fund manager with >$100 billion in AUM. And at the end of the day, it doesn’t matter whether you agree or disagree with these global policies. As an investor, my concern is only about making money for my clients. And outside of that, my time could be better spent with family and friends rather than discussing the questionable virtues of a “sound currency” or “sound policy”–whatever that means.

%d bloggers like this: